Regulatory Framework Impacts on DeFi Adoption

Decentralized finance (DeFi) is scaling up to become one of the most relevant sectors in the blockchain industry. This explosive growth makes DeFi witness a five-time increase in the total asset value locked in different DeFi platforms. It increased from $21,000,000,000 to $100,000,000,000 in a space of two years.

Despite financial opportunities—such as DeFi’s lending and decentralized derivatives trading—DeFi is bringing to the mainstream, and regulation may not happen to the space on a global scale yet. Blockchain technology maximizes DeFi to change the global financial systems by making financial markets more accessible, secure, and transparent.

This financial innovation is intriguing and profitable, but institutions worldwide are skeptical about diving into the space because there is no regulatory policy in place. At the same time, regulation is a critical factor in institutional DeFi adoption.

This is because some believe that compliance will help DeFi to be more sustainable. However, some opined that there should be self-regulation, and the community should be the primary determinant of the best future for DeFi. But the details of exclusive self-regulation have not been determined.

Establishing Control

The major stumbling block in applying conventional regulatory policy to decentralized finance (DeFi) is the different purposes both serve. DeFi was created to allow collaboration between individuals across the network to transact without the need for third-party supervision. Likewise, this includes the elimination of economic rewards from each transaction.

But on the other hand, traditional finance works on the model of establishing compliance, fund protections, and stability. Also, there is a third party monitoring the transactions at each interval. This explains why this framework doesn’t suit decentralized digital assets.

In recent years, regulatory policies have been set to have some level of control over the cryptocurrency industry. This is done to help investors establish specific levels of security on their funds. In turn, the amount of money pumped into the digital assets space is controlled. Each government is doing this to reduce financial crimes conducted by illicit people and other fraudulent activities.

DeFi innovation receives support, but individuals do not have the conviction to invest in crypto and DeFi. Familiarity and education can help push DeFi adoption faster than imagined. Everyone wants to know what their money is used for.

There is a lot of concerns over the regulatory effects on DeFi. But opinion has it that DeFi platforms that embrace regulation will survive and thrive while the illegal websites will fold up because of their opposition towards regulation.

The DeFi space will receive more experimental investment. This will increase the rate of innovation in the space as the infrastructure undergo expansion to satisfy requirements that will allow large institutions to start investing. During this year, we have witnessed different calls made in the blockchain space by some financial services.

An example is a call by JPMorgan to build its blockchain with its token that its clients can use to transfer funds in a split of seconds. Also, HSBD has proclaimed that it will support central bank digital currencies during the regulation processes and implementation. Additionally, Morgan Stanley will expose its clients to digital assets.

Another possible adoption is that of BNY Mellon. They revealed that they have been studying digital assets discreetly, and adoption is inevitable. The critical question should be returned to the experts and specialists, “How well can regulation keep up?”

Regulating Innovation

The blockchain industry has recently received funding from leading global financial services to ensure that blockchain solution agencies research the application ecosystem created on Web 3.0.

A report revealed that about half of traditional hedge fund managers are researching entry into crypto investments. Their investments may open the way up for adoption, but there must be adequate regulatory infrastructure in the DeFi ecosystem before this kind of adoption is witnessed.

Although there are a series of warnings from apex banks worldwide about risks associated with digital assets, most managers agree that DeFi can improve financial systems. These risks include money laundering, scalability, and security. But the U.S. regulatory agency will not allow DeFi to slip through regulation because it doesn’t offer to protect investors’ capital.

2020 saw other news related to international bodies and national regulatory departments spending time and money to have a detailed understanding of blockchain technology. Around September last year, the European Commission wanted a regulatory policy that protects consumers better and creates clear codes of conduct for crypto participants, with new licensing requirements.

Around March this year, the world terrorist financing and money laundering watchdog—the Financial Action Task Force (FATF)—released an updated guide for dealing in the virtual currency space. This guide is a risk approach to virtual assets. Likewise, in July, the Japan regulatory body also mentioned the importance of establishing a regulatory policy for DeFi.

Early this year, there was a call from Hester Pierce—the SEC commissioner. He mentioned that regulators should present legal clarity for DeFi and allow exclusive experimentation to take place. This will enable DeFi to compete alongside centralized alternatives. However, there was a report on actions taken against some groups associated with DeFi applications.

An example of this probe was an investigation by the regulator to understand how investors are leveraging the world’s largest decentralized exchange platform, Uniswap Labs, and how its marketing power is utilized. Likewise, the SEC Chairman, Gary Gensler, commented that a small portion of DeFi tokens are not securities.

While some platforms are initiating self-regulatory policies, governments and financial authorities will inevitably intervene in the DeFi ecosystem via their regulatory approach.

Rules Bender

The central climax for regulators is establishing a safety net for private investors and mitigating risks associated with using DeFi platforms. There may be an increased DeFi adoption, provided those two possibilities could be put into legislation. Likewise, the DeFi space will experience massive growth while managing its risk efficiently.

However, forced DeFi regulation is not the best solution because traditional regulations are associated with transactions between people. Thus, adapting that to smart contracts is a difficult task to execute. Meanwhile, there may be standard principles encoded for the space.

For instance, regulators may initiate capital limits or create a framework that puts risk management at the fore for private participants. But this may not be achievable as it may be at the focus of decentralization. As a result, the DeFi space needs to be cooperative while regulators approach it with a mindset putting innovation ahead of any considerations.

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