One rule after another decentralized economy is being phased out. This does not mean that governments specifically seek to make it illegal. Instead, each recent proposal seems to establish unattainable rules for decentralized financing.
The latest example of this is the regulations proposed by the US Financial Crimes Network, or FinCEN, which require banks and other monetary companies to verify the identities of customers who trade from “unlisted” wallets (wallets not supported by registered exchanges or other preservation services). .
This seems like a healthy situation from a criminal point of view, it does not work well with DeFi services such as Compound, which rely on smart contracts to link users’ funds. Unlike traditional cryptocurrencies, which are traditionally traded on exchanges, which also act as wallets, which enable the tracing of user identities, DeFi projects are often direct and confident (non-hosted) wallets.
The danger here is that if financial institutions are unable to meet the requirements for identity verification and record keeping of DeFi services, it is natural to expect that they do not support them. The more bases they risk, the less likely they are to support DeFi.
To exacerbate this effect, the Digital Commodity Exchange Act is proposed to prohibit symbolic transactions on exchanges if the exchange is not registered, is not ready to share necessary information, does not meet certain standards for the ability and avoidance of tampering and does not violate antitrust laws. Among these requirements, registration, exchange of information and compliance with antitrust laws, there is little certainty that decentralized exchange will fail.
The European Union
European regulators are not friends with DeFi either. In the proposed Cryptoasset Markets Regulation or MiCA, the European Commission requires stable issuers to have “robust governance arrangements”, including a clear regulatory structure with clearly defined responsibilities, as well as administrative and accounting procedures.
Another rule is that governing bodies for stable currencies and stock exchanges must have “good reputation and competence.” The problem is that Defi and DEX projects can, by their nature, have dynamic, organic management and decision-making processes. Although it basically meets the MiCA requirements, it is not meant to freeze approved design to be compatible.
Where does DeFi go?
One possibility is that the conflict between law and DeFi will continue, and that DeFi will be phased out in favor of regulated and compatible services that users are increasingly finding more reliable. The stock market is a good example of the power of conformity. Many rushed to comply with the established laws when it became clear that it won user trust after scandals such as Mt. Gox in 2014 and Bitfinex in 2016 were the keys to success.
Another possibility is that DeFi will maintain dynamism despite the fact that they are not punished by law. They will continue to be avoided, even if they will be common, such as illegal peer-to-peer networks that the law has not been able to close for over 20 years. Users will find themselves at the center of an ongoing cat-and-mouse game between Law and DeFi until one of them wins. For DeFi, this can be a tough battle to win because money is affected by the network, and if DeFi money cannot handle legitimate funds, their use will be limited.
The last option, which we hope will win, is for governments to see the potential of DeFi and start turning it on. The first step for regulators is to stop pretending that DeFi does not exist, and instead explicitly consider how the proposed rules will apply to it. If they conclude that the DeFi projects are not in line with the law’s goals, then so be it – at least we will start a substantive conversation about whether the law is moving in the right direction.