Regulation is becoming a big topic in the cryptocurrency business as governments grapple with how to respond to this still-nascent phenomena. With crypto firms operating in the United States now fighting for passage of an infrastructure bill in the House following a Senate rejection, the industry could look substantially different in a few years when newly suggested rule changes are adopted.
Numerous sub-sectors within cryptocurrency are expected to be impacted differently by new regulation, but one one that may be impacted more than others is decentralized finance (DeFi). This is partly because, as a result of its purportedly decentralized structure, it might become extremely difficult to conduct know-your-customer (KYC) and anti-money laundering (AML) checks on users if it becomes truly decentralized.
According to industry insiders who talked with Cryptonews.com, DeFi is currently beset by vagueness, ambiguity, and inconsistency in the execution of existing standards as well as proposed new legislation. While most analysts agree that DeFi will likely face continued regulatory ambiguity in the short-to-medium term, they also believe that authorities will ultimately choose to foster – rather than destroy – the embryonic sector.
Ambiguity, ambiguity, and more ambiguity
The aforementioned infrastructure bill is an excellent illustration of the minefield that current and pending legislation present to the DeFi community.
The bill’s initial draft included decentralized exchanges and peer-to-peer markets in its definition of „broker,“ effectively incorporating much of DeFi’s plan to require all „brokers“ to disclose big transactions to the Internal Revenue Service (IRS).
Jerry Brito, executive director of the Coin Center, applauded an amendment that attempted to exclude decentralized exchanges and peer-to-peer marketplaces from the bill’s scope. However, a following proposed modification advocated changing the language once again, so that the new definition of „broker“ looked to exclude solely proof-of-work mining.
This single example demonstrates how difficult it will be for DeFi players to comply with future restrictions.
However, there are numerous other instances of this type of lack of clarity and confidence. It is a recurring theme in virtually all legislation and regulations affecting the DeFi industry, from the European Commission’s latest anti-money laundering recommendations to the Financial Action Task Force’s (FATF) soon-to-be-revised rules.
There are two significant sources of ambiguity: one is conceptual and linguistic in nature, while the other is international consistency-related.
Anndy Lian, the Chairman of the cryptocurrency exchange BigONE and the Mongolian Productivity Organization’s Chief Digital Advisor, stated,
“At the FATF recent Plenary meeting in June this year, a key takeaway was the concern around the apparent lack of consensus across different jurisdictions and between industry players regarding the best way to comply with the Travel Rule. And while the private sector has led the way in developing solutions to enable implementation of the Travel Rule, ‘a majority of jurisdictions have not yet implemented the FATF’s requirements.’”
According to Lian, the true issue and challenge facing the DeFi sector is the inconsistent application of the Travel Rule across jurisdictions, which “creates substantial headaches for both DeFi enterprises and their customers.”
However, there is a significant issue with semantics and conceptual clarity in terms of incoming and future legislation. According to PaperImperium, a member of the MakerDAO (MKR) community, technical phrases are not consistently utilized by authorities and the crypto industry, making it unclear what policymakers desire.
According to PaperImperium, Cryptonews.com:
“A great example of this is the debate around stablecoins. As the Gorton-Zhang paper from a few weeks ago makes clear, later confirmed by private discussions, even a term as simple as ‘stablecoin’ has a different meaning in policy circles than in the cryptoverse.”
The majority of cryptocurrency professionals would use the term „stablecoin“ to refer to any token that is actively attempting to maintain a price band around a specific benchmark. However, PaperImperium stated that „policymakers and regulators are generally discussing redeemable-for-fiat tokens to the exclusion of algorithmically managed tokens.“
This presents a significant headache for stablecoins such as MakerDAO’s DAI. Indeed, prior to the passage of the current infrastructure bill, Democratic Representative Don Beyer introduced a draft bill that would effectively prohibit all stablecoins that do not meet specific regulatory requirements and are not registered by their issuer. The latter criteria, on the other hand, is one that DAI, for example, could never meet.
Nonetheless, the majority of those working in DeFi argue that regulation is not only unavoidable, but also beneficial to the industry in the long run.
Layerzero, a member of MakerDAO’s Core Unit for Sustainable Ecosystem Scaling, explained:
“I believe regulation is necessary and a sign that the industry matures. Not having legal certainty is a risk that hinders future growth.”
And Layerzero added,
“I welcome good regulation that provides legal certainty to market participants and that doesn’t hinder innovation, but of course, this is hard to achieve. The problem is that the current regulatory framework is outdated and was not designed for decentralized ledger technology.”
Golden eggs of DeFi
At the moment, new solutions are flooding the market, and it is unclear what regulatory challenges the DeFi ecosystem will face in the months and years ahead. Additionally, it is unknown whether all soon-to-be-imposed restrictions will be surmountable, and whether future expansion in the DeFi sector would be somewhat constrained as a result.
Nonetheless, DeFi industry participants believe the sector will exist for a long period of time, even though its mature form may seem substantially different than it does now.
According to Skirmantas Janukas, CEO and co-founder of DappRadar, DeFi’s longevity is assured by the fact that it is far too profitable for authorities and governments to entirely eradicate.
He explained to Cryptonews.com:
“The sheer amount of wealth generated and locked into our industry – especially now, at a time when governments inject trillions into the economy by way of rescue packages to the detriment of, say, infrastructure and other long-term needs that must also be met – makes us the proverbial goose that laid the golden eggs. And the act of laying golden eggs is a potentially taxable event.”
Given that DeFi’s total value locked in increased from USD 1 billion to over USD 90 billion in less than a year (according to DeFi Pulse), most governments will seek to extract a share of the value for taxation and public spending. In other words, they will avoid enforcing excessive restrictions.
Janukas continued:
“Regulators globally will very certainly want to capitalize on our sector, just as we crypto natives have done, putting us in a very strong position in an ongoing conversation. And, while it may take years of proposed, implemented, and repealed rules to arrive at a solution that protects consumers‘ and governments‘ interests while fostering innovation, the restrictions that do become law will almost certainly benefit DeFi in the long run.”
Anndy Lian concurred that DeFi will be far too profitable to be eliminated through regulation, regardless of how that regulation looks in a few years. According to him (as someone who advises governments), DeFi presents both opportunities and problems for governments and regulators in the aftermath of the coronavirus outbreak.
As Lian put it,
“The task for the DeFi sector is to carry on educating governments and regulators on the benefits of DeFi especially in parts of the world where banking is hard to access, and in promoting crypto entrepreneurship for the future. Nevertheless, governments are trying to know more to get themselves fitted with the new DeFi trends.”
The question is how long DeFi will have to wait for authorities to issue the clear legislation required for the sector to grow sustainably.
“In certain sectors, such as tax or anti-money laundering, it takes months. In some cases, it is unrealistic to expect complete regulatory clarification within a few years,” said Jacek Czarnecki, MakerDAO’s Global Legal Counsel.
Given the lengths of time that new DeFi projects are going to take, Czarnecki said that they should absolutely participate in communication with regulators and legislators.
According to Czarnecki, Cryptonews.com
“We pioneered these operations at Maker and have been engaging with several national regulators (including central banks) and international organizations (e.g., the OECD, the FATF, and the Financial Stability Board) since 2018. This has aided us in gaining the regulatory community’s trust and awareness.”
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Learn more:
– SEC Chairman Gensler Hints at Possible Regulation of DeFi – The Total Value Locked in DeFi is a ‚Deceptively Complicated Metric‘
– Square Eyes Bitcoin DeFi Business – Japanese Regulator Report Indicates Possible DeFi Regulations
– Bitcoin and Ethereum Can Coexist With DeFi Bridging the Gap – DeFi Had a Successful 2021, Fueled by New Trends and Paradigms
– How Bitcoin and DeFi are Completely Distinct Phenomena – How the DeFi Sector Is Violating The Law – Why Now Is the Time to Act
