The DeFi Regulatory Challenge (September 2021)

Foreword: METI Advisory wrote this report for SEBA Bank AG. Abstract: DeFi is a new financial paradigm that generates significant benefits. As of 14 September 2021, DeFi transactions were funded by no less than USD 88.7 billion. The risks associated with DeFi are also significant and amplified by its unregulated environment. Since 2017, the evolution of cryptofinance has shown that a regulatory approach that can provide certainty to the private sector, support innovation, and mitigate money laundering and investors’ risk can boost cryptocurrencies adoption. The same holds true for DeFi. The critical question is how to regulate DeFi. In this context, the current debate in the US suggests that the enforcement approach – the application of financial laws to DeFi – is ill-suited to achieve the intended goal, because it is built on the concept of centralised intermediary – which per definition is absent in DeFi. A prudential regulatory approach, focused on setting risk control and capital or liquidity boundaries on the private sector and actors, may be more conducive to the intended outcome, particularly when informed by a principle-based regulation. It will require a proactive stance from the DeFi sector and actors. Embedding RegTech solutions in smart contracts may constitute a constructive opportunity going forward.