DeFi – the ‘Wild West’ of crypto – set to face regulatory crackdown

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The rapidly growing decentralized financial industry may be on the verge of a sharp revival.

Decentralized finance, or “DeFi” as it’s commonly known, is a trend in cryptocurrencies that started to gain traction in 2020.

It has been called the “Wild West” of crypto – hordes of computer programmers trying to bring traditional financial products such as blockchain loans.

The idea seems promising. In theory, anyone could lend and borrow digital money at competitive interest rates, with no middleman. Investors are drawn to the promise of earning up to a double-digit percentage of returns on savings in certain digital tokens.

But with major hacks and scams plaguing the space this year, regulators are increasingly concerned about the risk of crime as well as the harm to consumers.

“I think they’re going to pay more attention to the space,” Sid Powell, co-founder of DeFi lending platform Maple Finance, told CNBC.

So far, nearly $ 90 billion has been deposited into Ethereum-based DeFi protocols, according to data from The Block.

“It’s probably inconceivable that you will have significant growth in DeFi that doesn’t need to supplement existing regulations in the future,” said Powell.

Regulators have already started to take a more stringent approach to the crypto industry.

Various countries have tried to evict Binance, the world’s largest digital exchange bureau, for operating without their permission. Since it does not have an official seat, Binance has so far managed to avoid scrutiny – although the company says it now wants to be a friend, not an enemy, of regulators.

Meanwhile, Coinbase engaged in a heated word war in September with the United States Securities and Exchange Commission over an interest-bearing savings product, which the regulator said looked too much like a title. Coinbase then abandoned its plan to launch the feature.

And just this week, a long-awaited U.S. government report called on Congress to introduce regulations for stablecoins, digital assets pegged to traditional currencies like the dollar to maintain stable value.

Now DeFi appears to be next in line.

Earlier this year, the Wall Street Journal reported that the United States Securities Exchange Commission was investigating the decentralized crypto exchange Uniswap, with officials seeking information on how investors are using the platform and how. it is marketed.

In September, Acting U.S. Currency Comptroller Michael Hsu compared DeFi activity to the controversial Wall Street practices that led to the 2008 financial crisis.

“One of the biggest questions regulators face right now is how to deal with DeFi,” David Carlisle, director of policy and regulatory affairs at crypto analysis firm Elliptic, told CNBC.

“How do you apply the regulatory standards designed for centralized intermediaries to the world of a few marketplaces where there is no clear centralization? “

Carlisle said that a source of concern for regulators is that DeFi services advertise themselves as decentralized when they may not. “We are seeing some situations where the founding teams and the developers who established the protocol have influence over the governance of the DeFi network.”

Last week, the global anti-money laundering watchdog, the Financial Action Task Force, released revised guidelines on cryptocurrencies. Part of the rules call on countries to identify individuals with “sufficient control or influence” over DeFi programs.

This means that some DeFi start-up founders could potentially be subject to rules requiring them to provide information about originators and beneficiaries when transferring funds.

“While DeFi protocols may offer similar functionality in financial transactions, they offer virtually none of the oversight that regulators need to ensure safe and efficient financial markets,” Rick McDonell, former executive secretary of the FATF.

“The lack of effective oversight creates a substantial risk of fraud, money laundering, circumvention of sanctions and other criminal activity in these markets.”

As to what regulators will do in response, McDonell said it was too early to tell.

“While it is possible to read the tea leaves on the potential for regulatory action, what this response may imply in detail remains to be seen,” he said. “But some coercive measures are already taken.”

“Regulators have made two things clear: They support the benefits that blockchain technology can bring to end users, but they are not prepared to trust the industry’s ability to manage its financial crime risks.”

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