Global Regulators Consider DeFi

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Decentralized finance (DeFi) is getting on the radar of regulators, but they don’t seem to have any plans to take it off yet anyway. Instead, a pair of reports from US and French authorities seem more focused on understanding what kind of risks DeFi could pose to both users and the wider financial world, and whether there are ways to mitigate these risks while allowing their operation.

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Decentralized finance (DeFi) is suddenly a major topic of concern among financial regulators, with the United States and France releasing reports analyzing the potential risks these projects could pose to their respective governments and providing recommendations on how regulators and developers can alleviate these concerns.

DeFi has been a growing part of the crypto sector for quite some time now, but recent exchange meltdowns, bank failures, and lender failures are shining a spotlight on decentralized (or allegedly decentralized) projects. Regulators are now considering how they can oversee these entities and services.

The US Risk Assessment highlighted some of the top DeFi hacks and issues in recent months, such as North Korea’s use of DeFi to launder funds and other related concerns about how whose DeFi projects may not meet Know Your Customer / Anti-Money Laundering (KYC/AML) rules or simply be very easy to steal.

To be clear, these reports weren’t exactly crypto positive. The US report, for example, noted that many DeFi projects are open sourced in hopes that the wider community can spot vulnerabilities, but that same open source can allow attackers to find an exploit.

This vulnerability can be compounded if smart contracts are not carefully written or lack a mechanism for rapid disabling or changes if a critical exploit is identified, according to the US report. As such, it is critical for the DeFi service to identify and fix potential vulnerabilities and exploits in open source code.

But the report seems fairly neutral towards DeFi itself, with recommendations ranging from strengthening existing monitoring and enforcement actions to meet legal requirements to better participation in private sector projects.

The French report also suggested that the government could create a set of minimum standards that define how it assesses risk and decentralization, or otherwise try to move financial transactions to specifically private blockchains. The report even suggested going so far as to create a certification that developers could meet.

The US Treasury Department also posed a number of questions for public comment, including how it should determine whether a given DeFi project is in fact a financial institution subject to Bank Secrecy Act regulations.

The US report even alluded to the suggestion of providing additional guidance for projects that could provide clarity.

The assessment finds that covered DeFi services’ failure to comply with AML/CFT obligations may be partly attributable to a lack of understanding of how AML/CFT regulations apply to DeFi services, according to the report, referring to the fight against the financing of terrorism (CFT). Are there any additional recommendations on ways to clarify and remind DeFi services that fall under the BSA definition of a financial institution of their existing AML/CFT regulatory obligations?

The reports, while often quite critical of DeFi, both seem to operate from the basic understanding that these projects will continue to operate and do not call for this segment of the crypto industry to be banned.

It’s that time of year again folks. CoinDesks Consensus 2023 will be held April 26-28 in Austin, TX. I will be moderating four sessions: one-on-one discussions with Coinbases Paul Grewal, NYDFS Adrienne Harris, and CFTC Christy Goldsmith Romero, and a panel with House Financial Services Committee Chairman Rep. Patrick McHenry and Senator Cynthia Lummis. As always, I’m interested in what matters to you: if you have any questions for any of these speakers, email me subject matter Consensus 2023 and I may ask the best ones on stage .

If you have any ideas or questions about what I should be discussing next week or any other feedback you’d like to share, please feel free to email me at [email protected] or find me on Twitter @nikhileshde.

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