(DeFi) Who, what and how do you regulate in a limitless, rule-based world?

Hold on to your hats, boys and girls! It’s a new world – a no-middleman financial system that anyone can access 24 hours a day with just a cell phone and wallet! As Julien Bouteloup told me:

“What we are building at DeFi is a completely decentralized, completely transparent, mathematically oriented technology. Nobody can beat that. “

He continued, “We’re building on research papers, 40 years of research, basic research, discrete math, and we’re building a chain that no one can beat. You can’t beat that. GitHub didn’t exist in the 90s. First, we are traveling at the speed of light because everything is open source and everyone can participate. “

Related: DeFi knowledge: Universities take on decentralized financial education

A report by Novum Insights in August claimed that the DeFi market has grown 40 since 2020, with the total value of DeFi at the time being around $ 61 billion (while TVL is currently around $ 165 billion). The capitalization of stablecoins, a key part of DeFi, rose to $ 112 billion in the first half of 2021.

Huge profits are made, but at the same time DeFi investors are also losing money because DeFi is not managed, censored, brokered, hosted or validated by a central authority, but is only controlled by smart contracts. So if a smart contract fails or is hacked, the consumer has no remedy. Loretta Joseph, global expert on digital asset management, told me, “Regulators protect consumers and investors. In DeFi you don’t have to regulate intermediaries, so it is pure P2P. The question is how this will be dealt with in the future. Everyone is being fooled. When people are betrayed, the first thing they do is complain to the regulator. “

Related: Will regulation adapt to cryptocurrencies or will cryptocurrencies follow regulation? Experts answer

In fact, DeFi logs have lost around $ 285 million to hacks and other mining attacks since 2019. And as experts have found, most of the hacks stem from developer incompetence and coding errors. This is useful when the field is completely code-dependent.

Related: Radical need to update blockchain security protocols

Regulatory challenges

This is what Hester Peirce of the US Securities and Exchange Commission said in an interview with Forkast. no intermediary. It’s great for a system’s resilience. But it is much more difficult for us when we try to tune in to find out how to do it. “

Regulatory concerns typically revolve around the volatility of the cryptocurrency market as opposed to government-backed fiat currencies, the risks of money laundering and terrorist financing, the unregulated nature of the market, and the inability to absorb financial losses. Non-fungible tokens are exploding, creating excitement, confusion, legal issues, and huge profits. The NFT markets are also attracting large crypto transactions, which is likely to upset regulators who may view large movements of money in the NFT as money laundering. At the macro level, the decentralization of the financial system and the ability to manage economic stability and protect consumer interests are more of a challenge for regulators.

Related: Tokens are not corrosive from a legal point of view

Decentralized Autonomous Organizations (DAOs) are a popular means of transferring cryptocurrencies across different blockchains. This supports crypto lending and productive agriculture. DAOs oversee more than $ 543 million by conservative estimates. In a DAO, IT governance and corporate governance are one and the same. The organization is managed and operated through smart contracts that are monitored and enforced by algorithms. Code is both managed and executed. If the algorithms fail, who is to blame?

In a joint paper entitled “Blockchain Regulation, DLT, and Smart Contracts: a Technology Regulator Perspective,” a group of researchers outlined several key points to consider: (1) The importance of identifying key points that can be used to regulate, for example miners, core software developers, end users. They even increase the potential for state or regulatory actors to become potential participants; (2) Liability issues – are core software developers responsible ?; (3) challenges related to the immutability and lack of updatability of smart contracts; and (4) the need for quality assurance and technology assessment procedures.

It is expected that exchanges and wallet providers will be the focus of regulators. Decentralized exchanges allow users to p2p directly from their wallets with no middlemen. The global watchdog to fight money laundering, the Financial Action Task Force (FATF), has its sights set on exchanges. Christopher Harding, Civic’s chief compliance officer, noted that the guidelines proposed by the FATF indicate that DApps must adhere to country-specific laws that enforce FATF, AML, and counter-terrorism requirements.

Related: FATF draft directive for compliant DeFi

A recent review of the top 16 exchange platforms by the London School of Economics and Political Science found that only four are subject to significant levels of regulation when it comes to trading, so there is clearly a loophole here. To get listed on a major exchange today, a project has to go through a review process, but meaningful security doesn’t stop there. Toby Lewis, CEO of Novum Insights, said:

“Also, keep in mind that smart contracts can be hacked. Even if they are tested, there is no guarantee that they will not be exploited. Do your own research before you begin. “

In an open source environment where projects are growing at an average growth rate of 20% per year, finding the right time to regulate where everyone is safe from risk but innovation is a classic is a classic problem. Some governments have achieved this balance using regulatory sandboxes (UK, Bermuda, India, Korea, Mauritius, Australia, Papua New Guinea, and Singapore) while others are reaching out to lawmakers directly (San Marino, Bermuda, Malta, Liechtenstein).

Far from breaking any regulations, DeFi’s top metrics see this as part of the industry’s maturation. In an interview with Cointelegraph, Stani Kulechov, founder of DeFi lending platform Aave, suggested that peer review was the future: “Auditors are not here to ensure user safety, the team itself was unaware of. Ultimately, it’s about peer review and we need to find out as a collaborative force to empower more security professionals in this area. In the same article, Emeliano Bonassi spoke about ReviewsDAO, a peer-reviewed forum that brings security professionals together with projects looking for reviews. Bonassi sees the potential in this to create a learning opportunity where experts with specialist knowledge can help improve the security of the ecosystem.

Tan Tran, CEO of Vemanti Group, suggests, “Going forward, I see a rapid rollout of platforms with permission-free financial products and services that can be used by anyone, anywhere, but each platform is managed by a regulated party with centralized accountability and control Ensure compliance. It’s not about stopping innovation. It’s more about preventing bad guys from taking advantage of uneducated consumers. Brendan Blumer, CEO of Block.one, shared a DeFi expert opinion with Cointelegraph, concluding: “The real winners in the digital economy will be the thinkers who take the time to ensure their products are professional in service and in the long run Meet regulatory requirements. . “

It looks like exchanges and software developers might be on regulators’ radar. We anticipate that regulators will try to improve DeFi governance and technology quality assurance processes, which can only be done in conjunction with the industry. Mark Taylor stressed that regulators must continue to work with players in the crypto industry to keep consumers safe.

“In DeFi, we are really building everything that traditional finance offers, but here it is faster, stronger, more transparent and accessible to everyone,” explains Julien Bouteluop. It’s really different. That means anyone in the world can access the technology without asking for permission. I think it is necessary to encourage innovation and build a better world. “

Who, what and how do we regulate in this 24/7 global market? This is a brand new ball game. Regulators and industry need to work together.