Global securities regulators on Thursday laid out the first blueprint to hold “decentralized finance” (DeFi) participants accountable for their actions and maintain market stability.
DeFi platforms allow users to borrow and save digital assets by using the blockchain technology that underpins encrypted assets, bypassing traditional financial gatekeepers such as banks and exchanges.
The collapse of cryptocurrency exchange FTX and the Terra USD stablecoin in 2022 shows that a shock to one segment of the cryptocurrency market could trigger billions of dollars in outflows from DeFi apps, according to IOSCO, the global umbrella body for global securities regulators.
IOSCO said that such incidents have caused the scale of DeFi to shrink from about US$180 billion (nearly Rs. 1,496.78 billion) at the end of 2021 to about US$40 billion (nearly Rs. 332.6 billion) at present, and that the industry has also been used for money laundering.
“There is a common misconception that DeFi is truly decentralized and governed by autonomous code or smart contracts,” said Tuang Lee Lim, chair of the IOSCO Fintech Working Group.
Stakeholders and their roles in DeFi, as well as the organization, technology, and communication mechanisms they use, tend to mimic those in traditional finance.
“Effectively, regardless of the operating model of a DeFi arrangement, the ‘owner’ can be identified,” Lim said.
Regulators have little standardized data on DeFi, a situation made worse by market participants using multiple pseudonymous addresses to obfuscate their activity, IOSCO said.
The regulator proposes a framework for regulators in the 130 jurisdictions covered by its membership to ensure investor protection and DeFi market stability, identify and manage risks, obtain clear disclosures and cooperate across borders to enforce applicable laws.
IOSCO said that regulators should use existing laws or introduce new laws if needed to gain a comprehensive understanding of DeFi, including the identities of the people and companies involved.
The proposals dovetail with IOSCO’s May proposal to regulate crypto assets themselves, whose public consultation will continue until mid-October before the framework is finalized around the end of 2023.
IOSCO members have pledged to apply agreed recommendations, and some member states, such as the United States, have begun researching how DeFi fits into existing securities laws.
© Thomson Reuters 2023
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