Concerns about the future of the sector have been raised by the U.S. Federal agency’s attitude to the DeFi market. Experts offer their opinions on the best course of action.
Given the decentralized structure of the industry, decentralized finance (DeFi), one of the cryptocurrency market’s fastest-growing ecosystems, has long presented regulators with a challenge.
In 2022, American officials gave the developing region its undivided attention while placing a high priority on removing the ecosystem’s anonymity.
Users can trade, borrow, and lend digital assets directly between each other via DeFi protocols. Decentralized autonomous organizations (DAOs) and automated smart contracts manage the majority of initiatives in DeFi ecosystems by nature. The majority of DeFi protocols allow for anonymous trading because they don’t have stringent Know Your Customer (KYC) requirements.
Some of the main areas of worry for regulators, such as DeFi stablecoins, DAOs, and crypto exchanges, were revealed in a leaked copy of a U.S. draft bill in June.
Sebastien Davies, principal at institutional infrastructure and liquidity provider Aquanow, attributed the regressive strategy to regulators’ ignorance of technolog.
“I think the point that policymakers were trying to get across is that they’ll make it very difficult for developers/users of protocols that completely obfuscate transaction history and that they’re willing to act swiftly. Officials may eventually walk their stance back, but the precedent will be severe. Participants in the digital economy should continue to engage with regulators as often as possible to maintain a voice at the table to avoid these types of shocks and/or partake in the balancing dialog after the fact.” he said.
Even though DeFi products only make up a small portion of the global financial system, according to a discussion paper published by the U.S. Federal Reserve Board in August, they could nevertheless be dangerous to financial stability. According to the paper, DeFi’s resistance to censorship is exaggerated, and transparency may put institutional investors at a competitive disadvantage and open the door to misconduct.
Forced law will kill out new initiatives
Although it makes sense for regulators to be concerned about user protection, innovation and advancement shouldn’t be sacrificed, according to experts.
The United States would fall behind in the race for innovation if the emphasis was solely on gathering data and erecting barriers that prevented invention.
The New Economy Institute’s secretary, Hugo Volz Oliveira, gave Cointelegraph an explanation of why authorities’ present strategy and emphasis on banning anonymous projects won’t be successful.
He stated:
“Take the fact that policymakers and regulators continue to insist on eliminating anonymous crypto projects and teams, de facto trying to choke this industry by targeting its builders. But this won’t be feasible in the more sophisticated projects that are being developed according to the ethos of the community.”
DeFi regulation necessitates a mental adjustment
Since there isn’t a single set of regulations in the United States for crypto operators, with the exception of a few states with specialized crypto-focused laws, crypto regulations themselves are a hot topic in the mainstream industry. Regulating a specialized ecosystem could therefore be difficult in the absence of fair transparency surrounding the larger crypto market.
There is a growing interest among policymakers in the DeFi field, according to Jackson Mueller, director of policy and government relations at blockchain-based financial and regulatory technology firm Securrency.
He explained:
“Policymakers are never going to be comfortable with a system based on complete anonymity, hence the push for the application of Anti-Money Laundering and KYC regulations. While this obviously triggers privacy and level-playing field concerns, advanced technologies capable of being deployed today can greatly preserve an individual’s right to privacy, without significantly restricting the potential of DeFi services or propelling opaque markets. Regulated DeFi is not an oxymoron. The two can, and must, coexist.”
The U.S. Securities and Exchange Commission (SEC) recently presented a new proposal that made clear how little knowledge the SEC has of the industry.
The Securities Exchange Act of 1934’s definition of “exchange” is being modified by the proposal. Since most DeFi projects are decentralized and must register as exchanges, the plan poses a danger to a number of these initiatives.
The well-known crypto supporter and SEC commissioner Hester Peirce was one of the first to criticize the problematic idea.said it could reach more types of “trading mechanisms, including potentially DeFi protocols.”
And said: “DeFi regulation requires a mindset shift — away from the concept of a ‘cop on the beat’ and toward the concept of ‘community management.’ In a DeFi world where the nature of interactions and entities is decentralized, the entire nature of the relationship between the regulator and the regulated must change. As opposed to being reactionary, regulation must be reimagined to shift towards preventative measures, supporting the constructive development of the industry.”
She continued by saying that the Global DCA is focusing on this issue in order to design and establish a self-regulatory organization that engages in extensive discussion with a wide range of stakeholders in the digital asset ecosystem.
These insights and perspectives will be “reflected back in a framework for self-regulation which may help to advance market integrity and consumer protection.”
The ecosystem’s stakeholders should be involved in legislative debates, according to Eric Chen, CEO and co-founder of DeFi research and development company Injective Labs:
“I personally believe that regulators should have more open conversations with Web3 companies and founders. I think this dialog would help both sides of the spectrum to reach definitive regulatory clarity more rapidly. Many may not recall but the early Web2 space was also beholden to an opaque regulatory structure. This of course was rectified over time as regulators and founders began to work together to craft proper guidelines.”
Regulators start to worry about any new technology that becomes popular.Their strategy, though, will be crucial in determining whether that technology can be used for good or if it will simply be outlawed because of a few bad people.
Industry analysts think that the present strategy for regulating the DeFi market under current financial rules could be disastrous for the developing sector and that conversation is the best course of action at this time.
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