Decentralised Finance (DeFi) is, by design, separate from traditional institutions, mainly the government.
DeFi operates based on a community of investors seeing value in the financial instrument. This causes a problem for regulators, seeing as it is difficult to know who is investing and for what purpose without extensive investigation.
Since the invention of blockchain technology, the potential for these emerging technologies to be used for illegal activities has been no secret, with some speculating the popularity and value of the digital economy is on account of money laundering or financing terrorism or piracy. As the emerging DeFi market grows, and matures over time, governments will work towards finding a regulatory solution that will aid in safeguarding their citizens.
The Challenge
Innovation of any kind will often see concerns raised from lawmakers and citizens alike.
The emergence of social media and eCommerce have brought into question how these firms should be treated from a tax liability perspective and, in many ways, DeFi is no different.
The challenge is that DeFi by design is meant to operate outside of centralised finance and government institutions. Traditional institutions operate within the confines of government regulation, so the closer DeFi comes to government regulation the more centralised it becomes.
However, a paradox is created where institutions wanting to adopt decentralised finance are simultaneously calling for more centralisation and as such a balance needs to be found.
Attempts at Regulation
Some success has been made at trying to introduce regulation. In the United States, a draft bill was made that would require DeFi projects to be registered with a regulator in the United States. The stance from lawmakers is varied with some seeing participation in the digital economy as encouraging innovation because adoption of DeFi-enables new technology development in the first world.
However, there is a very real fear that people may inadvertently invest in projects that pose a security risk to their own country. As such, authorities continue to warn about the potential of DeFi projects to fall victim to cyber-criminal behaviour.
As an evolving technology, DeFi's expansion could cause problems for creating regulatory frameworks. The problem is similar to online piracy and peer-to-peer file sharing; if the systems are built and designed for working outside of a centralised system, how is the government meant to regulate? Emerging technologies are often quick to innovate and find new ways to offer services to participants, and governments often rely on traditional methods for enforcing regulations.
Community Led Solutions
An often overlooked aspect of DeFi, is that these platforms are community-driven solutions. The basic principle of capitalism is that participants in the economy are 'voting' with their currency.
Currency is invested in, and finance is given for, projects where the general consensus finds superior utility. Just as unions leverage employers for better pay and conditions, or lobbyists negotiate with lawmakers for their benefit, the government could also leverage and lobby communities to participate in better-regulated DeFi environments.
The traditional solution of investigating and policing formal regulations could be replaced with a 'hearts and minds' approach of leveraging DeFi community interests into the regulator's practices and the government could work with financial institutions to facilitate this type of arrangement, which would aid traditional centralised finance in the adoption of DeFi technologies.
The Future
Most of the world's finance still exists within traditional structures, yet DeFi's continued expansion requires regulatory frameworks to enable growth.
For DeFi to cross the chasm to transition from being a tool of innovators and early adopters, a regulatory framework will need to facilitate this transition space.
DeFi developers and participants will benefit from having a seat at the table in these discussions to voice their concerns and become part of the system, working together in a bid to find workable solutions, rather than working against it.
Governments and institutions can see the potential in using DeFi technology to enable easier access and quicker transactions 24 hours per day, seven days per week and retail businesses could help drive a shift to DeFi with the potential of avoiding the 2-3 per cent charges associated with traditional payments.
After years of complaints about transaction fees and paperwork associated with burdensome regulation with the incumbent solutions, governments need to find a way to enable access to DeFi technology that is safe for consumers, conducive to local business and provides a legal framework to enable and support innovation.
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