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DeFi Industry Ponders Strategy as Regulators Begin to Circle

Tim Alper
Last updated: | 4 min read

2020 hasn’t been good for much, but it has been very good for one thing: decentralized finance (DeFi). The sector has boomed this year. And while DeFi fads have been frequent, it appears that the wider DeFi sector has built up a head of steam, and will prove to be no more flash in the pan.

Source: Adobe/mantinov

But those expecting the DeFi party to keep raging into next year could be in for a rude awakening – with regulators expected to move in on this once under-the-radar industry.

These were the conclusions of attendees at the V20 summit of crypto industry leaders and regulators last week, including the Financial Action Task Force (FATF), the American Treasury Department and the Japanese Financial Services Agency.

And while the FATF had already fired a shot across the bows of the peer-to-peer (P2P) crypto trading platform industry at the opening day of the V20 summit, it appears that the world of DeFi is also firmly in its crosshairs.

Speaking to, Jonathan DeCarteret, the CEO of INDX Capital, a crypto investment fund that specializes in masternode investment, stated that the industry widely accepts that “heavy regulation” would be catastrophic for the fledgling sector and would “likely collapse DeFi overnight.”

DeCarteret attended the behind-closed-doors V20 panel session named “Leveraging P2P: Managing the Anti-Money Laundering/Combating the Financing of Terrorism (AML-CFT) risks linked to Decentralized Finance (DeFi),” along with others including Tyler Spalding, the Co-Founder of crypto payments specialist Flexa.

But Spalding told that DeFi insiders were united in their intention to find a way to keep regulators onside.

He said,

“Despite the new opportunities and processes within DeFi, there definitely appears to be an approach that is compatible with existing regulatory frameworks.”

DeCarteret suggested that rather than create a new set of protocols and standards – as has been the case with Travel Rule compliance solutions for crypto exchanges – DeFi insiders, including those on the V20 panel, agreed that “best practice-led self-regulation” was advised.

There was a feeling, DeCarteret stated, that Decentralized Autonomous Organization (DAO)-led, “anonymous and peer-driven protocols will be extremely difficult to regulate.”

Crucially, though, it appears that the FATF does not buy into the idea of decentralization, with DeCarteret adding,

“The FATF maintains that someone always holds the keys.”

Spalding added that “for the most part” there is “enthusiastic support of building a compliant and meaningful ecosystem” among market players, and particularly those who were represented on the V20 panel.

But it appears that DeFi now finds itself at a crossroads.

DeCarteret explained that panelists were split on the issue of whether regulation efforts should focus on restricting regulations to the fiat on/off ramp process or whether to instead seek to regulate private keys.

Spalding opined that the path ahead is clear. He said,

“The simplest and most effective approach is to ensure compliant on/off ramps for digital assets. It’s impossible to completely monitor or enforce transactions within decentralized networks, which is analogous to current global cash-based systems. By ensuring appropriate compliance for users entering and exiting these networks, the overwhelming majority of illicit activity can be effectively mitigated.”

But DeCarteret suggested a different course of action, adding that the question would be “incredibly difficult and complex to solve.”

“Regulating the fiat on/off ramp fails to address any impropriety or incompetence at the protocol level. Similarly, enforcing regulation at the protocol layer damages the frictionless nature of DeFi. I propose a Know-Your-Customer (KYC)/AML version of private wallets that would be required to interact with DeFi protocols,” he said.

DeFi defense

Whatever course the industry decides upon, it is clear that the ball is firmly in the industry’s court – and that major players now face a race against time before the FATF and friends start gunning for DeFi.

As more than USD 14bn worth of funds is current “locked into DeFi protocols,” DeCarteret conceded that “it’s going to appear on regulators’ radars.”

It is hard to look into the crystal ball and see anything other than more frantic activity over the next year, but DeCarteret claimed that regulation would see big fish enter the pool, with a number of mainstream financial industry players already eyeing up what is becoming an increasingly tasty-looking pie.

DeCarteret said,

“The landscape will embrace crypto regulation as an accepted asset and this will accelerate institutional adoption. The opportunity is becoming too large to marginalize.”

In the meantime, it appears that both Spalding and DeCarteret are aware of the need to keep their own ships in order, in addition to looking to address industry-wide issues.

Spalding stated that in order to manage risks like these, his company had already taken steps, explaining, that Flexa operates with requisite licensing and employs KYC/AML standards for both individuals and businesses for each jurisdiction where it facilitates retail transactions: “Additionally, the entities within the Flexa network, such as exchanges, payment and point-of-sale (POS) providers, hold relevant licenses as well.”

And DeCarteret claimed that “INDX has structured its business as a regulatory-compliant offshore tokenize fund to meet these regulatory risks.”
Learn more:
The DeFi Sector Is Breaking The Law – It’s Time to Act
FATF Signals More Pressure on Crypto Industry As It Moves ‘Too Slow’
Crypto Regulation in 2021: The Piecemeal Approach & New Winds
BitMEX Case Might Prompt a Closer Regulatory Look into DeFi