The DeFi Sector Is Breaking The Law - It’s Time to Act
DeFi platforms might soon need to seek relevant licenses. Regulatory costs may be passed onto customers. Users mostly face technical and financial, not legal risks.
The decentralized finance (DeFi) sector continues to boom, with over USD 8bn in total assets locked into the ecosystem’s various platforms. The bigger it gets, the more regulators are likely to take notice of it, with crypto-focused lawyers warning that now’s the time to begin considering what regulatory challenges lie ahead.
Lawyers speaking to Cryptonews.com suggested that many if not most DeFi platforms are likely breaking applicable financial laws in at least some jurisdictions. They suggest that these platforms will soon need to seek relevant licenses depending on the services they facilitate, and that regulators might come after them.
This is unlikely to affect users beyond potentially depriving them of a platform they once used. Also, the main draw of DeFi (the ability to receive financial services without having to go through substantial signup and verification processes) is likely to remain strong even after regulators join the game.
Already at the end of July, Carlton Fields attorney Andrew “Drew” Hinkes highlighted the need for lawyers working in crypto to begin talking about the regulatory implications of DeFi.
Other lawyers agree that regulators are starting to take notice of DeFi, and that such attention may end up constraining the sector.
“DeFi is drawing a lot of attention these days, and the regulators are listening,” said Felix Shipkevich, a lawyer with expertise in cryptocurrency and fintech. “The regulators are very likely to compare DeFi platforms to the 2017 ICO boom, which obviously did not last very long.”
So far, no major regulator has actually issued any specific guidance or rules related to DeFi. An in-depth blog published by OKEx in July suggested that regulators don’t yet understand it enough.
However, when regulators and legislators do eventually act, it’s likely to result in a reckoning for DeFi. According to Niklas Schmidt, a lawyer with Wolf Theiss, the sector is full of unregulated platforms that should — from a legal perspective — be regulated.
“DeFi, which deals with financial services such as borrowing, lending, insurance, trading etc. and which has global reach, is necessarily breaking laws at any time in at least one jurisdiction (if not in most),” he told Cryptonews.com.
As examples, Schmidt suggested that “Compound and Aave probably need a banking license somewhere, Nexus Mutual probably needs an insurance license in most countries, yearn.finance and TokenSets are possible to be seen as illegally operating investment funds in many countries, PoolTogether will probably need a gambling license in some countries and might altogether be forbidden in others.”
The implication of this is that today’s ‘Wild West’ of DeFi will come to an end sooner or later, just as it did with ICOs. Regulators will force platforms to comply with applicable financial laws, while they’ll potentially shut down others.
Either way, there will be more regulatory friction, making the whole process of using DeFi a little less effortless, while also imposing regulatory costs on the sector that may be passed onto customers.
What this means for users
Given that DeFi platforms now count tens of thousands of users, people may now be wary that the ‘lawlessness’ of the sector could affect them directly.
Niklas Schmidt doesn’t think users should be too worried, other than being careful when it comes to their own cybersecurity.
“I don't believe that it is the users who face legal risks (they mostly face technical risks, such as bugs in the smart contracts, or admin key risks),” he said. “Rather, it is the projects which are not decentralized enough and where there are well-known developers that might have legal risks, since regulators might at some point go after them.”
Felix Shipkevich agrees that the main risk for users stems from using platforms that may not be wholly safe.
“There are plenty of risks when using the services of unregulated platforms,” he said. “You can't forget about the principles of customer protection when dealing with unregulated entities.”
In other words, users aren’t likely to face legal repercussions in using unregulated DeFi platforms, but they may take other risks. For example, a number of DeFi platforms have suffered hacks resulting in the loss of user funds (although this is also something that affects regulated centralized exchanges).
DeFi to remain lawless?
There’s still plenty of talk about just how (un)sustainable DeFi’s yields are, but it's nonetheless likely that the sector is here to stay. This means the major DeFi platforms will eventually fall under regulation, something which will potentially make them safer while inserting a degree of regulatory friction.
Certain figures believe that at least a portion of the DeFi space will remain unregulated, since this is what makes crypto as a whole distinctive from the legacy financial system.
For Felix Shipkevich and Niklas Schmidt, this view is wrong. For them, the main draw of DeFi is that it offers much easier access to finance, even in a scenario where it’s regulated.
Schmidt said, “If you have a bit of technical expertise, the attraction of DeFi currently is that it is so super easy to do banking business: no filling in of forms to get a loan or to open a bank account, no waiting at a counter to hear that the bank doesn't want to do business with you, no waiting until the bank opens in the morning, etc.”
Put simply, DeFi might retain its main value proposition even after the US Securities and Exchange Commission and FATF have had their way with it.
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