Home Blockchain DeFi, a growing sector and a new playground for regulators

DeFi, a growing sector and a new playground for regulators

The DeFi ecosystem brings undeniable advantages, such as the democratization of access to financial products, better market efficiency and easier access to liquidity. However, innovation and automation in financial markets also carry risks.

A sector experiencing rapid growth

Unlike fintech, DeFi does not just build financial services, but rethinks the entire ecosystem of finance on new technical bases. The DeFi industry took off in 2020, with a meteoric rise in DeFi assets between July 1 and September 1, one of the harbingers of the current bull run.

FTX DEFI-PERP index in daily time unit (1D)

DeFi experienced sustained growth in 2020, with the number of wallets multiplied by 11 and the volume of decentralized exchanges increasing from $ 500 million to more than 13 billion. This growth has continued since the start of 2021, with steadily rising trading volumes and a locked in total value now reaching $ 75 billion.

Growth of the DeFi ecosystem between 2019 and 2020
Source: DappRadar, DeFi Pulse, Dune Analytics

Regulation soon in place

However, this ecosystem poses unique regulatory challenges that will grow in importance in the years to come. Indeed, blockchains, such as Bitcoin or Ethereum, are recognized as being particularly secure, but this is not always the case with smart contracts that operate decentralized finance services. Since 2019, more than 280 million dollars have been lost within the ecosystem as a result of hacks as well as scams.

Moreover, DeFi is complex and intricate. Indeed, projects are often interdependent, which increases the risk of systemic collapse in the event of a major failure in a popular service. The novelty and complexity of this sector therefore represent a thorny problem for regulators.

The risks associated with DeFi have prompted the European Commission to propose a regulatory framework for this sector. The draft European regulation “Markets in Crypto Assets” (or MiCA) includes a set of measures aimed at regulating decentralized finance. However, it turns out that this text is particularly restrictive for DeFi companies. In particular, it prohibits the existence of the Decentralized Autonomopus Organization (DAO) and favors players already in place, such as banks and insurance companies.

According to Kevin Werbach, professor of law and business ethics at Wharton, curbing innovation would not be the right solution. The teacher recommends systematizing the establishment of a regulatory sandbox where entrepreneurs and regulators can discuss the best way to resolve the regulatory challenges that arise. This strategy has been successfully implemented by the Financial Conduct Authority in the United Kingdom.


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