Regulating DeFi: Safeguarding Market Integrity While Managing High Expectations

Abstract

Digital finance has contributed to the dematerialisation and disintermediation of financial transactions. Technological innovations, namely blockchain technology and smart contracts, have generated an additional ecosystem – decentralised finance (DeFi). Since its main characteristics are pseudonymity and a lack of intermediaries, which are currently challenging to systemically evaluate, it requires an equally innovative approach from policy makers, regulators, and legislators. The purpose of the paper is twofold. Firstly, it illuminates market trends and highlights the emerging risks associated with DeFi. Secondly, it examines policies, legislative proposals, and existing regulation, focusing on three main areas: consumer protection, anti-money laundering, and determining jurisdiction and applicable law. Drawing on a qualitative analysis of primary sources, namely EU and US legislation, and supported by relevant reports and case studies made by financial authorities, international standard-setting bodies, and business associations, this paper adopts a theoretical approach. It puts forward arguments in favour of the hypothesis that regulatory certainty fosters a favourable environment for the development of financial services in the realm of crypto innovations, a correlation that will hopefully hold significance within the context of DeFi.

Keywords

• decentralised finance (defi)
• mica
• crypto assets
• financial regulation
• consumer protection
• aml
• jurisdictional issues