The Bank for International Settlements believes that the DeFi ecosystem can help regulators create neutral regulation, with a more efficient approach to technological development.
In a Valid identity document In its analysis of how to incorporate regulation into decentralized finance (DeFi), the Bank for International Settlements (BIS) is supporting the creation of a neutral regulatory framework that does not affect innovation and technological development.
The BIS, whose primary function is to foster international banking cooperation, believes that the DeFi ecosystem can fit into existing regulation, to minimize the underlying risks in financial markets while promoting their evolution.
As a decentralized ecosystem, DeFi finance promotes new forms of data transparency and credibility. This would help, according to the bank, reduce the need for regulators to require companies in the crypto financial ecosystem to actively collect, verify and deliver data.
According to him, his proposal to apply “built-in oversight” to decentralized finance would help resolve the conflict that companies face when required to collect user data, which mainly involves the difficulty between data availability, the cost of compliance for collecting and verifying such data, and the violation of users’ privacy rights.
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However, while the BIS proposal supports the establishment of neutral regulations that do not affect the development of financial technologies that implement DeFi, such as DLT, the crypto community has reacted to the clear conflict that exists between decentralization and compliance.
Compliance in decentralized finance
Sebastien Meunier, director of financial services and consulting firm Chappuis Halder & Co., said that decentralized finance and compliance with financial regulations are not compatible.
“Indeed, it can be decentralized or it can comply with financial regulations, but it cannot do both.”, the expert said on his Twitter account, in response to the BIS proposal to improve the efficiency of the current system by incorporating DeFi into supervision.
Financial regulators have been exploring, since last year, ways to incorporate DeFi into existing regulations, to increase control and supervision within this growing ecosystem, which maintains more than $107.000 billion in liquidity deposited by users at the time of this writing, according to data provided by the DeFi Llama platform.
Managing underlying risks in DeFi
The US Securities and Exchange Commission (SEC) has been one of the first regulators to point out the need to regulate decentralized finance. In August last year, it described how the rapid growth of this financial ecosystem can carry significant risks to the stability and security of investors. Because of this, the regulator indicated that it would focus on understanding what is happening within this ecosystem governed by smart contracts.
The SEC announced the hiring of AnChain.AI to create new DeFi oversight tools.
Likewise, venture capital firm Andreessen Horowitz, one of the largest investors in the crypto world, filed a proposed regulation in order to help the US government oversee decentralized finance.
Andreessen Horowitz noted that we are currently on the threshold of the third generation of the Internet, Web3, and therefore believes it is necessary to formulate new policies on digital assets and decentralized technology, which allow the private sector and governments to experiment and build within the new digital economy, with adequate management of the underlying risks.
Principles for integrated supervision of DeFi
To supervise DeFi, the BIS proposes, first of all, that Compliance is achieved by reading the data recorded directly in distributed ledger technology (DLT)This is in order to reduce the administrative burden for companies and increase the quality, veracity and speed of the data available to the supervisory body.
As basic principles, the organization also establishes that integrated supervision should operate only as part of a general regulatory framework, which is supported by an effective legal system and supporting institutions.
He also specified, as a second principle, that such supervision can be applied to decentralized markets that achieve the economic purpose. He also indicated that it must be designed in such a way that the impact that all regulatory actions will have on the market is considered, in order to allow the creation of an economic consensus that is sufficiently robust to prevent any attempt to deceive the supervisory body.
Finally, he noted that integrated supervision of DeFi must ensure that compliance is low-cost and on a level playing field for both small and large companies.
Institutional DeFi
In March this year, the BIS joined the Cambridge Digital Assets Programme (CDAP), which aims to assist government agencies and institutions to explore the use cases and potential of new finance that are built in the blockchain.
Through CDAP, government organizations and regulators can access empirical data to gain insight into the crypto industry and improve their regulatory approach.
One of the biggest concerns regulators have regarding cryptocurrencies is the risk of financial crime and other illicit activities.
In its document, the banking organization points out that the rise of cryptocurrencies has increased the risk of evasion of current regulations and standards, especially those related to the fight against money laundering (AML).
In light of the potential risks, some decentralized finance protocols, such as Aave, have opted to launch versions tailored to the needs of businesses and regulators, to encourage institutional entry into the decentralized financial ecosystem in a reliable manner.
Aave Pro, for example, is an institutional DeFi tool from the Aave lending protocol, which integrates Know Your Customer (KYC) controls to allow only companies that have met the appropriate verifications to access its financial services on the blockchain.
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