From the moment of its inception crypto has been very attractive to scammers; fake accounts, rugpulls, and hacks began almost as soon as Bitcoin did. DeFi may have made finance accessible to millions worldwide, but it has also opened up the floodgates to uncertainty and speculation.
Many Web3 companies might cite in their marketing materials a commitment to transparency, that they adhere to regulatory requirements, while also safeguarding the anonymity and privacy of their customers.
It doesn’t take a genius to spot out the inherent contradiction in these claims.
Currently only one thing is clear: regulators need to work with industry leaders to strike a balance between regulatory compliance and innovation, consumer protection and anonymity.
If someone claims to know how this conundrum will play out - they’re a wiser man than I. Without a crystal ball, I don’t think anyone can envision the exact shape of DeFi in the future.
Traditional Regulatory Frameworks won’t suffice
DeFi set out to be the alternative to traditional finance, providing an alternative means to access traditional financial services. For many, marrying DeFi with elements of traditional finance seems counterintuitive. And undoubtedly, when rules come into play, anonymity takes a hit. This is highly problematic given this is one of DeFi’s core values.
Now, we don’t want to get to a place where we are forced to over-regulate until DeFi becomes a watered-down version of the same old thing. Too much involvement from intermediaries and you alter the DNA of DeFi; too little regulation and we put investors’ hard-earned assets at risk.
To add to the complex dynamic, DeFi is notoriously complex to navigate, even for those who operate within its borders, but especially for everyday folks, or the so-called ‘normies’. Without a comprehensive playbook to reference, regulatory authorities simply can’t expect to navigate and comprehend the nuances of an industry that is in constant evolution.
Finding a way to keep true to the original values of decentralisation and anonymity , while adding additional layers of protection in a way that can be integrated across various global systems is no easy feat. But without comprehensive safeguards we face the demise of DeFi, or perhaps even worse, the creation of a frankenstein-like monster that barely resembles its original form.
An Enforcement Approach is not the Answer
Unfortunately, existing regulation seems more geared towards penalising Web3 companies, rather than helping facilitate constructive policies. The SEC’s current ‘Regulation by Enforcement’ approach, led by Chairman Gensler, who recently stated crypto business models “rely on being noncompliant”, does not facilitate healthy policy-making. By working against the Web3 industry, rather than in synergy with its leaders, regulators risk halting innovation.
From the MtGox flash crash to the Ethereum DAO hack; a number of episodes have played their part in contributing to the mounting pressure to regulate the industry. Last year's catastrophic events are the latest additions to this list of watershed moments, with each of these events underscoring the urgency for decisive legislation and meaningful reform.
Given the glaring example of the lack of integrity in the traditional financial system, it is even more important for DeFi to ensure it takes a more transparent and accountable approach, even if this means softening and reinterpretation of some of its features.
This doesn’t mean the end of DeFi, far from it. Regulation, while crucial, won't snuff out DeFi. Even as the market somersaults, we would do well to remember that DeFi is built on blockchain technology, and technology tends to find a way to endure and evolve.
To unlock DeFi's potential, we need smarter rules in place. The exact form of those rules is anyone's guess. We may still be in the early stages (with circa 8% of global adoption), but the stage has been set, and now it is time for both regulators and our crypto leaders to perform in concert.