The total amount of funds blocked in Decentralized Finance sector has grown from just over $ 1 billion six weeks ago, to the 4 billion mark in August 2020.
Regulation that is difficult to implement
Despite this explosive growth, the DeFi space is still in its infancy, especially in terms of regulatory clarity. The main reason for this regulatory gap is that financial observers have a limited understanding of the nascent ecosystem.
At its core, DeFi is intended for being used without permits, and currently operates in the grey area of the strictly regulated financial sector. According to an unofficial report by Collins Belton, managing Director of the law firm Brookwood, DeFi projects present a unique legal challenge for regulators, compared to initial coin offerings (ICOS).
Belton explained that the centralization and issuance of security tokens that are found in ICOS are not present in the decentralized Finance sector. He added that despite the fact that the sector owns a huge amount of funds, investors can avoid regulatory consequences due to its structure.
According to him, regulators may have no reason to prosecute the sector, because most of these decentralized platforms do not have an identifiable organization or person carrying legal sanctions. Unlike centralized crypto-lending platforms such as the BlockFi Network, DeFi platforms use smart contracts to exclude third parties in transactions. When it comes to governance, most platforms are completely controlled by community members who vote on the direction in which the specified Protocol should move. A great example of this decentralized structure is Compound, which allows users to vote for management proposals using the service Protocol token (COMP).
The lack of an identifiable operator makes these platforms a problematic target for authorities, who usually prefer to take selective measures against visible targets in order to make examples of them, and prevent future violations. Belton cited the successful DeFi Yearn Finance (YFI) project, which is managed by several token holders. Thus, there is no person responsible for any violations affecting the millions of user funds blocked in its liquidity pools.
Not all projects are clear. At the same time, the California lawyer noted that not all DeFi platforms are clear, especially those who simply use innovation as a buzzword for marketing purposes.
He believes that decentralization flirting or protocols that support vital substructures outside the network, own and control most of the tokens, are an easy target for attacks by regulators.
Permitted stablecoins can also be targeted by regulators, especially if banks have a lot of stored funds. However, it seems that the emerging digital agriculture sector may be beyond the reach of regulators.
No matter which way financial watchdogs choose to implement DeFi regulation, there must be a proper balance between excessive regulation, which can stifle a nascent industry, and insufficient regulation with high risk.