Over the course of just a couple of years, decentralized finance leapfrogged the products and regulatory frameworks that took decades to put in place.
The fact that users can interact with financial products on the smart contract level, and essentially build programmable money as opposed to products, is empowering and disruptive.
Not unlike disruptors in other industries, DeFi is operating outside of the regulatory environment. This environment is designed to handle institutions that spend millions of dollars on compliance alone.
Mainstream VC-backed platforms like Uniswap have distributed assets to tens of thousands of people. All without Know Your Customer (KYC) and Anti-Money Laundering (AML) considerations. This unprecedented “airdrop” has no parallels in either financial markets or any other industry.
The spectre of over-regulation has reared its head
Regulators and law enforcement have set their sights on anonymous cryptocurrency transactions, while FinCen regulations focus on “unhosted” hard wallets.
The United States senate-approved Infrastructure Bill features a section addressing cryptocurrencies and the operations around them. Among the proposals is a licensing fee for anyone participating in a network. This includes activities like staking or running a node.
The new proposals in the bill add industry obstacles favoring well-funded entities who can secure the licensing. Thus, encouraging centralization in an industry built around decentralization. Higher fees essentially lock out casual and nonprofit participants from the crypto industry.
With ambiguous wording, its passing in the House of Representatives could stifle progress in the cryptocurrency industry and prevent a better, decentralized future.
The California-based exchange Coinbase has cautioned its investors that US regulations might undermine its ability to compete with DeFi.
“Economic freedom is a necessary, if not sufficient, condition for human progress,” Coinbase CEO Brian Armstrong noted in a letter embedded within a new prospectus filed with the U.S. Securities and Exchange Commission (SEC).
DeFi is decentralized by design – regulating “the house” isn’t enough
Anyone can interact with the products directly sans an intermediary responsible for compliance. The sole mechanism standing between a user and the contract enabling the DeFi function is the blockchain with which the user’s wallet interacts.
Although certain bluechip DeFi entities are quite transparent, even more than some CeFi entities, many projects were deployed by anonymous founders. Therefore, there was no one to hold accountable for failure or success (value made or value lost).
The DeFi space has evolved into a Dark Forest where code is the law and even rug pulls, for example when developers abandon a project and run away with the participants’ funds, are a part of the game.
During the previous 2017-2018 cryptocurrency bull cycle, there was chaos. This was in the sense that most players didn’t know what future regulation was going to look like.
A team’s focus was largely taken away from working on a project. Rather they were concerned with legalities, ensuring they held no personal criminal liability for their actions.
However, even then, the focus was on the central entity that was issuing the tokens, making promises, and profiting from the sale. With DeFi, in some cases, there is no obvious central counterparty responsible.
Matured markets — from both a product and regulatory perspective
The blockchain market participants of today take into account tax and compliance considerations and have no expectations of anonymity. Monero, zCash, Beam, and similar privacy coins remain fringe products with a fraction of the traction seen in traceable cryptocurrencies.
Privacy-conscious currencies are in fact on the radar of nation-states. The IRS, for instance, offered a $625,000 bounty for cracking Monero’s encryption.
Most cryptocurrencies are traceable. Therefore, every centralized entity can indeed comply with the regulatory infrastructure in every jurisdiction in which it operates.
If a cryptocurrency participant doesn’t pay their taxes, the IRS might get in touch. The IRS sent 10,000 digital currency holders letters warning them to catch up with their unpaid taxes.
A lot of the people play very aggressively to make sure that they pay fewer taxes. However, that is not drastically different than in any other industry.
Companies and individuals optimize and plan but rarely strive to avoid paying taxes. When it comes to regulations, there’s been a gradual transition from a state of great uncertainty to what I consider to be a transitional state with continuously increasing certainty.
Regulatory infrastructure will only mature
An expanding pool of tools is under development to ensure that the cryptocurrency space operates within a specific framework. This is not entirely different from the way classical financial systems operate.
The closer we are to a clear solid framework, the closer we are to creating a more transparent space that will offer more value to retail participants.
Complete clarity with regards to every single aspect of cryptocurrency regulation―with what one can and cannot do―will standardize crypto and make it more safe and accessible for all. As the regulatory issues become clear, companies developers and entrepreneurs can innovate on top of easier-to-understand frameworks.
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