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DeFi Regulation: New Approaches, Same Outcomes

Blockhead contributor Kenneth Bok highlights some suggestions on how DeFi can be regulated, with specific reference to the Crypto Council for Innovation’s excellent report on DeFi regulation.

Image: DALL-E 3

Many DeFi “hardliners” strongly oppose regulation and argue for a "strong" form of DeFi that operates completely outside of regulatory boundaries. I disagree with this narrow-minded approach. I am of the view that while the outcomes of regulation are non-negotiable, the implementation of DeFi regulation needs a lot more work.

DeFi Risks

There are risks in life that the average person may not consider, mainly because the government has already assessed and mitigated them. Financial applications, in particular, are subject to stringent regulations. When a consumer downloads an app from the app store, they can trust that the company has already undergone evaluation by the financial regulator, ensuring its proper functionality and safety for use.

However, this is not always the case in the realm of DeFi. I personally remember certain apps like Celsius or Terra's yield platform Anchor, which had interfaces that closely resembled other fintech apps. It is not surprising that consumers were shocked when these apps collapsed.

There are also risks that are simply too far removed from the average person. In the course of writing my book, I came across the particularly worrying case of North Korean hackers stealing crypto to fund the regime’s nuclear weapons program. According to Chainalysis, the same cybercriminal group Lazarus was responsible for one of the largest hacks in DeFi history for a combined value of $600 million on the Ronin/Axie Infinity hack in March 2022. Lazarus was also named by the US Treasury’s Office of Foreign Assets Control (OFAC) in August 2022 when Tornado Cash was sanctioned.

To be sure, these risks also exist in TradFi. Nonetheless, the nascent and decentralized nature of DeFi may make it particularly vulnerable to organized crime looking to exploit DeFi for their nefarious purposes.

DeFi Clarity? Some Confusion Remains
We look at recent CFTC actions against DeFi protocols, which raise questions about just how legal DeFi is in the US. If the government is going to take up the task of regulating an automated financial system seriously it is going to need to get a bit deeper in the weeds.

Regulation & DeFi’s Potential

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