Decentralised Finance Comes Under Global Regulators' Scrutiny as They Seek to Safeguard Market Stability

Global securities regulators set out on Thursday their first blueprint to make participants in "decentralised finance" (DeFi) accountable for their actions and safeguard market stability.

DeFi platforms allow users to lend, borrow and save in digital assets, using the blockchain technology that underpins cryptoassets to bypass the traditional gatekeepers of finance such as banks and exchanges.

The collapse of crypto exchange FTX and of the Terra USD stablecoin during 2022 showed how shocks in one part of the crypto market can trigger billions of dollars in outflows from DeFI applications, said IOSCO, the global umbrella body for securities watchdogs from across the world.

Such events have seen DeFi shrink from about $180 billion (nearly Rs. 14,96,780 crore) in late 2021 to about $40 billion (nearly Rs. 3,32,600 crore) currently, and the sector is also being used for moneylaundering, IOSCO said.

"There is a common misconception that DeFi is truly decentralised and governed by autonomous code or smart contracts," said Tuang Lee Lim, chair of a fintech taskforce at IOSCO.

Stakeholders in DeFi and their roles, and the organizational, technological, and communication mechanisms they use, tend to mimic those in traditional finance.

"In reality, regardless of the operating model of the DeFi arrangement, 'responsible persons' can be identified," Lim said.

Regulators have little standardised data on DeFI, a situation made worse by market participants using multiple pseudonymous addresses to obfuscate their activities, IOSCO said.

The watchdog has proposed a framework for regulators across the 130 jurisdictions covered by its membership to ensure investor protection and stable markets with DeFi, identify and manage risks, obtain clear disclosures and cross-border cooperation to enforce applicable laws.

Regulators should use existing laws or introduce new ones where needed to get a full picture of DeFI, including the identities of people and companies involved, IOSCO said.

A public consultation on the proposals, which dovetail with proposals from IOSCO in May to regulate cryptoassets themselves, runs until mid-October before the framework is finalised around the end of 2023. 

IOSCO members commit to applying agreed recommendations, and some member countries like the United States have already begun looking at how DeFi fits into existing securities laws.

© Thomson Reuters 2023