The sector of decentralized financial applications, or DeFi for short, is growing inexorably. With increasing relevance, however, there is also a threat of government countermeasures in the form of massive regulatory measures. Where we are currently in terms of DeFi regulation, why one should not underestimate the influence of the banking lobby and why progressive banks themselves are approaching DeFi.
For a few months now, financial institutions and, above all, asset management companies have been able to detect outflows of funds into the crypto sector. The bulk of the capital is likely to be in the central crypto exchanges such as Coinbase or bison as well as BSDEX from the Stuttgart Stock Exchange.
With the current strong expansion of the decentralized financial sector (DeFi), which is not classically regulated like the aforementioned central crypto exchanges, there is now a threat of the next migration to decentralized exchanges such as Uniswap or non-custodial wallets such as MetaMask. More and more money is flowing back into the dark gray capital market, where no authority really knows who is investing how much and what in the DeFi sector.
Know-your-customer or anti-money laundering requirements simply do not exist. Both states and traditional financial institutions have every reason to act against the DeFi sector.
DeFi: No more niche
The process leading to tough regulatory measures is almost always the same. At first something – in this case the crypto or DeFi sector – is too small for the state or authority to worry about. But with increasing size and relevance, ignoring is simply no longer possible.
If it comes to this point, states are forced to act – in order to supposedly protect consumers and prevent crime and terrorism. With DeFi applications, we have come pretty close to this threshold. After all, it is companies like Square and people like Jack Dorsey who, with their pockets and huge reach, are making the DeFi sector a majority. As fast as the sector is developing, it would not be inconceivable that the DeFi industry will leave its niche in the next two to three years and gain a critical mass of users worldwide.
Regulation ad absurdum
The state is currently trying primarily to regulate the centrally administered applications of the crypto economy. For example, the central custody of cryptocurrencies and their tax registration, as is the case with brokers such as Coinbase, Bitpanda etc. occurs. Often the same criteria and standards are applied as for traditional banks or financial services. Particularly with regard to the DeFi sector, however, such specifications can hardly be implemented in practice. The digital association Bitkom has also already emphasized the disadvantages that this creates for the sector. The decentralized logic of the DeFi sector cannot be forced into a centralized corset. After all, the road traffic regulations do not apply to shipping or flight operations.
DeFi applications, such as initial dex offerings, NFT staking within DAOs, liquidity mining etc., may be on the to-do list of the authorities, but these are currently tolerated due to the authorities’ impotence. However, not only is the state watching this development awkwardly, but also many large banks do not know how to deal with this development. Financial institutions in particular, which feel pushed into a corner, could ensure that the pressure on the decentralized crypto sector increases.
Bank lobby should not be underestimated
In contrast to the blockchain sector, the traditional financial world has a massive influence on politics. Bank lobby groups are among the most influential lobby groups. The influence of former top bankers in politics is particularly evident in the USA. From finance ministers to central bank chiefs, many top positions in public offices are held by former bankers at top addresses, such as Goldman Sachs or JP Morgan, occupied.
Should the top banks not be able to integrate interfaces to DeFi applications themselves and offer them to their customers in the near future, then one could very effectively direct one’s interests to politicians. Even if it is said again and again from the USA and Europe that crypto will not be banned, this does not exclude that the de-fi sector is de facto regulated to death. The requirements for DeFi users and operators could be so high that they are no longer economically attractive within the legal framework. A concrete example of this is the draft of the Federal Ministry of Finance (BMF). This provides for an extension of the staking holding period from one to ten years.
Banks and DeFi are not mutually exclusive
If one takes the assumption that innovation will always prevail in the long term, then it is a big mistake for banks not to rely on DeFi. Contrary to the view that the DeFi sector leads to the substitution of the banking sector, banks can use DeFi protocols to increase their own added value.
A purely decentralized financial sector may be an idealistic wish for some, but it is completely unrealistic. A functioning economy requires middlemen who take responsibility and liability and reduce risks. The DeFi sector can therefore be seen much more as an extension of the financial sector that leads to better, more inclusive and fairer offers. The first banks have understood this and are trying to connect to these interfaces – such as ING Diba or the TEN31 in Germany.