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On Thursday (September 8, 2023), global securities regulators revealed their initial framework aimed at holding participants in the world of “decentralized finance” (DeFi) accountable for their actions and ensuring market stability.
DeFi platforms utilize blockchain technology to enable users to lend, borrow, and save digital assets, sidestepping traditional financial intermediaries such as banks and exchanges.
The collapse of the crypto exchange FTX and the Terra USD stablecoin in 2022 demonstrated how disruptions in one part of the crypto market could lead to massive outflows from DeFi applications, according to IOSCO, the global body that represents securities regulators worldwide.
These events have caused the DeFi sector to contract from approximately $180 billion in late 2021 to roughly $40 billion today. Additionally, IOSCO noted that the DeFi sector is susceptible to money laundering.
Tuang Lee Lim, chair of a fintech taskforce at IOSCO, remarked, “There is a common misconception that DeFi is truly decentralized and governed by autonomous code or smart contracts.”
In reality, DeFi stakeholders and their roles, as well as the organizational, technological, and communication methods they employ, often resemble those found in traditional finance.
Lim added, “Regardless of the operating model of the DeFi arrangement, ‘responsible persons’ can be identified.”
Regulators currently have limited standardized data on DeFi, exacerbated by market participants using multiple pseudonymous addresses to obscure their activities, according to IOSCO.
The watchdog has put forth a framework for regulators in its 130 member jurisdictions to ensure investor protection and market stability within the realm of DeFi. The framework also aims to identify and manage risks, facilitate clear disclosures, and promote cross-border cooperation to enforce relevant laws.
IOSCO has recommended that regulators employ existing laws or enact new ones if necessary to obtain a comprehensive understanding of DeFi, including the identities of individuals and companies involved.
A public consultation on these proposals, which align with IOSCO’s previous recommendations in May regarding the regulation of cryptoassets, will run until mid-October. The finalized framework is expected to be in place by the end of 2023.
IOSCO members commit to implementing agreed-upon recommendations, and some countries, such as the United States, have already initiated examinations of how DeFi fits within existing securities laws.
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