The European Commission, along with the European Banking Authority (EBA) and the European Securities and Markets Authority (ESMA), are working on a report set to be released by the end of 2024. The report will assess the progress of decentralized finance (DeFi) within crypto-asset markets and consider the necessity of regulations specifically tailored for decentralized crypto-asset systems. One significant area of focus will be on regulating crypto-asset lending and borrowing, as highlighted by Maxim Galash, CEO of CoinChange Financials.
The report hints at potential actions that the EU might take against DeFi protocols that lack authentic decentralization. There are ongoing initiatives to study embedded supervision in preparation for the report, although no policy decisions have been made yet. MakerDAO co-founder Rune Christensen has expressed concerns about the regulatory changes affecting DeFi. He believes that new licensing requirements could be introduced for DeFi protocols, which may result in a divide between fully decentralized and fully KYC-enabled platforms.
Nathan Catania, a partner at XReg Consulting, has suggested that DeFi regulations could extend to all applications that are not fully decentralized, including DeFi frontends. Defining decentralization is identified as a complex task with significant implications for regulatory practices. The key focus remains on determining whether a DeFi arrangement is primarily a technological structure or if there is a controlling entity capable of influencing user transactions.
The landscape for DeFi protocols in Europe is anticipated to face increased regulatory scrutiny through the MiCA framework. As DeFi is a departure from traditional centralized financial systems and utilizes blockchain technology for peer-to-peer finance, new regulations raise questions about the legal status of certain crypto projects.
Under MiCA, entities known as Crypto-Asset Service Providers (CASPs) offer digital asset-related services to external parties. Regulators may take into account factors such as professional service provision when assessing the level of decentralization. Additionally, regulations influenced by the Financial Action Task Force (FATF) could designate individuals or entities impacting DeFi arrangements as Virtual Asset Service Providers (VASPs), regardless of claimed decentralization.
Recent data from DefiLlama indicates a significant increase in the Total Value Locked (TVL) within DeFi protocols over the past four years. The TVL rose from $570 million in April 2020 to $96.7 billion presently, demonstrating a remarkable growth of 16,865% during this period.
