The debates over regulatory compliance rage in Washington, in the press, and across the crypto community. Whatever the ultimate fate of the bills and amendments put forward one thing remains constant: distributed ledgers and DeFi are here to stay.
They offer solutions to a host of issues that we’ve, so far, been unable to properly address through the fiat system. However, for those problems to be tackled we must take inventory of the issues we face in the shift to mass adoption, decide on the best approach to solving them, and understand what compromises are needed to integrate blockchain solutions into the mainstream once and for all.
A Practical Middle Ground Fosters Practical Regulation
As long as compromise is on the table in good faith from all interested parties, the crypto industry will be able to augment the traditional financial system and make the world a better place for countless people. One thing we should all strive to keep in mind during these ongoing discussions is the real opportunity in reducing financial exclusion. People in developing countries need an alternative to their fiat-based systems and, provided certain safeguards are in place, DeFi is the perfect solution for them.
There is a balance that needs to be met here – the opportunity exists to provide economic stability and opportunity to the world, but we need to do so while protecting users and operating in an anti-money laundering (AML) regulatory framework. We (“the crypto industry”) need real solutions, not half-measures that will lead us further away from legitimacy or pull the rug out from under us when the rules inevitably evolve.
Progress is being made to get everyone on board with the reality that regulations are unavoidable. But we’re still at the point in the cycle where there is a lot of friction and reticence to allow DeFi to even be considered in the regulatory conversation. There are dyed-in-the-wool crypto enthusiasts who reject the idea of regulations on a decentralized platform. But for the industry to grow, flourish, and ultimately become the dominant mechanism of our global economy, we must deploy compliance layers into DeFi.
The Lay of the Regulatory Landscape
The Financial Action Task Force (FATF), the global money laundering and terrorist financing watchdog, should finalize its standards in Q4 of this year. Upon publication of these standards, more than 200 member countries and jurisdictions will be obliged to enforce them, typically in the form of country specific laws and regulation. This creates a problem. The countries and jurisdictions around the world that fall under the global FATF agreement will likely enforce the standards differently. There’s no aspect to the agreement that unifies the enforcement rules across those 200-plus countries and jurisdictions. This could severely complicate global participation in DeFi protocols due to the unique regional know-your-customer (KYC) and AML requirements.
For example, in the U.S., we are okay with verifying people through electronic means such as facial recognition for KYC purposes. In Germany, however, that is not allowed. The only way you can collect KYC information in Germany, in certain instances, is if somebody is physically on a video call with service representatives recording a conversation and following a script.
Since different jurisdictions will have their own separate, nuanced version of the rules, DeFi protocols operating within those jurisdictions will most likely need to rely on licensed, regulated companies to provide compliance services. This will create a de facto need for partnership between decentralized application (dApp) developers and licensed regulated entities. A new industry subset is being born that will broker that relationship between regulators and these private entities, presenting new opportunities to create innovative and competitive solutions that grow the space exponentially, netting DeFi participants a level playing field full of options that reduce cost while increasing liquidity all around.
The Victory is in the Preparation
It is vitally important to set up a standardized framework under which individual jurisdiction-based licensed and regulated entities provide compliance services to create the relationship between regulators and dApps. Only through a standardized and layered compliance approach, which allows for jurisdictional uniqueness and international consistency at the same time, will DeFi protocols remain accessible for global participation. DeFi participation would become regional without such a layered compliance approach, which would have the net effect of increasing financial inequality globally.
The wonderful thing is that we have incredibly smart and passionate people within our own industry who believe in a set of shared core principles. Coordinated activity is already underway to provide solutions and find the fabled perfect balance of compromise. Using the tools of our trade, we are creating safe and non-intrusive solutions from within. And the best thing we could do is enthusiastically put them in place now, so when regulators come for DeFi they find it is ready and able to meet standards without needing change forced upon it. We can operate in a regulated world and keep the core ethos of decentralization intact. If a solution is in place before regulators dictate a solution, we are ahead of the game and in charge of our own decentralized destiny.
Christopher Harding is Director of Risk & Compliance, Compliance Officer at Civic, a decentralized identity platform.