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What Should Regulation Look Like For DeFi?

With the world steadily adopting cryptocurrencies and adjoining innovations, many have also continued to cry foul about the risk of putting money in a young market. While traditional systems have remained relatively stagnant and overregulated, DeFi offers an alternative that is ever innovative.

Peer-to-peer payments enabled by cryptocurrency have increased involvement in the global economy for millions of people who do not have access to traditional banking services. The advent of decentralized finance (DeFi) promises to broaden access to financial services such as savings, loans, derivatives, asset management, and insurance.

People use DeFi to lend or borrow money and earn interest. However, instead of transacting through a third party acting as a mediator, users can interact directly between themselves (with no intermediary) via smart-contract programs.

This financial inclusion-enabling innovation should be able to thrive in a regulated environment in which individuals and institutions are safeguarded and suspicious conduct is discovered and reported. But how do you regulate without fully eliminating the key features of financial inclusion and decentralization? Astra Protocol has the answer. 

The DeFi Regulation Problem

Decentralization is the core philosophy behind DeFi. DeFi has grown during a period of overall economic prosperity and continuous rise in cryptocurrency prices. The steady increase in the value of collateral locked in DeFi protocols indicates that neither individual protocols nor the system as a whole has yet been stressed. It is unclear what will happen to interconnected protocols if one or more of them suffers from significant market-wide pricing fluctuations or large-scale technical outages.

This is a significant concern because DeFi has the potential to be a vector for all three of the primary risks that financial regulators are tasked with managing. The first category is criminal conduct, which includes money laundering, tax evasion, and terrorist financing. The second issue is fraud, which was on full show during the 2017 initial coin offering (ICO) boom, helped by early implementations of DeFi. The third goal is to reduce systemic risk. DeFi and crypto are still unlikely to be large or influential enough to cause widespread financial disruption in the case of a significant market collapse or system failure, but you never know.

Regulators have traditionally relied heavily on the people who administer traditional platforms to control those risks by monitoring their customers and suspicious activity on their platforms. The situation is different with DeFi.

DeFi transactions done between individual users using unhosted wallets, for example, are exempt from Bank Secrecy Act (BSA) procedures like as Know-Your-Customer and anti-money laundering checks. The applicability of the BSA and related FinCEN laws is dependent on the participation of intermediaries offering hosted wallet, exchange, or other specified services, according to Financial Crimes Enforcement Network (FinCEN) guidance. Furthermore, because DeFi protocols permit anonymous transactions, market participants subject to the BSA currently have no practical way of determining what obligations apply to their DeFi transactions. These are also all applicable when thinking about sanctions that apply to DeFi activities. 

Although DeFi projects do not fit well into the present financial regulatory framework, this does not mean that policymakers or regulators should not or cannot control them. As DeFi projects grow in size, it’s becoming clear that they may pose the same kinds of risks that financial regulation is supposed to address. Financial crime, consumer protection, and financial stability issues are among them.

What Does Regulation Look Like?

To address DeFi issues, regulators must incorporate them into their public policy objectives, which include investor protection, market integrity, and the prevention of financial crime. Classification considerations will be difficult, as they are in any new market. The plethora of existing regulatory categories evolved as a result of many statutory and administrative frameworks built with centralized financial services in mind.

Regulators must modify the existing regulatory framework to accommodate DeFi services. They can learn from approaches that are working in the current cryptocurrency industry. Specialized divisions, such as the Securities and Exchange Commission’s FinHub and the Commodity Futures Trading Commission’s LabCFTC, enable regulators to gain experience in new technology, communicate productively with the sector, and provide informal regulatory guidance. Disclosure rules or safe harbors might encourage market players to give regulators with information that will assist them in better understanding market dynamics and developing best practices.

Regulatory sandboxes, such as the one established for fintech by the United Kingdom’s Financial Conduct Authority, provide a safe area for regulators and new services to work through challenges. Security and Futures Act in Singapore also represents a similar regulatory model. Furthermore, authorities should initially clarify relatively simple issues in order to provide direction to the industry. This allows regulators to focus on more difficult issues while ensuring market participants remain secure.

Another way to regulate without sacrificing decentralization is to implement regulatory protocols hard-coded into DeFi platforms or added as a layer to existing platforms. One of such layer is the Astra Layer, a legal compliance and regulatory protocol for the DeFi space. 

Astra As A Regulator 

The Astra Protocol provides a unique way for decentralized entities to comply with global standards and regulatory norms while remaining decentralized. At a crucial moment when there is so much skepticism, Astra strives to instill the required trust in the crypto and blockchain ecosystems.

Astra’s goal is to develop a legal layer that can be linked to any existing DeFi platform. Astra ensures that funds are always delivered safely to their intended recipient. If there is a problem, the team can quickly rectify it and return the cash. Any issues can be resolved amicably by including a conflict clause – also known as proof of trust – in the platform and smart contract.

This innovation is predicated on a Proof of Trust system, which delivers peace of mind in commercial transactions and contracts via an extra-judicial and extra-jurisdictional dispute resolution method. The PoT system aids in the rapid resolution of inadvertent or fraudulent transactions, hence protecting stakeholders.

 

To resolve all problems, Astra uses a combination of human knowledge and technology. This includes human mistakes, accidental payments, and fraudulent transactions.

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