DeFi regulation cannot kill the values behind decentralization

DeFi regulation cannot kill the values behind decentralization
The increase in the number of DeFi platforms improves financial integration and should be allowed to flourish in a regulated and thus protected environment.

The development of decentralized finance (DeFi) allows people who previously did not have a bank account to access financial services. Thanks to DeFi, these people have the opportunity to save money, take advantage of simple loans, derivatives and insurance products.

This innovation, which enhances financial integration, should develop in a regulated environment where individuals and institutions are protected and suspicious activity is identified and reported. But how to regulate these decentralized products without completely removing the basic attributes of decentralization?

Know Your Customer (KYC) procedure is a key function of risk assessment and legal compliance with anti-money laundering (AML) laws, which vary by jurisdiction. Most of these anti-money laundering laws are introduced for good reasons: to deter criminals by making it more difficult for them to launder money obtained through illegal activities (e.g. human or drug trafficking, terrorism, etc.). AML regulations require financial institutions to know the true identity of their clients, monitor transactions, and report suspicious financial activity.

Given that decentralized applications (DApps) do not have a central controlling entity, it is unclear who is responsible for ensuring that DApps, including DeFi applications, comply with applicable laws and regulatory requirements.

Suppose someone is using a decentralized exchange (DEX) to launder stolen funds. Who is responsible for reporting such transactions? Who goes to jail or pays a fine for failing to report such information to the relevant authorities? Members of the decentralized autonomous organization (DAO) that manage DApps? Developers who wrote the code?

While these questions remain largely unanswered, the global anti-money laundering authority, the Financial Action Task Force (FATF) recently proposed guidelines that make it clear that the owner / operator of DApps will be responsible for illegal use of its service.

This suggests that DApps (DEX and other DeFi applications) will be responsible for complying with national laws enforcing FATF, AML and Counter Terrorism (CTF) standards.

Remember that the rules are currently aimed at businesses, not individuals. So your peer-to-peer transactions aren’t much of a problem for regulators, unless you’ve laundered millions of dollars in cryptocurrencies and sent them through the cryptocurrency platform’s payment network. At this point, the exchange would be required to identify the transaction as suspicious and alert the regulatory authority in its jurisdiction.

In this exciting stage of the investigation, if law enforcement requests certain personally identifiable information correlated with the transaction, the exchange is required to provide it. This is why centralized exchanges require users to fill out KYC – to have this personal information if required. However, the vast majority of DEX do not have fully compliant processes. Will the DEX exchanges have to destroy the freedoms of our decentralized revolution to meet evolving standards?

24-08-2021, Mr Advice TEAM

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