Decentralized Finance (DeFi), which is pegged to be the next frontier of fintech innovation, has grown exponentially over the past year. With regulatory scrutiny over DeFi increasing at a rapid pace, Merkle Science’s President, Americas and Global Chief Legal Officer Mary Beth Buchanan was joined at Blockchain Central UNGA 2021 — hosted by the GBBC — by industry experts Ambre Soubiran (CEO, Kaiko), Daniel Peled (Co-Founder, Orbs), Harriet Browning (Director, Business Development and Strategic Sales Manager for EMEA, ConsenSys), Raymond Zenkich (President and Founder, Evertas), and John Salmon (Partner, Hogan & Lovells) to talk about the advancement of DeFi and crypto.
Fulfilling the Promise of Increased Access & Financial Inclusion
With the rise of DeFi in the last few years also came the increased optimism that the nearly 1.7 billion unbanked population around the world will finally gain access to the global economy; however, some share the belief that DeFi may, as of now, be limited to technologists and large financial institutions. To ensure that financial inclusion becomes a reality, it is essential to ensure that the various DeFi services are not only accessible to the everyday consumer but are also adopted by them.
According to Daniel Peled, the DeFi services should be available to consumers in their simplest form as most consumers might not want to dive deeply into the technical aspects of DeFi. To make DeFi more accessible, he urged the developers of DeFi projects to create simpler, consumer-focused services. Another way to increase accessibility is to let trusted traditional financial institutions provide user-friendly frontend while DeFi platforms provide a highly efficient backend.
Harriet Browning took an optimistic view: despite the hurdles, she believes that mass DeFi adoption is well on its way. According to Harriet, the key to increasing accessibility is creating new and innovative use cases for DeFi products that prioritize the needs and safety of users. She observed that user adoption of blockchain infrastructure has gone up due to the increased usage of services such as crypto wallets specifically MetaMask wallet — a non-custodial crypto wallet that focuses on usability and ease of transactions across DeFi platforms. Using the MetaMask wallet as a proxy of the DeFi space, usage of the wallet has grown by 1800% in the past year with over 10 million active users.
Harriet then emphasized the importance of education and DeFi literacy in adoption — from the types of DeFi platforms and their products, emerging trends, regulatory concerns, as well as the opportunities and risks users may be exposed to when engaging with the ecosystem. It is the collective responsibility of the industry to inform users of the risks associated with the DeFi ecosystem.
DeFi Compliance - Ensuring Consumer and Investor Protection
To ensure investor protection and maintain market integrity, regulators are closely monitoring the DeFi space and enacting new regulations to mitigate the risks originating from different DeFi use cases. Therefore, to gain mainstream acceptance, the DeFi industry will have to put consumer and investor protection at the forefront.
Mary Beth Buchanan noted that just because DeFi platforms are not regulated now, they are not immune from oversight. Chairman of the U.S. Securities and Exchange Commission (SEC), Gary Gensler, in an interview discussed the possibility of bringing DeFi under the purview of the SEC. She also stated that regulatory developments in DeFi are coupled with a stronger emphasis on enforcement actions. On 6 August 2021, The U.S. Securities Commission brought its first enforcement action involving a DeFi platform, alleging that Cayman Islands-based Blockchain Credit Partners and two of its top executives illicitly issued unregistered securities and misled investors from February 2020 to February 2021.
Mary Beth accepted that due to the self-governing nature of DeFi and the anonymity it accords to its developers, it might be difficult to bring DeFi platforms under regulatory oversight. Though the technology to facilitate AML/KYC compliance on DeFi platforms may not exist now, she is hopeful that this will be solved in the near future and lauded the efforts of blockchain analytics companies looking for innovative ways to solve AML/KYC compliance problems
Harriet Browning also added that DeFi platforms are coming up with the institutional version of their protocols to fulfil the gaps created by a lack of regulatory clarity. These DeFi products are specifically tailored to meet the requirements of institutions that have strict compliance needs with segregated white label products that have robust KYC processes. Though the industry is working hard to create features that enable the execution of robust monitoring and compliance practices, more regulatory clarity is still required for DeFi platforms to build better tooling
Beyond KYC/AML - A Look at Risk Management in DeFi
Raymond Zenkich urged the DeFi platforms to look beyond AML/KYC risks and actively focus on other risks plaguing the DeFi industry. Unlike Centralized Finance (CeFi), DeFi protocols are not legally obligated to put in place risk management requirements or capital and liquidity requirements. Participants should analyze the underlying operational, insurance, and cybersecurity risks before entering into a DeFi project and proactively enact risk mitigation strategies.
According to Raymond, the DeFi industry is missing a key piece of risk management structure that is DeFi insurance. With crime in DeFi rapidly increasing, it is imperative to put in place a framework that would safeguard platform participants from fraud, scams, and exploits surrounding DeFi. He stated that “insurance is a really important way to help manage risk and also plays a very powerful role in helping people feel comfortable.” This is because users are assured that some other company that posses industry expertise has already checked various elements of the DeFi projects.
About Merkle Science
Fuelled by the increased focus on consumer and investor protection, the regulatory bodies around the globe are looking to strengthen their crypto regulatory regime. Merkle Science’s highly customizable and easy-to-use platform provides near real-time detection of blockchain transactional risks. Our predictive cryptocurrency risk and intelligence platform set the standard for the next generation of financial safeguards and criminal detection.
Merkle Science’s proprietary Behavioral Rule Engine allows crypto businesses to tailor the tool according to their risk policies based on the recent changes so that businesses may stay ahead of emerging illicit activities and fulfill their local compliance obligations.