by Norman Wooding, founder and CEO of SCRYPT
External or centralised regulation is incompatible with decentralised finance (DeFi). This should not be considered a controversial statement. After all, the very essence of DeFi – its distributed ledger technology, such as a blockchain – should preclude the need for oversight. And yet, driven in part by deception and distortion at the intersection with traditional finance, it is now necessary to defend the DeFi concept.
Sadly, misinformation and bad actors have conspired to undermine the reputation of one of the greatest innovations in the history of transactional exchanges. The future of DeFi is in the balance. I believe self-regulation can secure its future.
Over the last decade, instead of spreading and diluting risk by increasing the number of ‘nodes’, legacy banks have been encouraged to combine and centralise the risk, thereby increasing all customers’ exposure to it. That was the impetus behind blockchain’s conceptualisation in 2008.
Consider current events. Despite increased regulation and oversight of the banking industry post the global financial crisis, many people are once again grappling with the realisation that the traditional financial system doesn’t always adequately protect their interests.
It seems absurd that in this situation DeFi is on the back foot. If it were not for the sudden demise of SVB and the subsequent investor flight to cryptocurrency, DeFi might have been sunk by the latest failures of the banking system. Besides, if a malign player is determined to perpetuate a fraud, they will often find a way regardless (see Bernie Madoff, Wirecard, Theranos, etc.).
The truth is BlockFi, FTX and Genesis were never DeFi. These were centralised counterparties profiting off the back of the DeFi industry’s hard-won gains. As a result, some have called for national governments, regulators, and central banks to bring blockchain services under their control. That would be a mistake.
It is not that the sector cannot work with regulation; it can. It is that regulators are not currently set up to deal with DeFi’s foundational concept – a truly boundless and borderless financial system of, and for, its peers. If we are to keep the DeFi system free from outside interference, however, something has got to give at our end.
Self-regulation is possible when an industry shares a strong sense of collective responsibility. Few industries are better primed for this than DeFi since its distributed model relies on a collection of equal peers, each responsible for authenticating and sharing transactional data. What is more, peer-to-peer architecture functions better the more active peers are part of the network. It follows, therefore, that existing users would want to encourage and maintain a safe environment to attract new peers and improve the system.
Even a cursory glance at the numbers suggests this is largely already the case. According to blockchain analytics platform Nansen, DeFi user numbers have gone from 4.7 million at the start of 2022 to more than 6.5 million today – a 38% increase. The number of unique users has increased by nearly 700% over a two-year period, up from just 940,000 users at the start of 2021.
Guided by a crowd-sourced framework or collectively agreed-upon approach, a code of ethics could guide the DeFi market and mitigate against bad actors to defend the common interest. Imagine a DeFi form of the Bar Council, the ‘approved regulator’ of barristers in England and Wales, which exists to serve the public and plays a crucial role in upholding the principles of accountability under the law.
At the same time, we, the DeFi community, must demonstrate the significant, practical, and beneficial use cases of distributed ledgers beyond the cryptocurrency hype. Unfortunately, blockchain and Bitcoin have become synonymous since they went mainstream, and little has been done to correct this.
Blockchain goes far beyond being the bedrock of well-known cryptocurrencies. It is an example of the foundations of DeFi. Its security, transparency, and data traceability features create beneficial use cases in financial services which could include smart contracts, bank transfers and remittances, and KYC/AML data authentication.
As the public learns the difference between those profiteering from speculative cryptocurrency trading and DeFi innovation, levels of trust users will grow. The process of self-regulation combined with the provision of better information about what DeFi can do will make all the difference.
External regulation will not work on DeFi. It’s time to start talking about an approach that will and DeFi’s benefits can support the rise of a truly global and inclusive financial system.