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A European approach to DeFi regulation

Cointelegraph | Thibault Verbiest  | Jan 22, 2022

total value locked in DeFi - A European approach to DeFi regulationThe question for DeFi regulation: Is there an "owner" of the platform who can be held accountable for complying with the regulations?

The great particularity of DeFi protocols is that there is no centralized institution in charge of verifying and carrying out the transactions. All transactions are performed on the blockchain and are irreversible. Smart contracts replace the intermediary role of centralized financial institutions. The code of DeFi applications is open source, which allows users to verify the protocols, build on them and make copies.

The FATF "test": Truly decentralized?

As of Oct. 28, 2021, the Financial Action Task Force (FATF) issued its latest guidance on digital assets. This international organization sought to define rules for identifying responsible actors in DeFi projects by proposing a test to determine whether DeFi operators should be subject to the Virtual Asset Service Provider or "VASP" regime. This regime imposes, among other things, Anti-Money Laundering (AML) and Counter-Terrorist Financing (CFT) obligations.

See:  Rise of Regulatory Compliant DeFi Protocols

FATF, under the new "owner/operator" test, states that indicia of control include exercising control over the project or maintaining an ongoing relationship with users.

Application of security law?

We know that the approach is very different in the United States where the Securities Exchange Commission (by applying the famous "Howey Test") qualifies tokens as securities that would be seen as digital assets in Europe. Their approach is, therefore, more severe, and this will certainly result in more prosecutions of "owners" of DeFi platforms in the U.S. than in Europe.

See:  Central bank institution, BIS, says ‘The decentralization in DeFi just an illusion’

Thus, if DeFi services do not involve digital assets, but tokenized financial securities as defined by the European Markets in Financial Instruments Directive (MiFID Directive), the rules for investment services providers (ISPs) will have to be applied. In Europe, this will be a rare case as the tokens traded would have to be actual financial securities (company shares, debt or investment fund units).

The MiCA regulation

On November 24, the European Council decided its position on the "Regulation on Cryptoasset Markets" (MiCA), before submitting it to the European Parliament. It is expected that this fundamental text for the cryptosphere will be adopted by the end of 2022 (if all goes well...).

See:  Decentralized Finance—Risks, Regulation, and the Road Ahead

We should think about a legal system that takes into account the automated and decentralized nature of systems based on blockchain, so as not to impose obligations on operators who do not have the material possibility of respecting them or who run the risk of hindering innovation by removing the reason for progress: decentralization.

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