The decentralized finance (DeFi) market capitalization crossed the $ 140 billion mark for the first time today, an increase of over 500% since the start of 2021, and there are now over $ 128 billion. of dollars of total value stuck in DeFi, according to CoinGecko Data.
DeFi, which exploded in popularity during the summer of DeFi 2020, continued to grow in terms of the total value locked in DeFi protocols and the number of users. Last week, blockchain software technology company ConsenSys said the number of monthly active users for its MetaMask crypto wallet – a gateway to access DeFi – had increased five times in the past six months and now exceeded five million. .
DeFi refers to peer-to-peer financial services that are built on distributed networks without central intermediaries. DeFi applications include stablecoins, blockchain-based lending and borrowing, margin trading, payments, insurance, gaming, and non-fungible tokens (NFTs).
As the DeFi market matures, the industry sees a wave of regulatory focus on Know Your Customer / Anti-Money Laundering (KYC / AML) requirements, particularly related to self-hosted wallets, according to a recent ConsenSys Q1 2021 DeFi report. Regulators are trying to keep pace with developments and provide clarification to users and businesses, the report notes.
See the related article: What is the future of DeFi and what does it mean for traditional banks?
What is the FATF and why what it does matters
In March, the Financial Action Task Force (FATF), the global money laundering and terrorist financing watchdog, released its draft guidelines on “a risk-based approach to virtual assets and vendors of virtual asset services ”. According to some analysts, these guidelines, which could be approved later this year, could pose an existential threat to the burgeoning DeFi industry.
The FATF guidance, first published in 2019, imposed anti-money laundering and terrorist financing (AML / CFT) obligations on virtual assets and virtual asset service providers – similar to requirements generally required by banks and financial institutions. The 2019 guidance also extended FATF Recommendation 16 – commonly referred to as the “travel rule” – to VASPs. The travel rule requires financial institutions to transmit certain information to the following financial institution, as part of certain fund transfers involving multiple financial institutions.
According to the FATF, changes to its pre-existing guidance are aimed at maintaining a level playing field for VASPs, based on the financial services they provide in accordance with existing standards applicable to financial institutions, as well as minimizing opportunities for regulatory arbitrage between sectors. and countries.
What the FATF recommends is important because it defines global AML / CFT standards that regulators must implement, and countries are assessed every few years for their compliance with FATF AML / CFT standards.
See the related article: Hong Kong plans to ban retail investors from trading cryptocurrencies
“MAS keeps pace with the rapidly changing space of virtual assets. We are ready to adjust our regulatory approach to continue to promote responsible innovation that properly manages risk, ”said a spokesperson for the Monetary Authority of Singapore. Forkast. News in an email. “The FATF Guide, which is being finalized, aims to help jurisdictions and virtual asset service providers address risks in the industry. We study it carefully to assess whether our rules need to be changed. ”
Given the ease with which virtual assets can cross borders and the uneven implementation of international standards globally, international cooperation and coordination will be vital for regulators, according to a recent report on “Overseeing crypto-assets for the fight against money laundering ”by the Bank for International Settlements.
See the related article: KPMG: virtual asset service providers ready to professionalize and grow
If adopted, the updated FATF draft guidelines could significantly broaden the definition of VASPs to include cryptocurrency exchanges and Decentralized Application Owners or Operators (DApps), which could therefore require that ‘They are regulated to perform in-depth KYC / AML checks for every part of a transaction, including self-hosted wallets. VASPs should collect the required client information even for transactions involving non-hosted wallets where there is no home institution or beneficiary.
See the related article: How FATF’s Anti-Money Laundering Guidelines for Cryptocurrency Put Pressure on Banks and VASPs
Industry Responses to the FATF Guidance Draft
The public comment period for the draft guidance ended on April 20, with many organizations in the blockchain and crypto industry submitting responses to the FATF and calling for more clarification. The draft guidance was not approved and the FATF will make further changes at its June 2021 meetings.
These guidelines are “overall a step in the right direction” in terms of providing more clarity and certainty on regulations, said Chia Hock Lai, co-chair of the Blockchain Association Singapore, in an interview with Forkast. News. However, Chia added, more discussion is needed on the implementation timeline as well as the definitions of DeFi and NFT.
Others have expressed reservations or expressed concerns. They say parties could be classified as VASPs even when they are not responsible for the AML / CFT governance of a virtual asset project and therefore face unnecessary regulatory burden, alongside increasing responsibilities for supervisors in general.
The draft FATF guidelines were “a bit too broad” and need to be more narrowly defined so as not to have the unintended consequence of integrating people into the ecosystem, especially decentralized ones, which would subject them to regulations at the national level. said Malcolm Wright, chairman of the advisory board of Global Digital Finance, an industry group.
“We are very supportive of the guidance, but we want to continue working with the FATF and with national regulators, as we are doing now, to be able to shape this in a way that does not stifle growth, opportunities and innovation, and at the same time, mitigate the risks of money laundering, terrorist financing and the types of behavior we want to exclude, ”said Wright, in an interview with Forkast. News.
Grace Chong, FinTech regulatory lawyer at the international law firm Simmons & Simmons, advocates a balanced approach and that the FATF consider the practical implications of its draft guidelines.
“There have been a lot of concerns about how these recommendations, if implemented, might chill the industry,” she said in an interview with Forkast. News.
Lucy Gazmararian, co-chair of the blockchain committee of the Hong Kong Fintech Association, said Forkast. News: “DeFi currently operates with minimal KYC / AML controls and is largely unregulated compared to CeFi (centralized funding) where the regulatory framework is clear and centralized VASPs at a minimum must meet the standards set for traditional financial institutions.”
“While this imbalance between CeFi and DeFi needs to be addressed and expanding the definition of VASP is a reasonable way to achieve this, the problem is that without clear guidelines as to who / what / when becomes a VASP in the within a diverse decentralized ecosystem, regulators in different jurisdictions can be cautious and enforce too strict a regime, ”Gazmararian said. “As DeFi is still in its infancy and experimental stage, a tough regulatory approach can serve to stifle innovation and healthy development in the FinTech industry. At worst, a nonspecific approach can drive DeFi innovation underground and with it any associated ML / TF activity. “
For now, CeFi companies are already taking steps to meet FATF requirements. Cryptocurrency exchange Crypto.com announced this week that it will use CipherTrace’s Traveler solution, the first commercial solution to enable compliance with the FATF travel rule.
But there is still a lot to do. In its response to the draft guidelines, the Washington DC-based Blockchain Association pointed out that “newly captured non-conservative VASPs would not be able to comply with requirements such as asset freezes because protocol users decentralized financial institutions retain full independent control over their assets. Entities potentially captured by the draft updated guidelines that would be unable to implement or comply with existing AML / CFT controls in decentralized financial protocols include governance token holders, software developers, entities non-custodial and stand-alone computer programs. “
The Blockchain Association wrote that instead of trying to regulate a middleman that doesn’t exist or forcing projects to operate as regulatable forms, a more effective approach would be to focus efforts on development and adoption by consensus of new regulatory mechanisms that can be incorporated. in decentralized financing protocols.
“This way forward will require a partnership between the FATF and national authorities, on the one hand, and digital asset industry leaders, on the other hand, to design standards and solutions that meet legal needs, technical and commercial, ”the Blockchain Association wrote.