The report emphasizes the potential of DeFi for lower financial audit costs and significant opportunities for cross-border financial integration.
Analysts from the European Commission demonstrated an unexpected understanding of how decentralized finances (DeFi) work, having defined it as distinct from the traditional financial system and acknowledging that it would necessitate a rethinking of regulatory approaches.
Patrick Hansen, a crypto venture advisor at Presight Capital and a long-term expert on European regulation, shared some key details from the EU Commission’s “European Financial Stability and Integration Review 2022” on Monday, May 2. A 12-page chapter on DeFi is included in a report dated April 7, in which the authors demonstrate a reasonable approach to the topic.
DeFi is defined as “a newly emerging form of autonomous financial intermediation in a decentralized digital environment powered by […]’smart contracts’ on public blockchains,” according to the report. It recognizes smart contracts as “substitutes for regulated intermediaries” and recommends that regulatory efforts focus on communication with the specific DeFi teams that create these contracts.
The report highlights the key advantages of the DeFi over the traditional finance system, emphasizing the distinction between the two:
“Compared to the traditional financial system, DeFi claims to increase the security, efficiency, transparency, accessibility, openness, and interoperability of financial services.”
The potential of the public blockchain for researchers and supervisors is highlighted, as they will have free access to the entire time series of historical and real-time trading data, which will help them better understand the risks that “often remain obscure in the traditional financial system.”
Among other things, the report emphasizes DeFi’s potential for lower financial audit costs and significant opportunities for cross-border financial integration. It also advocates a sensible regulatory approach, proposing a shift from an entity-based to an activity-based strategy:
“However, it is obvious that simply copying traditional regulatory approaches in a decentralized environment may not be an option, since they have traditionally focused on intermediaries that play a central role in the financial system. Adapting the regulatory framework to a decentralized environment may be challenging and would require a rethink of how we approach regulation.”
As Hansen concludes, despite the “worrying takes on the regulation of […] project teams and code,” he is pleasantly surprised by the DeFi chapter’s level of knowledge. In that sense, the document comes as a relief after a string of contentious episodes in the EU’s regulatory routine, including a last-minute reversal of a planned PoW-mining ban in the MiCa draft and an attack on non-custodial wallets in the Transfer of Funds Regulation amendments.
