In the quest for the involvement of institutions in decentralised finance (DeFi), there’s an excellent deterrent – regulatory uncertainty.
While the inherent features of DeFi, such as permissionless markets, pseudonymity, and censorship-resistance, are desirable, they pose challenges for institutions seeking compliance with existing or future regulations.
To foster the growth of DeFi and attract a broader capital base, it must strive to achieve the equilibrium between privacy and transparency using a proactive approach to compliance.
Transparency and Compliance
Specific crypto verticals undermine or disregard the significance of regulatory compliance, even standard disclosures meant to increase transparency, because of belief in the industry’s philosophy origins (commitment to privacy) and technical foundations (being transparent by default). For the most part, DeFi has leaned towards this view.
However, recognising the importance of transparency and compliance is imperative. Privacy and transparency need not be viewed as mutually exclusive; they exist on a spectrum.
DeFi and Web3 devise novel methods to navigate this spectrum. This can benefit individual traders and entire industries, help return privacy to its rightful place as an actual business prerogative, and ultimately, something to be negotiated under flexible terms.
Advanced research in zero knowledge technology, secure multi-party computation, and other cryptographic areas offer the potential for traders to maintain privacy while implementing compliant fraud-prevention mechanisms.
Addressing institutional concerns requires demanding solutions, such as on-chain intellectual property protection and real-time anti-money laundering (AML) analytics.
Protections for proprietary trading
Ensuring that the strategies of prominent players remain safeguarded and protecting intellectual property are crucial aspects for DeFi’s usability to appeal to more institutional investors. No institutional investors will get meaningfully involved in DeFi if all their intellectual property is displayed to competitors on any block explorer or in the exchange.
Streamlined identity verification
Streamlining identity verification is another challenge to overcome, particularly in integrating DeFi infrastructure with compliant systems. As regulations loom over crypto and Web3, a user-friendly, end-to-end compliant approach should be available, including interoperable KYC and KYB tools within blockchain ecosystems like Ethereum.
The intersection of identity verification and AML regulations is significant, and on-chain AML analytics present viable alternatives to traditional software. These analytics facilitate compliance and offer advantages in on-chain risk management and due diligence processes for institutional players.
Is DeFi ready?
As conversations about exchange-traded funds (ETFs), tokenisation of real-world assets, and significant fintech brands entering the Web3 space signal increased institutional capital inflow into crypto markets, the readiness of DeFi becomes a pertinent question. While the necessary technology is emerging, sustaining DeFi’s growth requires maintaining a balance between privacy and transparency. This equilibrium is essential for alleviating institutional concerns and ensuring compliance with legal obligations, thus paving the way for sustainable growth in DeFi markets.