The IOSCO, the global umbrella body for securities watchdogs from across the world, has designed a framework for regulators across 130 jurisdictions covered by its membership to ensure investor protection and stable markets with DeFi, identify and manage risks, obtain clear disclosures and cross-border cooperation to enforce applicable law.
The watchdog explained that shocks in one part of the crypto market can trigger billions of dollars in outflows from Defi applications, evidenced by the collapse of crypto exchange FTX and of the Terra USD stablecoin during 2022.
DeFi platforms allow users to bypass banks and exchanges, the traditional gatekeeps of finance, using blockchain technology which allows from the lending, borrowing and saving of digital assets, however, issues have arisen around whether they are truly decentralised.
Ganesh Viswanath Natraj, Assistant Professor of Finance at Gillmore Centre of Financial Technology at Warwick, said: “The move to crack down on decentralised finance (DeFi) is a significant step in the evolving landscape of cryptocurrencies and digital assets, and it remains essential to strike a balance between innovation and regulation to ensure the long-term sustainability of the DeFi ecosystem.
Transparency and collateralisation can be key factors in ensuring stability, and regulatory bodies should look to possibly mandating stablecoin issuers to maintain transparent levels of capital and conduct scheduled audits to ensure adequate collateral.
The future of stablecoins and DeFi will likely depend on the maturity of individual economies and payment markets. Ultimately, the responsibility lies with authorities to navigate a path forward that fosters innovation while safeguarding the interests of investors and the stability of financial markets. Striking the right balance in regulating DeFi and stablecoins is a complex but necessary task in the evolving world of digital finance.”
Tuang Lee Lim, chair of a fintech taskforce at IOSCO, commented: “There is a common misconception that DeFi is truly decentralised and governed by autonomous code or smart contracts. In reality, regardless of the operating model of the DeFi arrangement, ‘responsible persons’ can be identified.”
Regulators at the moment have little standardised data on DeFi, made worse by market participants using multiple pseudonymous addresses to obfuscate their activities, IOSCO said.
A public consultation on the proposals, which fit with the proposals from IOSCO in May to regulate crypto assets themselves, runs until the middle of October before the framework is finalised nearing the close of this year.
Some member countries of IOSCO, like the US, have already begun looking at how DeFi fits into existing securities laws.