DeFi: A shrinking window of opportunity

With regulators unlikely to change old-fashioned rules in favor of the emerging market, DeFi might be burdened under fraud and new portions of restrictions.

Over the years, we have seen a lot of trends such as initial coin offerings, initial exchange offerings, security token offerings, decentralized autonomous organizations and many more, but none of these have become the mainstream. The concept of decentralized finance undoubtedly has its merits, but as the factors that sank the predecessors remain, we have reason to conclude that DeFi is not for long. 

The window of opportunity has shrunk for several reasons: firstly, because of fraud within the space; secondly, the readiness of regulators to “save” the market from violators by imposing old-fashioned red tape and new restrictions; thirdly, the lack of understanding that emerging crypto companies are pointless under traditional bureaucratic regulations, as fintech itself is the response to their ineffectiveness and constraints. However, the idea of nurturing an absolutely new approach for crypto-based services has not yet gained a foothold.

The highwaymen will return

In the initial coin offering boom of 2017, many unscrupulous entrepreneurs tried to leverage the emerging industry for easy money. Now, it seems like those entrepreneurs are coming back. There is a thing called a “statute of limitations” that makes criminals free from punishment if they are not caught. When the period for a specified crime expires, the courts no longer have jurisdiction.

For example, in the United States, the statute of limitations for fraud is three to four years, depending on the state. This means that bad actors who have been laying low since committing fraud during the 2017 ICO boom as well as those who missed their opportunity to do so may come back for round two. Moreover, they intuitively understand that the opportunity might be short, and so are more likely to act aggressively and use more sophisticated means of deceit.

Regulators are more prepared

Regulations on securities and exchanges in different countries specify formal rules and procedures for financial markets and instruments, which involve registration, licensing, due diligence, Know Your Customer commitments and more. The possibility of fraud and violations of these rules leads us to another consideration: At some point, the authorities might hold investigations on both fraudsters for committing crimes and honest entrepreneurs for formal noncompliance.

After years of exploring new technologies and emerging markets, regulators are now more knowledgeable than ever before.

Token sales disappeared from the scene due to two factors: scams that cast a shadow on the emerging industry, and regulators that demand compliance and fine violators. The regulators are heroes who protect the society from unscrupulous businesses — we will hear this narrative when a large number of naive small investors find themselves fooled and demand justice.

Sublimation is not an effective response to regulator pressure

One may think that following the rules and procedures is the best strategy for the emerging crypto market. But the fact is that old-fashioned regulations constrain emerging industries. Fintech, and specifically decentralized finance, is actually the response to an ineffective, overcomplicated and outdated bureaucratic system.

A new industry of tokenomics introduced easy ways to access crowdsourcing as an alternative to venture capital funds and traditional financial markets, but the bureaucratic regulations subsequently imposed led to a reduction in token sales.

Instead, some parts of the market tried to respond by inventing the security token offering as an ICO alternative. STO intended to wrap crypto startups into “proper” business forms and procedures, but it did not become mainstream. People remember a lot of successful ICOs — Ether (ETH) itself is the result of a token crowd sale, but who knows any successful STO that could be compared to Ethereum? The reason is obvious: The market does not want to deal with dead-weight bureaucracy.

Did Lichtenstein’s law fail?

Understanding that regulations require change, some countries undertook efforts to introduce legislative amendments. Unfortunately, they could not go beyond the causal paradigm of paper-based regulation and the redundant involvement of central authorities. There are no smart laws and no automated decision-making systems — code is still not law.

For example, Liechtenstein, after two years of legislative work, introduced a new statute law in 2019 dubbed the Blockchain Act. A new bureaucratic machine to serve the purposes of ICOs and other fintech initiatives is up and running, but nobody wants to use it. As of today, its public registry contains just one fintech provider, registered for four types of activities.

Some legal advisors urge that this is only the beginning, but because registration takes up to three or four months and is clunky and bureaucratic, the act is unlikely to have any prominent future. As one of the more popular DeFi memes stated: “One hour here is seven years on Earth.”

Conclusions

As the trend of DeFi technology consistently outpacing legislation continues, we might eventually see a better response from authorities. They now more quickly identify misconduct and draw astute conclusions. They are educated and have powerful tools to trace and analyze transactions, which, as we remember, are transparent on a blockchain. But they will be chasing both fraudsters and honest entrepreneurs for formal noncompliance with obsolete regulations.

Therefore, a possible future for DeFi is that the emerging industry has a shorter window of opportunities than others (ICOs, IEOs, STOs, etc.) enjoyed. Meanwhile, more fraudsters could try to get in on the action, possible scandals will attract the attention of the authorities, and regulators will come up with new portions of restrictions to save the market and protect people.

The only viable response is rethinking the fintech regulation model from scratch and renouncing traditional instruments such as bureaucracy and paper-based rules in favor of autonomous decision-making systems. But that’s a subject for another discussion.

The views, thoughts and opinions expressed here are the author’s alone and do not necessarily reflect or represent the views and opinions of Cointelegraph.

Oleksii Konashevych is the author of Cross-Blockchain Protocol for Government Databases: The Technology for Public Registries and Smart Laws. He has been collaborating with the RMIT University’s blockchain innovation hub, researching the use of blockchain technology for e-governance and e-democracy, and works on the tokenization of real estate titles, digital IDs, public registries and e-voting. Oleksii co-authored a law on e-petitions in Ukraine, collaborating with the country’s presidential administration and serving as the manager of the nongovernmental e-Democracy Group from 2014–2016. In 2019, Oleksii participated in drafting a bill on Anti-Money Laundering and taxation for crypto assets in Ukraine.