Cryptocurrency

Stablecoin regulation could spell the beginning of the end for DeFi

Zegex

Since the concept of decentralized finance (DeFi) came to the forefront of the crypto space in 2020, critics (including me) notes that much of this sector is decentralized by name alone.

One key area of ​​centralization lies in the various stablecoins that make up a large part of the DeFi economy.

To understand how important these centralized stablecoins are to the DeFi space, consider: Over half of Uniswap’s trading volume in the last 24 hours Implemented on the UDC-ETH trading pair, About 94% of assets rented in compound USDC, USDT, or DAI (Substantially USDC Derivatives at this point).

There are multiple projects with the intention of building more decentralized permissionless stablecoins for DeFi, but the reality is that USDC, USDT, BUSD, DAI, and all other major stablecoins , currently backed by assets held by traditionally regulated financial institutions. In other words, governments can outlaw large parts of the DeFi economy with a pen strike.

Latest comments from the Fed

during the last week DC Fintech Week, Michael Burr, Deputy Chairman for Oversight of the Federal Reserve Board, made mixed comments regarding the crypto industry. Barr doesn’t see a viable future for native cryptocurrencies like Bitcoin as money, but he believes stablecoins have potential.

That said, Mr. Barr has covered many of the risks associated with dollar-pegged crypto assets. Perhaps most interesting in the DeFi context, Barr points out that stablecoin issuers may not be able to track who is using their tokenized dollars.

“As banks explore different options to harness the potential of technology, it is important to identify and assess the new risks inherent in those models and whether those risks can be overcome.” Mr Barr said.

“For example, in some models under consideration, banks may not be able to track who holds tokenized liability or whether their tokens are being used for dangerous or illegal activities. “

Work is underway on technical solutions to manage these risks, but it remains to be seen whether banks will be able to make such arrangements consistent with safe and sound banking practices and in compliance with relevant laws. This is an open issue.

Given these outstanding issues, banks considering experimenting with these new technologies should do so only in a controlled and limited manner. As banks experiment, they discuss the benefits and risks associated with these new use cases early and often with regulators to ensure that banking operations are conducted in a safe, sound and legally acceptable manner. Encourage banks to verify that they are consistent with “

This is not the first time the issue of anonymous stablecoin usage has been brought up or even alluded to by regulators and government officials, but it is perhaps the most obvious. In September 2020, the U.S. Office of the Comptroller of the Currency (OCC) provided guidance (PDF) for banks wishing to provide assistance to stablecoin issuers.

However, the comments from the OCC did not specifically address the issue of stablecoins being held in an uncustodial manner. “We are not currently addressing authorities supporting stablecoin transactions involving non-hosted wallets,” read the guidance.

Most recently, the White House announced The White House said the Treasury Department will complete an illicit financial risk assessment for the DeFi sector by February 2023. In the same announcement, the White House said the development of a central bank-issued digital currency (CBDC) could help support the effectiveness of the economic sanctions imposed by the United States around the world. This is of particular interest in the context of the recent boom in stablecoin usage in Russia (According to data from blockchain analytics firm Chainalysis) has been subject to severe economic sanctions in response to its invasion of Ukraine.

While there is still a lot of regulatory uncertainty when it comes to stablecoins today, the current best practices used by major providers are the Collecting personal information. While this leaves room for stablecoins to be used pseudonymously on the blockchain, Chainalysis is constantly on the lookout for when users interact with the traditional banking world. It is important to remember that in most cases you will need to identify yourself.

What is the impact on DeFi?

For clarity, there are currently no plans to implement stricter Know Your Customer (KYC) and Anti-Money Laundering (AML) regulations for US stablecoins. Over the past year, we have pushed for stablecoin regulation.

In terms of impact on DeFi, increased regulation of stablecoins will be massive. A major selling point of various DeFi apps is the ability to trade, borrow, lend, and perform other financial activities without surrendering personal information. While this has obvious usability benefits and can also improve end-user privacy, those selling points are lost in situations where stablecoin users must identify themselves.

While it is true that stablecoin holders can hold their own keys in a more regulated environment, the reality is that these are still IOU tokens where traditional banks hold real value. So it’s a moot point. Users should also consider the following issues: Minor extractable value And expose their finances, directly tied to their real-world identities, on a public blockchain. At that point, it may make sense for many DeFi users to return to the traditional centralized exchange model.

“If stablecoin transactions had to follow travel rules, a centralized stablecoin would essentially be PayPal,” he said. sovereign When contributor Yago was asked for comment. “DeFi will probably fork under scenarios where some protocols are allowed and others become more censorship resistant. There is none. “

The Travel Rule Yago referred to is a guideline of the Financial Action Task Force (FATF), an anti-money laundering intergovernmental organization. By complying with the Travel Rule, the FATF will allow virtual asset service providers to block terrorist financing, stop payments to sanctioned entities, enable law enforcement to subpoena transaction records, and prevent suspicious financial activity. It says it can help with reporting and prevent money laundering through cryptocurrencies more generally.

Of course, stablecoin issuers like Tether still recognize the role of dollar-pegged tokens as the regulatory hammer hits the sector. “

We envision USDT to remain the most widely used stablecoin on the market as a stable and efficient way to send dollars globally, just as Tether customers do today. AML regulations have been implemented.

In an exclusive chat with CryptoSlate, Ardonio commented:

“Tether has a wide variety of use cases, especially in developing countries like Argentina, Brazil, and Turkey. Instead of sending money through banks, you can easily send money between exchanges and people. Available at places to buy currency (exchanges), tethers are often used as a way for traders to hold money on exchanges when they feel the market is very volatile. It is also finding utility within emerging markets working to combat inflation and within the bustling e-commerce ecosystem.”

Regarding the potential impact of tighter stablecoin regulation on DeFi, Aldoino specifically avoided the topic of DeFi, pointing instead to the potential growth benefits of clearer regulation in this space:

“Stablecoin regulation will provide the clarity needed for large corporations, financial institutions and fintech companies to enter the crypto market,” said Ardoino. “We believe a more secure and regulated crypto ecosystem will benefit all parties involved and regulation will open up gateways for more products to enter the market. The fact that stablecoin regulation has become such a hot topic for regulators since they were invented in 2014 is further validation of their usefulness and is very It’s exciting. If anything, regulation will send the message that stablecoins and digital currencies are here to stay as key elements of economic freedom.”

It is unclear whether the potential division of the DeFi space into regulated and unregulated environments will occur at the stablecoin layer or at the base blockchain. Potential regulatory capture of Ethereum Since the transition to Proof of Stake was completed. “Unless the global regulatory regime changes dramatically, more and more centralized stablecoins will become PayPal,” Yago added.

DeFi won’t go away completely in a world with tighter KYC and AML enforcement for stablecoins, but the sector will be a tiny fraction of its current size as many of DeFi’s utilities will be removed once and for all. It is clear that leading you to regulate stablecoins.

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