Decentralized Finance Crypto Marketplace Under Scrutiny By The Market Regulator 

By Vijeth Shivappa

Interest in cryptocurrency & decentralized finance has been soaring for sometime now as institutional investors & family offices of super-rich began investing in this asset class seeing it not only as an inflation hedge but also as an exposure to gains if it becomes a more widely adopted digital currency & alternate financial system. A well known Investment bank strategists in US in January 2021 , had even wrote that crypto assets emerged as an alternative asset class to gold if it becomes a safe-haven asset.Things are changing fast in the crypto space, and decentralized finance or DeFi is a current trend. Undoubtedly, It’s an exciting space & let’s dig a little deeper into this space to understand more about it.

The Decentralized Finance or DeFi is a financial system that runs without the centralized intermediaries. DeFi creates a financial system that runs on its own. The most well-known application of decentralized finance is online transactions through DeFi cryptocurrency. Inspired by blockchain technology, DeFi is referred to as financial applications built on blockchain technologies, typically using smart contracts. Smart contracts are automated enforceable agreements that do not need intermediaries to execute and can be accessed by anyone with an internet connection.But decentralized finance enables to handle a number of financial applications – like exchanging, borrowing, investing, insurances and lending in a more efficient and transparent way.  DeFi is an open network and works on a peer-to-peer system, where transactions are not routed through a centralized system such as a bank or a brokerage firm.

DeFi revolves around decentralized applications  known as DApps. DApps performs financial transactions on distributed ledgers called blockchains, a technology which was first made popular by Bitcoin and has since been adopted more broadly. DeFi has grown into a complete ecosystem of working applications and protocols that deliver value to millions of users. Assets worth over $82 billion are currently being managed by DeFi Industry, making it one of the fastest-growing segment within the public blockchain space.

There are several Ethereum-based applications which facilitates decentralized, peer-to-peer borrowing and lending. These applications connects lenders with borrowers and manages loans using smart contracts. This has led to a rise in fame for concept of ‘yield farming’, which enabled anyone to lend their crypto assets and earn interest in the process. These apps can also be used for depositing cryptocurrency as collateral and borrow fiat money against it. DAI is a decentralized stablecoin which is pegged against the US dollar – i.e 1 DAI is equal in value to $1 USD. DAI’s value is backed by cryptocurrency collateral, rather than being backed directly by US dollar reserves. Because of its stability, DAI has been an ideal currency for decentralized finance.

The decentralized exchange (DEX) permits to buy, sell, and trade cryptocurrencies on the Ethereum platform without having to go through an exchange operator , without the need for sign-ups or ID verification , and without any fees for withdrawing funds. Unlike centralized exchanges, exchanging with DEX doesn’t need any initial deposit .Trades are executed autonomously with the terms and process based on smart contracts. It is a crypto marketplace for DeFi developers, traders and liquidity providers.Smart contracts in the decentralized finance system make peer-to-peer, decentralized insurance possible as well . In a decentralized finance system one can connect with anyone around the world who is willing to insure assets, and on the other end one can insure other’s assets at a premium, without having to go through any insurance company or an agent. Everything happens autonomously with smart contracts ensuring a secure processing.

The benefits of a decentralized finance system goes beyond online payments. Money transfer is just one aspect , decentralized finance looks to replace every aspect, including exchanges, loans, insurance, and saving plans.Smart contracts on Ethereum allows these decentralized services to exist and operate securely.There are no centralized entities who runs this market place & the platform is ultimately governed by its users . Any development team can leverage the open-source software & there is no entity to check the identities of the people using the platform to adhere to Know-your-customer or Anti-money laundering regulations. Know Your Customer (KYC) standards are designed to protect financial institutions against fraud, corruption, money laundering and terrorist financing.The person or entity behind a DeFi protocol may be unknown, and may disappear with investors’ money. KYC compliance plays a key role in real-time, cross-border payments, facilitating greater levels of trust, transparency and collaboration, while mitigating the risk. A community approach is essential to accelerate the compliance process and create new & more collaborative ways to address financial crime

The Securities market regulator in US is now probing the main developer behind one of the world’s largest cryptocurrency exchanges.The investigation in to this crypto marketplace has come up during these increased regulatory focus into cryptocurrencies and the digital asset market place .The regulatory investigators are looking for more information on how investors use the crypto marketplace and the ways in which it is marketed.It is yet to become clear on what position the regulator may take on the legality of a these platforms. The first major action against the DeFi space came in 2018, when the market regulator shut down another ‘DeFi’ exchange that it deemed to be operating illegally. It is clear that market regulator is seeking more legal powers to better regulate crypto trading and lending.

The market regulator is seeking government to give more authority to regulate DeFi platforms, which are not regulated so far.

–  All views expressed are personal