‘Wake up and smell the coffee’ — regulation is coming to DeFi, says expert

Since the Financial Action Task Force, or FATF, introduced its controversial “travel rule” for businesses in the crypto space, the debate over the suitability of established regulatory frameworks for cryptocurrencies has been unrelenting. 

Some experts, however, believe that the industry’s experience with the FATF guidelines is only the tip of the iceberg and hints at more significant challenges down the line. 

During the concluding panel of the V20 conference on Nov. 18, Siân Jones said that the collision between new, decentralized models of finance and older models of regulation has implications that both regulators and the community are not yet really tackling head-on.

XReg Consulting, where Jones is a founding and senior partner, is a group of former regulators who have practical experience in developing public policy and regulation for blockchain and crypto assets. During the panel, Jones said that the FATF’s overall framework for preventing money laundering, and its travel rule in particular, emerged out of a different operational and technical era altogether: the years in which structures such as SWIFT became widely adopted and globalized transactional finance took off.

SWIFT’s founding members, which count 239 banks across 15 countries, were all well-funded and part of a mature banking industry, Jones noted. By contrast, the entities that the FATF has defined as Virtual Asset Service Providers, or VASPS, come from a much younger, less established space. For this reason, the imposition of the travel rule and the expectation that it could be so swiftly implemented by these businesses is “beyond me,”  Jones said.

These significant difficulties notwithstanding, Jones said that the FATF’s framework, narrow as it is, could be reconcilable with the parts of the crypto industry that have become “industrialized,” i.e., mediated by exactly those entities defined as VASPs. 

Over time, however, more and more participants in the space are attempting to restore the original vision of cryptocurrency that began through projects such as Bitcoin (BTC) and Ethereum (ETH): an actual disintermediation of transactional finance. 

The nascent space of decentralized finance is exactly this attempt to return to crypto’s original goals, and as it grows, large parts of crypto will once again fall out of intermediated structures.

DeFi developers and users, as well as regulators, need to “wake up and smell the coffee,” said Jones. This original ethos and decentralized model for crypto, which aims to realize truly trustless transactions, is “fundamentally at odds with how the FATF delivers on its objectives to prevent money laundering,” she said.

Moving forward, Jones said that DeFi developers and users will need to come together as a single voice to give effective feedback to the FATF. 

Regulation is coming to DeFi, like it or not, she said, but if those involved feel that frameworks like the FATF’s travel rule are not proportionate to the level of money laundering risks in their space, they will need to “step up their game” and make the case themselves. 

Regulators, too, will have to recognize that while the older models used by the FATF may just about work for a still-intermediated crypto world, they won’t necessarily do so for DeFi.