Why DeFi Products Will Meet Regulations Sooner Than Most People Think

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While no one will deny the growing success of decentralized finance, it is impossible to turn a blind eye to its shortcomings. Regulating this industry may be necessary, even if not everyone favors it. The DeFi segment may never reach its full potential without a regulatory framework. 

The Spectacular Growth Of Decentralized Finance

Although cryptocurrency and blockchain are home to various subtrends, few of them are as prevalent as decentralized finance. People enjoy the idea of accessing financial products and services without requiring approval from anyone. More importantly, these DeFi protocols help close the gap between the banked and the unbanked. Anyone with internet and eligible cryptocurrencies can venture into decentralized finance.

Moreover, DeFi has seen explosive growth since May 2020. It represented a $1.07 billion industry on May 4, 2020, and grew to over $268 billion by early January 2022. Today, it represents under $118 billion, primarily due to bearish crypto market conditions. All assets have fallen in price and still struggle to find stable price floors. That will, in turn, devalue the currencies used to depict the Total Value Locked across DeFi protocols. 

Despite the current market dip, things still look promising for decentralized finance. The top protocols represent over $8 billion in Total Value Locked each, with MakerDAO, Curve, and Aave leading the charge. Ethereum is still the primary chain for DeFi development with 491 active protocols and $75.5 billion in Total Value Locked. BNB Chain, in second place, represents $9.73 billion with 402 protocols.

All of the above sounds impressive, but the DeFi industry has hit a glass ceiling. To fully unlock the industry’s growth potential, there needs to be a stronger focus on regulation, security, and accountability. As Phree points out, a collaboration between DeFi protocols and a regulatory compliant environment will prove crucial. Moreover, it may help organizations entrenched in traditional finance cross over into DeFi. 

Industry Issues And Hacks Remain Prevalent

While DeFi still shows growth potential, there have been numerous security incidents over the past few months. In virtually all incidents, people lost good money due to smart contract coding issues, validator issues, or other problems. Decentralized finance still puts people at risk in multiple ways, and there is often no way to recuperate stolen funds. Moreover, a recent Chainalysis report confirms that 97% of all stolen crypto funds in Q1 2022 is due to DeFi. Some of the recent incidents include:

  • Mirror Protocol: Lost $90 million due to a code exploit
  • BreedTech: Roughly $9.4 million in funds were lost due to the team pulling an exit scam.
  • Saddle Finance: A net $11 million deficit after someone exploited code in the protocol’s smart contracts
  • Deus Finance: A flash loan attack triggered an unauthorized outflow of $17.9 million
  • Beanstalk: Another victim of a flash loan attack, resulting in the theft of $181 million
  • Ronin: the Ronin bridge, used by the popular play-to-earn game Axie Infinity, was exploited for $615.5 million

That is a brief list of exploits happening between March 29 and June 3, 2022. The REKT Database, which tracks all kinds of DeFi issues, including exploits, rug pulls, exit scams, etc, has 281 pages filled with projects losing money one way or another. Unfortunately, that list continues to grow weekly, further highlighting the need for protection. That protection may need to come in the form of regulation, as there are no other viable alternatives. 

Regulation Doesn’t Stifle Innovation

To many, regulation is the opposite of innovation, even though that doesn’t need to be the case. Looking at the fintech industry, innovative efforts will give rise to better competitive advantages. Although there is still work to do, regulation has transcended its analog nature and found a way to offer protection and insurance for these digital financial services and products. The Bank for International Settlements favors an entity-based and activity-based regulatory approach, ensuring financial stability. Moreover, this focus on regulation has significantly reduced the number of projects purposefully trying to defraud uers. 

However, regulators need to keep an eye open to fuel innovative efforts. In the current landscape, projects like Manta Network can come to market with ease. The zero-knowledge-oriented privacy solution for the Polkadot ecosystem wants to advance the technology and serve as a plug-and-play solution. Being the architect and sponsor of WASM ZKP performance enables Manta Network to push the boundaries even further. 

Any form of privacy is often a problem for regulators, though. Many see Bitcoin as an anonymous cryptocurrency, even though it lacks privacy across the board. Moreover, regulators forced numerous changes to halt trading on privacy-oriented currencies like Monero and ZCash years ago. Finding a balance between innovation – even on the privacy front – and protection and security will be the biggest hurdle to overcome.

Problem-Solving Benefits Everyone

At its core, regulation is a way of solving pressing problems and finding solutions that work for all parties involved. In DeFi, it would help address what happens after theft due to security issues or rug pulls, providing users with peace of mind. Moreover, it would weed out the number of rug pulls, as unregistered DeFi protocols would face a hard time attracting users. 

Taking DeFi into the mainstream will require a form of regulation. Whether that’s through Phree or other providers remains unclear, although it is beneficial to have multiple options. Nevertheless, compliance in decentralized finance is a must at this stage, and it should be pursued in whatever way possible. There is much to gain by going down this route, and the fintech industry has shown regulation will not negatively affect innovation. 

Being an active participant in the Blockchain world, I always look forward to engage with opportunities where I could share my love towards digital transformation.
The presented content may include the personal opinion of the author and is subject to market condition. Do your market research before investing in cryptocurrencies. The author or the publication does not hold any responsibility for your personal financial loss.

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