IOSCO (International Organization of Securities Commissions) has shared its opinion on DeFi, or decentralized finance, by providing nine policy recommendations for regulation.
DeFi is an approach to using technology to remove a central counterpart to manage transactions and services. Some blockchain proponents believe this is the future of financial services while others believe there is always a central party engaged in a transaction that must be accountable (and perhaps not really DeFi).
IOSCO encourages responsible innovation that benefits users while proposing “principles-based and outcomes-focused” recommendations for DeFi services.
The recommendations are as follows:
- Analyze DeFi Products, Services, Activities, and Arrangements to Assess Regulatory Responses. A regulator should analyze DeFi products, services, activities, and arrangements, occurring or located within its jurisdiction, with a view to applying its Existing Framework or New Framework, as appropriate, to the offer of financial products, the provision of financial services, and the engagement in financial activities.
- Identify Responsible Persons. A regulator should aim to identify the persons and entities of a purported DeFi arrangement that could be subject to its applicable regulatory framework (Responsible Person.
- Achieve Common Standards of Regulatory Outcomes. A regulator should use Existing Frameworks or New Frameworks to regulate, supervise, oversee, and address risks arising from DeFi products, services, activities, and arrangements in a manner consistent with IOSCO Standards.
- Require Identification and Addressing of Conflicts of Interest. In applying Existing Frameworks or New Frameworks, a regulator should seek to require Responsible Persons, as appropriate, to identify and address conflicts of interest.
- Require Identification and Addressing of Material Risks, Including. Operational and Technology Risks In applying Existing Frameworks or New Frameworks, a regulator should seek to require Responsible Persons, as appropriate, to identify and address material risks, including operational and technology risks.
- Require Clear, Accurate, and Comprehensive Disclosures. In applying Existing Frameworks or New Frameworks, a regulator should seek to require Responsible Persons, as appropriate, to accurately disclose to users and investors comprehensive and clear information material.
- Enforce Applicable Laws. A regulator should apply comprehensive authorization, inspection, investigation, surveillance, and enforcement powers, consistent with its mandate, to DeFi products.
- Promote Cross-Border Cooperation and Information Sharing.
- Understand and Assess Interconnections Among the DeFi. Market, the Broader Crypto-Asset Market, and Traditional Financial Markets
Following the DeFi report being shared to the public, CI received a comment on the recommendations from Nathan Catania, Partner at XReg Consulting, a public policy and regulatory affairs consultancy specializing in crypto. Catania stated:
“As expected, the report hasn’t materially changed from the one which went for consultation just over three months ago. I believe there are some concerning gaps – Fully decentralised protocols cannot be addressed by the existing regulatory paradigm and that the report still primarily addresses DeFi with centralised components, an approach we can term as Hybrid Finance or HyFi.”
“The existing approach will not adequately address fully decentralised projects, where ‘responsible persons’ cannot be identified. However, it is clear that the recommendations are expected to be interpreted and applied extremely broadly, meaning that many existing DeFi projects could find themselves within the regulatory perimeter.”
“In fact, in response to the consultation feedback, the IOSCO confirmed that activities being decentralised should not be a measure of whether a product, service or activity should be subject to regulation.” The report was amended to clarify that regardless of how an entity is organised or how decentralised an arrangement is, they may be considered a responsible person.”
“Overall, DeFi projects can expect more scrutiny from regulators, particularly as to whether arrangements are already subject to existing regulation. Also expect regulatory policy to shift and the perimeter to be stretched to capture more existing projects, even those which are quite decentralised (for example, HyFi as opposed to true DeFi projects).”
The report is available below.