Decentralized finance protocols in Europe are facing the possibility of new regulations as the European Commission examines the industry. As part of the Markets in Crypto-Assets (MiCA) framework, the commission is required to produce a report by December 30, 2024, assessing the decentralized finance market and the potential for specific regulations within the sector. In preparation for this report, the commission has initiated various actions, including a study on embedded supervision. However, no policy decisions have been made yet, according to a spokesperson. The report will focus on how decentralized systems, particularly those without a clear issuer or service provider, should be regulated. One key aspect of the assessment will be the exploration of crypto-asset lending and borrowing, which is a core activity in the DeFi space. The CEO of CoinChange Financials, Maxim Galash, highlighted the importance of this in an analysis. DeFi represents a shift from traditional centralized financial systems to peer-to-peer finance facilitated by decentralized technologies on the blockchain. While traditional finance laws often rely on regulating central parties like banks, decentralized systems operate without such intermediaries. The potential introduction of new regulations has raised concerns about the legal viability of certain crypto projects. Rune Christensen, co-founder of MakerDAO, expressed worries that the rules could impose licensing requirements on some DeFi interfaces, such as decentralized exchanges. Similarly, Nathan Catania, a partner at XReg Consulting, believes that any future DeFi regulation would apply to all non-fully decentralized applications, including DeFi frontends. However, the MiCA regulation does not currently define what constitutes decentralization, and the extent of DeFi rules would depend on the criteria used to determine this concept. Under the MiCA regulation, a Crypto-Asset Service Provider (CASP) is any entity that offers services related to digital assets to third parties, including exchange services, transfer services, and custodian wallets. Regulators may consider whether a professional service is being performed when evaluating the level of decentralization. Another possible avenue for DeFi regulation is through the Financial Action Task Force (FATF). The FATF proposes that individuals or entities with control or significant influence over DeFi arrangements may be categorized as Virtual Asset Service Providers (VASPs) in certain scenarios. This classification would apply even if the arrangements appear decentralized, highlighting the challenges of defining and regulating DeFi activities. The total value locked (TVL) in DeFi protocols has experienced significant growth over the past four years, according to data from DefiLlama, rising from $570 million in April 2020 to $96.7 billion currently, representing a 16,865% increase. The key question for regulators is whether a DeFi arrangement is simply a technological setup or if there is a controlling party that can influence user value, according to Catania.
Europe's forthcoming DeFi regulations may prohibit non-decentralized protocols.