Major projects oriented toward DeFi currently account for millions of dollars’ worth of locked-down or invested digital assets, across multiple platforms. It’s also growing fast, synergistically with technical innovation which it’s both benefiting from and driving.
Some governments will view this as an opportunity, others as a potential source of trouble. Some will seek tax revenue, others stability and fairness, still others will focus on control or prevention. This guide to DeFi regulations around the world isn’t exhaustive. Instead it focuses on the most important jurisdictions for the digital asset industry, and those which might point the way ahead.
DeFi regulations in the USA
America’s relatively fragmented political system means courts and regulators are more likely to decide guidelines than in some other countries; it was a court case that gave the SEC the power to regulate ICOs, for instance. Legislation moves comparatively slowly and the country has a history of general positivity toward business innovation.
However, for US regulators, DeFi raises novel regulatory challenges. US financial regulations assume the existence of intermediaries and place regulatory burdens on them. What, then, should regulators do about disintermediated financial protocols like DeFi?
Obviously, decentralization is a typical feature of digital assets and of their blockchain substrates. But Bitcoin and other traditional financial assets have shown themselves relatively easy to integrate into the traditional financial system and its regulatory framework. DeFi is different.
As Jai Massari and Christian Catalini write in The Regulatory Review, “the more fundamental innovation of DeFi is that it may eliminate intermediaries in financial transactions altogether by using software and market design to match orders automatically, determine and charge interest rates, and maximize investment returns”.
Thus many US financial laws would not currently apply to DeFi transactions because there is no regulated intermediary to whom they could be applied. DeFi transactions conducted between individuals through unhosted wallets would not be subject to the Bank Secrecy Act’s KYC and anti-money laundering rules, for instance, because BSA and other financial regulations apply to intermediaries supplying financial services. There’s also no meaningful way for anyone to figure out which elements of BSA or similar laws they should be applying to their anonymous DeFi transactions, because knowing your customer under those circumstances is necessarily impossible.
It’s currently unclear how the SEC will react to the emergence of DeFi. As a regulator its attention to ICOs was a decisive factor in ending the 2017 ICO boom, but it’s questionable how much of federal securities law in the USA can be made to cover DeFi transactions.
In June 2021, a series of private video calls took place, in which representatives of digital asset businesses like UniSwap and dYdX presented to members of the world’s securities and exchanges authorities, including the US SEC and the Commodity Futures Trading Commission.
No participants were willing to speak to the press, though we have some idea of the opinions involved; in particular, the argument that open-source code is protected speech under the First Amendment may make it difficult for US regulators to come after the underlying technology in lieu of the intermediaries they’re used to regulating. This proviso won’t apply in other places, though.
None of this necessarily means DeFi in the US is in the clear. After cursory examination of the subject, CFTC commissioner Dan M. Berkovitz has called for a crackdown and said DeFi was “a bad idea” and “probably illegal”. The SEC has charged Blockchain Credit Partners, which it describes as a DeFi lender, together with two of the company’s top executives, with raising $30 million through allegedly fraudulent offerings.
Recently, the US senate entered the final stages of passing a complex tax and infrastructure bill which, if unaltered, will make digital assets software developers and network validators tax-liable as “brokers”. Though what this will mean for the DeFi space is unclear, some commentators regard it as an attack on the Ethereum blockchain and thereby on the DeFi space.
DeFi regulations in India
India’s government has delayed the next reading of its Cryptocurrency and Regulation of Official Digital Currency Bill until the Monsoon session of parliament, leading the Indian digital assets community to believe that the government may be softening its stance on digital assets.
However, Indian policy on digital assets is still strongly influenced by a sharply negative report produced in 2019 by the SC Garg Committee, which stated:
“These cryptocurrencies cannot serve the purpose of a currency. The private cryptocurrencies are inconsistent with the essential functions of money/currency. Hence, private crypto currencies cannot replace fiat currencies”. The report went on to recommend a blanket ban on digital assets and criminalization of related activities in India.
However, Sharat Chandra, of the IET Future Tech Panel, told the Financial Express that “the delay in tabling the bill augurs that the government seems to have bought more time to shape the contours of the bill”, adding that “the Union Finance Minister has reiterated multiple times that the government is open to allowing a window of experimentation to fuel innovation in crypto and fintech space”.
The fate of DeFi in India hangs on the results of this period of reflection and deliberation.
DeFi regulations in Hong Kong
Hong Kong’s traditionally positive attitude toward digital assets underwent a change following a period of consultation that ended earlier this year. In the next session of Hong Kong’s Legislative Council, it’s expected that digital assets investment will be limited by law to professional investors. In Hong Kong this is a legally defined term, meaning those with portfolios worth HK$8 million (about US$1 million). These provisions will apply to DeFi investors as well.
Currently, there are no Hong Kong laws or regulations that apply specifically to DeFi. But assuming that the new law passes more or less as it currently stands, much will hinge on the definition of VASP: Virtual Asset Service Provider. It looks at the moment as if offering any kind of financial services relating to digital assets will be enough to be classified as a VASP, even if the actual financial functions are performed through self-executing contracts.
If that’s the case, DeFi will also be restricted to professional investors in Hong Kong.
DeFi regulations in Singapore
In November, Singapore introduced the Payment Services (Amendment) Bill, which introduced new regulated activities including:
- Transfer of DPTs
- Provision of custodian wallet services for DPTs
- Facilitating the exchange of DPTs without possession of money or DPTs by the DPT service provider
Any entity that provides these services as a business in Singapore will be subject to regulations under subsidiary legislation.
The bill also broadens the definition of cross-border money transfer services to include moving money from one account in one country, to another account in a different country — even if the money never flows through Singapore.
The disintermediation effect of DeFi means lending through DeFi platforms may fall under Singapore’s Moneylenders Act, which requires a license to carry on a money lending business, but permits exemptions. How this will play out with regard to DeFi is not yet clear.
DeFi regulation in the EU
The EU’s flagship digital assets regulation is MiCA, for Markets in Crypto-Assets. MiCA creates new categories of digital asset based on how the EU plans to treat them legally, and requires companies operating digital assets businesses to be a legal or natural person with a registered office in the EU.
However, there is a potential problem with applying this legislation to DeFi. As Guilherme C. Maia, of the Faculdade de Direito at the University of Lisbon observes, “MiCA only applies to natural and legal persons and the activities, issuances [sic], and services performed and provided by them. In some DeFi projects, it seems a stretch to consider that [there] exists a natural or legal person who performs or provides those activities”.
In other words, the situation is similar to the US’ financial regulations; there are no intermediaries, and thus no entities for the legislation to be applied to. In the US, this may simply result in a dysregulated DeFi market. In the EU, it may result in additional legislation, a redrafting of MiCA, or potentially a more restrictive environment for DeFi.
DeFi regulations in China
China moved in 2017 to ban all digital assets activities except mining, at the same time as aggressively pursuing its own Central Bank Digital Currency. In May of this year, the Chinese authorities revisited the ban and extended it to products and services that didn’t exist in 2017, including DeFi.
However, there is nuance here. China has not banned digital assets outright; you can’t be arrested for possessing Bitcoin. Chinese courts have repeatedly upheld the right for Chinese citizens to own and exchange Bitcoin and other digital assets, which in China is almost exclusively done through peer-to-peer OTC exchanges. But it’s against the law for the financial system to interact with digital assets.
A note (Chinese language), issued by the China Internet Finance Association, China Banking Association, China Payment and Clearing Association, stated: “Financial and payment member institutions shall not provide services that relate to virtual currencies or directly and indirectly offer crypto-related services for their clients, including crypto trading, custody, lending and settlement; accepting virtual currencies as a payment tool; exchanging virtual currencies with the RMB.”
DeFi is not illegal in China: Chinese citizens can access offshore DeFi services, and there was a thriving Chinese DeFi ecosystem prior to the May 2021 crackdown. The moderator of r/loopringorg, a subreddit dedicated to one of the viral stars of pre-2021 Chinese DeFi, Loopring, called the post-ban environment “business as usual”, adding that “as far as I am aware this recent news is actually just a reiteration of regulations that have already existed since 2017 and nothing has really changed”.