Impending European DeFi regulations may prohibit non-decentralized protocols

Europe’s decentralized finance (DeFi) protocols may face new regulations as the European Commission examines the industry. The Markets in Crypto-Assets (MiCA) framework, which governs digital assets in the region, requires the European Commission to produce a report by the end of 2024, assessing the DeFi market and the feasibility of specific regulations for the sector. To prepare for this report, the Commission has launched a study on embedded supervision. The report aims to determine how decentralized systems, particularly those without a clear issuer or service provider, should be regulated, with a focus on crypto-asset lending and borrowing. DeFi represents a movement away from centralized financial systems towards peer-to-peer finance facilitated by blockchain technology. However, concerns have been raised that new regulations could render some DeFi interfaces, such as decentralized exchanges, impossible under licensing requirements. The extent of DeFi rules will depend on how decentralization is defined and assessed. The MiCA regulation defines a Crypto-Asset Service Provider (CASP) as any entity that offers services related to digital assets to third parties. Regulators may consider whether a professional service is being performed when evaluating the level of decentralization. The Financial Action Task Force (FATF) may also play a role in DeFi regulation, classifying individuals or entities with control or influence over DeFi arrangements as Virtual Asset Service Providers (VASPs). The total value locked in DeFi protocols has grown significantly, from $570 million in April 2020 to $96.7 billion currently, raising questions about the control and influence behind DeFi arrangements.