Bridging the Gap: DeFi Can Coexist with Non-Regulation
Traditional finance and decentralized finance (DeFi) have long been seen as two separate poles. Only visionaries believed they could merge. However, the wave of tokenizing Real World Assets (RWAs) is changing this view and making history. It is attracting institutional attention to DeFi but also highlighting the main barrier: regulation for DeFi.
Tokenizing RWAs Brings Historic Opportunities to DeFi
Tokenizing real world assets (RWAs) is currently the hottest topic in the crypto industry, driven by major asset management firms like BlackRock, which launched a tokenized asset fund earlier this year. Not only BlackRock, but major banks like JPMorgan Chase, HSBC, and Citi are also exploring ways to tokenize RWAs. This allows physical assets such as real estate, gold or debt securities to be represented on the blockchain, connecting traditional and decentralized financial markets, opening the door to trillions of dollars of capital.
Industry insiders agree that tokenizing real-world assets can bring utility to blockchain, transform DeFi and develop the financial system. The participation of investment groups such as BlackRock marks a milestone for DeFi. The participation of large institutions not only makes the tokenized asset market grow faster but also helps the market become more stable.
The market's interest in RWA-related protocols is clearly demonstrated by the numbers. The value of RWA protocols has increased by more than 4,000% over the past year, from $146 million to over $6.31 billion in April 2024. However, it still accounts for only 6.1% of the total $102 billion value locked in DeFi protocols to date.
Considering the total value of real-world assets, such as the $380 trillion real estate market, tokenized RWA has huge potential. Experts predict that the tokenized physical asset industry could reach $16 trillion by 2030.
However, for this merger to become a reality, seamless integration between traditional finance and DeFi is crucial. As always, regulatory clarity plays a key role in such situations.
Regulations Remain a Gray Area
No government has yet implemented clear regulatory frameworks for DeFi, which operates differently from traditional finance. Regulating DeFi remains challenging around the world due to its decentralized nature. DeFi operates without a centralized governing body and relies on automated smart contracts to facilitate operations, making it difficult to enforce rules and ensure compliance. Additionally, the rapid pace of innovation and evolving technology further complicates regulatory efforts.
While individual initiatives for crypto asset regulation are emerging in various countries, no formally adopted policy on DeFi regulation exists anywhere. Even the European Union’s (EU) Markets in Crypto Assets (MiCA), which is set to become the world’s most comprehensive crypto regulatory standard, coming into effect in December 2024, has left DeFi regulation completely outside its scope.
Decentralizing DeFi Protocols Differently
The EU’s MiCA framework sets out rules for crypto asset service providers and stablecoin issuers but does not address how decentralized finance should be handled and regulated. The document only asks EU authorities to review the progress of the DeFi industry within 18 months of MiCA coming into effect. It also asks the European Commission to assess whether MiCA legislation is adequate to address DeFi and decide whether specific rules for DeFi are necessary and feasible.
The approach could change if EU lawmakers follow the guidance of the Financial Action Task Force (FATF), a global body for anti-money laundering standards. FATF suggests that individuals or entities with significant influence over DeFi could be labeled Virtual Asset Service Providers (VASPs), subject to anti-money laundering and counter-terrorism financing (AML/CFT) obligations.
However, the question of how decentralized DeFi protocols are has been a major sticking point in the debate over DeFi regulation. Only partially decentralized crypto services are subject to MiCA regulation, while fully decentralized services provided without intermediaries are excluded from its scope. The main challenge is that the DeFi industry operates across a broad spectrum of decentralization, making it difficult to determine when protocols become partially or fully decentralized.