The time is ripe: We need compliant decentralized finance

Society needs to educate regulators and help them create an achievable framework that preserves the goals of both parties.

The crypto space is an incredibly risky environment to learn in. Its volatility is a dire warning to those who like to test the depth of a pool by jumping in headfirst. The old guard constantly reminds the newcomers: “Take your time and learn the basics first.” Wealth, in this space, can appear and disappear in an instant.

Many newcomers got their first taste of crypto winter in 2018. This wasn’t the first Bitcoin crash, and it certainly won’t be the last.

Even though the crypto space has been around for over 10 years, it is still in its infancy. Technology is advancing at a rapid pace, and every year we are able to experiment with new concepts, new ideas, new applications, and new ways to change the face of the world.

Of course, we have our challenges as bad actors find new ways to defraud people of their hard-earned money. There are also new, untested projects that, while capable of gaining value, are also prone to failure, bugs, and vulnerabilities. Decentralized finance is one of these new experiments; while it holds the promise of exciting new ways to finance and invest, it can often have disastrous consequences.

As more traditional organizations adopt cryptocurrencies — think Square and PayPal — we’ll have the opportunity to take on new challenges; of course, this depends on those who understand the space, understand the core values, and want to see it become more than just a well-kept secret. This is also a call to action.

What will compliant DeFi look like?

Let's define "compliance" first. It not only means that the project needs to follow anti-money laundering regulations, but also means that the project needs to meet the standards of quality and trust. In other words, DeFi projects should increase their efforts in security, quality, user responsiveness, and regulatory compliance. In short, DeFi projects should ensure compliance.

To be clear, this is not an argument for allocating responsibility and compensating for losses. After all, these are decentralized projects, not financial institutions. However, billions of dollars are piled up in DeFi projects, so there should be an explanation.

Our goal should be to increase the number of users, that is, to encourage mass adoption and attract traditional markets and non-technical investors. We should bring the benefits of blockchain and DeFi to society. In an era when governments issue floating bonds with negative interest rates and print money like crazy, people need better solutions to avoid the depreciation of wealth. Of course, it is better that people should be able to achieve economic growth regardless of who the central bank is that manages a specific currency or decides monetary policy.

So what can DeFi projects, and the crypto space as a whole, do to become more competitive and attract a wider customer base? Let’s start with the basics:

Whitelisted addresses. A list of projects/IP addresses that are allowed access to a system or protocol once they have received initial verification. In DeFi, we can verify an address and perform KYC on the user through one or two trusted anchors. Once the user is verified, all other projects within the same trust channel - that is, a group of virtual asset service providers, or VASPs that have agreed to follow the same set of rules and cooperate within a well-defined platform - can allow their users to obtain products and services without having to redo the entire KYC process.

The advantages of this are twofold. One is that users only need to show private documents to one or two entities, thus reducing the attack surface for any potential data hackers. The second is that VASPs (Vehicle Application Service Providers) can reach a larger user base without having to increase compliance costs. In addition, such a system can also allow individuals and entities that are excluded from the traditional banking, savings, and trading ecosystem for geopolitical reasons to invest in yield products and alternatives to high-interest loan accounts. DeFi is another option for these citizens and business owners to save, make money, and trade.

Anti-Money Laundering (AML) and General Data Protection Regulation (GDPR) compliant systems. Institutional capital markets are subject to strict regulation and oversight by local and international regulators with the goal of preventing money laundering and the financing of terrorist actions. Through the certification framework, projects can verify and comply with existing AML regulatory requirements, attract institutional capital, while protecting user privacy by not requiring users to create copies of personally identifiable information.

Audited codebases and third-party certifications. Many blockchain projects are not built to minimum acceptable standards, making it difficult for every user to go through the codebase and verify that the code is doing what it is supposed to do. By having third-party validators check the code and prove its honesty, functionality, and reliability, the bar can be raised, making these projects more competitive and safer for investors.

Insurance. This is a relatively new area in blockchain, but there are projects that are addressing risk management issues through decentralized insurance. Insurance projects can capture a larger audience that is willing to take more market risk and less security risk.

Limits and security margins. By building in guardrails and layered security measures, users can choose to increase or decrease their risk tolerance threshold. Additionally, it allows projects to limit losses in negative events, for example, investment and withdrawal limits.

The right to choose is the right way

I firmly believe that individuals should be free to choose whether to invest their wealth in untested projects, volatile investments, or cutting-edge technologies; we should not rely on the government to tell us what, how much, and when to invest. It is ridiculous that a person can spend thousands of dollars on lottery tickets but cannot invest the same amount of money in risky investment projects without jumping through huge regulatory or bureaucratic hoops.

This is why optionality becomes so important: it allows project builders to do what they do best, and for users to be the key drivers of project evolution. The less trust a project has — especially compared to compliant, audited projects — the less capital and user base will flow to it. These are market forces that should be allowed to flow freely.

It is also important to understand that in our space, competition occurs at different levels, some require collaboration, some do not. The overall goal is not to build projects that win short-term wars, but to build an industry that changes everyone's life for the better, along with the way we manage our financial wealth. These methods are accessible to everyone, without unnecessary third parties and unbridled knee-jerk regulation. This is an infinite game.