Impending DeFi Regulations in Europe Might Prohibit Non-Decentralized Protocols

European Commission’s scrutiny of the DeFi sector could result in mandatory MiCA licenses for protocols soon.

European authorities are contemplating new regulations for decentralized finance protocols, signaling potential changes ahead for the industry.

Under the Markets in Crypto-Assets (MiCA) framework, which oversees digital assets in Europe, the European Commission is obligated to present an evaluation report by December 30, 2024, assessing the decentralized finance market and the necessity of tailored regulations for its operations.

A Commission spokesperson informed Cointelegraph that preliminary steps have been taken, including a study on embedded supervision, but emphasized that no policy decisions have been finalized.

The upcoming report will delve into the regulation of decentralized systems, particularly those lacking a clear issuer or service provider. Maxim Galash, CEO of CoinChange Financials, highlighted the scrutiny on crypto-asset lending and borrowing, a core DeFi activity, as a focal point of the assessment.

DeFi represents a departure from conventional centralized financial systems, embracing peer-to-peer finance facilitated by blockchain-based decentralized technologies. Unlike traditional finance, which hinges on regulating central entities like banks, decentralized systems operate without intermediaries.

Concerns have arisen regarding the legal implications of potential regulations on certain crypto projects. MakerDAO co-founder Rune Christensen pointed out that forthcoming rules might subject some DeFi interfaces, such as decentralized exchanges, to licensing requirements, potentially altering the landscape of DeFi accessibility.

Nathan Catania, a partner at XReg Consulting, echoed these concerns, noting that any DeFi regulation could extend to non-fully decentralized applications, including DeFi frontends. He emphasized the ambiguity surrounding the definition of decentralization within the MiCA framework, suggesting that the extent of DeFi regulations would hinge on the interpretation of this concept.

Catania highlighted the significance of professional services in evaluating decentralization levels, indicating that frontends merely providing access to DeFi without controlling users’ funds and without fees might face lower regulatory risks.

Alternatively, the Financial Action Task Force (FATF) could provide another avenue for DeFi regulation. CoinChange’s Galash outlined FATF’s stance, emphasizing that even seemingly decentralized arrangements could fall under regulation if individuals or entities maintain significant control or influence over them.

With the total value locked (TVL) in DeFi protocols skyrocketing over the past four years, reaching $96.7 billion at present, regulatory scrutiny intensifies. Catania emphasized the pivotal question of whether a DeFi arrangement merely represents a technological structure or is subject to control by an influential party.