Standard financial policies are not sufficient for regulating decentralized finance, according to a research report funded by the European Commission published this week.
“This report is part of our ambition to understand DeFi further, to inform our thinking about how to address any concern potential public public policy consequences,” Mattias Levin of the European Commissions department for digital finance, said in a webinar outlining the report on Friday.
Recognizing the difference in the way DeFi structures information compared to traditional finance, the report on approaches to the regulation and supervision of decentralized finance says that “standard policies [are] inadequate to the treatment of DeFi services.” As a response, it breaks down a taxonomy of policy proposals.
Firstly, the report proposes to have a separate policy to regulate the activity of legal entities based on micro-prudential requirements. This would apply to “entities that were legally subjected to the authority of standard public institutions,” according to the report.
Secondly, a voluntary compliance framework would cover both protocols and legal entities. Here, “protocols and users freely choose to adhere to some policy requirements in order to obtain different forms of public support and guarantee such as a stamp of public approval,” the report reads.
The third is a public observatory based on public opinions and on-chain data. “Such an institution would deploy public investigations and issue opinions and warnings publicly about specific DeFi protocols, practices and public address activities,” according to the report.
Finally, the study recommends building an approach for off-chain markets — like oracles, which connect on-chain and off-chain data. Oracles are key for connecting DeFi with traditional economies. The report gives preliminary routes for this but admits that “the optimal design for oracle markets remains largely under-developed.”
The report, written by an academic linked to KU Leuven, will inform the debate on DeFi within the EU institutions and upcoming EU Commission proposals.
The European Commission is gaining traction with studies on how to regulate DeFi, with a tender for a study on “embedded supervision” of Ethereum released earlier in October.
The EU’s comprehensive Markets in Crypto-Assets regulation, set for a final Parliamentary vote in November, is focused greatly on centralized entities of crypto — such as service providers — and stablecoin regulation. With no clear-cut framework for regulating decentralized entities, the institutions are pulling resources into bridging that gap.