How the Industry is Responding to Client Demand for Regulation

Written by Guest Contributor, Timo Lehes,

Co-founder of DeFi exchange, Swarm Markets

Regulators around the world are grappling with crypto as both retail and institutional investors demand more protections to keep their money safe.

Some regulators have tried to outright ban the crypto industry from operating, others like the FCA are using a sandbox approach to test the water and forward leaning regulators like BaFin are working directly with DeFi projects to apply existing laws to the crypto sector.

Equally, crypto businesses are responding in different ways to meet client demand for increased regulation, in order that millions of capital that has been sitting on the sidelines can finally enter the DeFi ecosystem. There is a scale of responses that depend on a company’s appetite, resources, existing business model and future direction of travel.

Some are going for outright banking licenses from the off, like Swarm Markets. Others are ring fencing certain products and services designed specifically for institutional participants who have a fiduciary responsibility. Others are simply doing a spring clean of what assets they can offer as some are proving too problematic from a regulatory perspective.

Impact on assets

The only way we can expand the DeFi ecosystem is if we bring more real world assets on-chain to trade alongside crypto. However, tokenising assets like securities in a compliant way and then finding a liquid market for them to trade on, has proven to be problematic.

By digitalising products like securities, we are increasingly moving the crypto industry into the purview of regulators as certain services and products cannot be operated without it. The conversation is moving on from how to regulate bitcoin to what happens if we tokenise Tesla?

Uniswap Labs, the development firm which oversees decentralised exchange Uniswap announced it has culled some tokens it supports through its interface, as regulatory scrutiny increases. The firm said it was removing a selection of around 100 tokens that included tokenised stocks, options and other derivatives. These pools were clearly problematic from a regulatory point of view, which is why they’ve been removed.

Uniswap is not the first exchange to do a spring clean of the assets it offers. Binance suffered a series of crackdowns by different regulators across the globe for its Tesla security token, which eventually resulted in the exchange halting trading in the asset.

The market must skate to where the puck is going, meaning tokens need to be issued in a compliant way, if they are to have any chance of trading success on the blockchain. And the buck doesn’t stop with just assets. The same regulatory pressures are being extended to what type of participants can enter the ecosystem.

Impact on market participants

There is a growing demand from institutional participants who have a fiduciary responsibility requiring sufficient KYC and AML checks before they will trust a platform enough to put theirs and their clients’ capital with it.

Aave Arc is a prime example of a company responding to this need with their insitutional offering in the form of a KYC pool. Branded as an arc to act as a bridge between CeFi and DeFi, it’s essentially creating a walled garden for a specific set of investors to enjoy the benefits of crypto lending and borrowing.

There are companies who have arguably done phenomenally well in the crypto space without regulatory status, Aave, Binance and Uniswap being just a few examples, so the fact we’re seeing announcements such as these suggests the industry is heading in one direction if it is to grow - straight for regulation.

The issue now for many will be how do you instill a culture of compliance within an industry that inherently operates outside of government control and proudly so?

The innovator's dilemma

Regulation does not have to stifle innovation. For example, at Swarm Markets we see regulations as a way to integrate new participants, assets and capital with the DeFi ecosystem, ultimately expanding it accordingly. Our banking licenses from the Federal Financial Supervisory Authority enable us to do more and we’re a direct response to offering a trading and liquidity home for digital assets.

Binance CEO Changpeng Zhao (CZ) announced there is a succession plan in place for someone who can take the helm with more regulatory experience. CZ laid out plans for the crypto behemoth to become a fully regulated global player in the future.

DeFi projects - regulated or not - have to respond to customer demand. If that demand requires regulation, and we believe it is, it is only a matter of time before we see more projects adopt an approach that sits on the compliance scale.

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