The Association for the Financial Markets of Europe (AFME) published a document on Decentralized Finance (DeFi). With the recent adoption of Markets in Crypto Asset (MiCA) regulations in the EU, DeFi was largely bypassed. The document includes suggestions from AFME regarding possible regulatory approaches.

It acknowledges that DeFi operating within the regulatory perimeter could see broader adoption in the future.

“Current DeFi efforts can be seen as innovation and research and development (R&D) labs outsourced to the formal financial system,” the document says.

With DeFi encroaching on lending and exchanges, incumbents are eager to see a level regulatory field. At the same time, they would also like to use DeFi technology and would like legal clarity on where private permissioned blockchains are used.

They suggest using significant parts of existing legal frameworks, but clearly DeFi is a bit different.

As a first step, there is a need for a new taxonomy to classify various aspects of DeFi, and AFME provides a few. For example, it defines DeFi lending and DeFi exchanges.

Even more interesting, it analyzes the classification of smart contracts based on the degree of decentralization. A type is decentralized in name only (DINO). Unsurprisingly, they believe these should be subject to existing regulations. Another is governed by Decentralized Autonomous Organizations (DAOs) and in many cases is considered by AFME to be similar to DINO smart contracts. However, some DAOs are truly decentralized with anonymous participants and need different treatment. One avenue is to potentially require DAOs to be incorporated.

The paper explores some of the many challenges DeFi presents, such as the jurisdiction involved when the counterparty is a smart contract.

These cross-jurisdictional issues are some of the most difficult, and AFME urges further research and global cooperation to address these challenges.