Decentralized finance (DeFi protocols) are interpreted as exempt from the scope of the European Union’s Markets in Crypto-Assets Regulation (MiCA), according to consultancy BCAS. But only if it is ‘fully decentralized’ – meaning no single person or company has control over the platform used.
The European Commission will be tasked under MiCA to develop a detailed report assessing the pros and cons of DeFi in the coming year, Mark Foster, EU policy lead at the Crypto Council for Innovation, told Blockworks.
This will help determine what the next steps for DeFi in the EU will be.
“If risks are identified, they can propose legislation at a later stage so that the EU can then potentially develop something on DeFi over the course of the next parliament,” Foster said.
For now, however, there is very little direct impact on the region’s DeFi protocols.
“This was a conscious political decision by EU policymakers when negotiating MiCA, given the small size of the emerging market and the desire to see the market evolve and be better understood before deciding how to regulate it,” said he.
Read more: Why crypto companies are flocking to Ireland ahead of MiCA
MiCA’s original intent was to create comprehensive provisions and rules around stablecoins and centralized exchanges, a connection point between cryptocurrency and fiat currency, Foster explains.
“These were the things that they felt should be prioritized, so when it came to other parts of the ecosystem, particularly DeFi as a broad concept and NFTs, there was a conscious decision by the legislature to say, ‘Let’s don’t do this now. ,'” he said.
Foster notes that DeFi today is still very small compared to the size of the traditional financial industry as a whole, which handles values in the trillions of dollars.
According to data aggregator DeFiLlama, the total value (TVL) on DeFi protocols is $77 billion.
The EU’s careful approach to MiCA has significant benefits, says Kevin de Patoul, co-founder and CEO of Keyrock, a maker of digital asset markets.
“I believe it is better to have potential gaps in the framework that can be addressed as understanding of the implications deepens, rather than over-regulating too early and just killing innovation,” De Patoul told Blockworks.
While that is the case, there are risks associated with excluding DeFi from MiCA, de Patoul notes. Risks include gaps in oversight, compromising consumer protections and risk management, to name a few.
“To mitigate these risks, it becomes imperative for providers of digital asset services and products to proactively maintain high standards and transparent practices,” he said. “Self-regulation based on best practices will be critical in protecting the interests of consumers and maintaining the integrity of the digital assets industry.”
Unlike the EU, there is a distinct lack of clarity in the US when it comes to dealing with DeFi protocols.
Read more: DeFi is facing a ‘full frontal attack’ from regulators
Christina Fraziero, associate at CMS Legal, told Blockworks that the EU’s initiative to tackle the regulatory landscape of crypto assets and blockchain technology gives it a competitive advantage over the US. She noted that MiCA reflects the EU’s avant-garde and evolving approach to regulation.
“It is a comprehensive regulatory framework for crypto assets that provides a stark contrast to US regulators’ dismal regulatory enforcement approach to the sector, demonstrating to industry participants around the world that thoughtful, clear regulation that balances consumer protection with innovation is possible. ,” she said.
Fraziero notes that Web3 software developers in the United States have focused on distributing profits outside of centralized control and among unaffiliated community members.
This is largely due to a speech by William Hinman of the U.S. Securities and Exchange Commission, who shared that digital assets are not considered a security offering if the digital asset’s network is “sufficiently decentralized.”
According to Foster, following the development of the European Commission’s detailed report on DeFi, lawmakers will have an opening to draft new legislation.
“It can be a very long process between a report being approved and becoming a bill, but at this point DeFi is outside the scope of MiCA,” Foster said.
For now, Foster notes that MiCA provides necessary legal clarity on the broader framework in the EU for centralized exchanges and stablecoins, even if there are still detailed technical provisions that need to be resolved.
Read more: eToro receives registration in Cyprus ahead of MiCa rollout
“Having such legal certainty allows the industry to plan and invest, which helps build the ecosystem without fear of litigation,” he said.