What the SEC can learn from German regulators

Chairman of the U.S. Securities and Exchange Commission Gary Gensler Announced this month that the crypto industry should not Escape from regulatory authorityHe emphasized that in terms of investor protection, decentralized finance (DeFi) transactions and lending agreements require special attention.

Regulation can be extended to a range of options, including custody, reporting, counterparty verification, and asset classification and issuance. There are reports that people are waiting with bated breath for how the SEC will regulate the DeFi industry, but the German Federal Financial Supervisory Authority (also known as BaFin) has found a way to apply existing securities laws to the crypto industry.

related: Draft FATF guidelines for DeFi compliance

Decentralization does not mean anonymity

It is a utopian view that all DeFi will evade supervision. There will always be compromises to the degree of decentralization of the platform and the degree of centralization that exists on different DeFi platforms. For example, even data oracles require some form of external input.

Investors need to choose. Those with fiduciary responsibilities need to operate in a regulated environment, and others who trade for themselves may not necessarily have a compliance team to satisfy them. However, for DeFi to reach a market value of $1 trillion, institutional capital must enter a long-term wait-and-see market.

In fact, the entire stack needs to be supervised before institutional capital enters. Traders need to know what they are trading, and the counterparty who is trading with them is not an illegal participant. In this way, both asset issuance and the elimination of counterparty risks require clear regulation.

related: Will regulation adapt to encryption, or will encryption adapt to regulation?Expert answers

BaFin has always been avant-garde in this matter, and very knowledgeable. Considering how many blockchain developments were born in Berlin, this makes sense.This German Banking Law Update In 2020, with the introduction of the crypto custody license, crypto assets will be included in its terms of reference, enabling banks to hold crypto assets. However, these participants will need a licensed counterparty to conduct the transaction.

Regulators can track blockchain activities easier than traditional finance

Gensler said that encrypted assets are mainly used to circumvent money laundering laws, but this statement is flawed.There is fraud in both the cryptocurrency market and the traditional market, and the latter has illegal activities Still higher than the crypto market, According to a report by Chainalysis. The same report found that illegal activities using Bitcoin (Bitcoin) Has been significantly reduced: it dropped from approximately US$21.4 billion in 2019, or 2.1% of all cryptocurrency transaction volume, to US$10 billion, or 0.34%, last year.

In fact, due to the transparency of blockchain technology, transferring transactions to the chain will enable regulators to better understand how funds flow in the financial sector. Regulators are able to gain insight into the internal situation on their own, which means they are less dependent on the companies that report to them.

Regulators need to spend time educating themselves on how to apply this technology to existing financial structures, such as loans. This is evident in some of Gensler’s comments, who did not realize that loans using distributed ledger technology (DLT) infrastructure currently rely on overcollateralization, rather than loans based on future income. The data supporting the latter will take time to transition to the blockchain.

related: Bitcoin can no longer be regarded as an untraceable “criminal token”

Should encryption be regulated like TradFi?

The crypto market should not be more or less regulated than the traditional market. It should be subject to the same license, prospectus issuance, and customer protection as any other market where you deal with financial instruments.

This is BaFin’s point of view Has modernized its securities law Make the assets issued by DLT comply with traditional financial laws and stipulate that encrypted tokens should be classified as securities. Although many people may be worried about this ruling, clarity actually helps the market and its participants, who are now getting a clear direction from one of the world’s leading regulators.

This means that asset-backed securities tokens must have a prospectus like a traditional market when applicable. This is a positive development for the DeFi market, as it helps to promote the integration between the traditional market and the crypto market.

To quote Marc Andreessen, “Software is eating the world.” When it comes to the underlying assets that support them, the synthetic products that currently exist are vague. The solution to this is to tokenize more real-world assets, which will help expand the current DeFi ecosystem by even 10-100 times. In order for this to make sense, it needs to use compliant packaging and complete it under a legal structure and prospectus approved by regulatory agencies (such as BaFin or SEC).

related: Is there a correct way to regulate encryption?Yes this is the way

Investor protection must expand counterparties and assets

Tokenized assets require a mobile home to be traded. As long as the investor’s identity is associated with the DeFi platform, investors can be protected from transactions with bad actors. This approach solves a key issue for institutional participants-counterparty risk. This is easy to accomplish in the traditional financial world, so it should be easy to apply the same principles to DeFi exchanges.

German Spezialfonds or special funds specifically designed for the institutional market can now be held 20% of their portfolio is in cryptocurrency Assets as of early August, which means that about 4,000 companies are not eligible to invest in this asset class. For cryptocurrency and blockchain supporters in Europe and around the world, the legal change is a huge victory, because the introduction of such a large institutional pool of funds to the industry will be of great significance.

However, Spezialfonds must cooperate with licensed counterparties to purchase, hold and trade crypto assets. Although this is not necessarily an obstacle in itself, the current pattern of the sector is growing, and given the potential of this legal change, it must adapt to new demands.

The funds will not be all gone all at once, but it marks the beginning of a huge change, and we expect other jurisdictions to follow up soon.

related: Europe awaits implementation of the regulatory framework for crypto assets

Put the pile on the ground

BaFin has made great strides in adopting existing financial market law and applying it to the crypto market. As more and more real-world assets are tokenized, legislators may feel more comfortable regulating the industry. Securities tokens issued without a prospectus should not be allowed to trade unless exemptions apply—similar to stocks and bonds issued on the traditional market, none of them.

The industry must slide in the direction of ice hockey. Entrepreneurs around the world must work with global regulators to find the most suitable environment for establishing use cases for licensed DeFi projects. For this reason, guessing games that lack clarity and compliance can stifle innovation.

Through comprehensive investment, BaFin gives entrepreneurs confidence, which will enable a healthy market to develop through regulatory methods.

The views, thoughts, and opinions expressed here are only those of the author, and do not necessarily reflect or represent the views and opinions of Cointelegraph.

Philip Piper He is the co-founder of Swarm Markets and Swarm Network, open source projects and DAO. Philipp also co-founded Proximic (acquired by comScore), Loop Media and Bitadel Crypto Trading. Philipp has been engaged in decentralized technology and crypto asset trading since 2015. He is also an entrepreneurial investor and mentor for Singularity University and StartX. He is a member of AIMA Blockchain Committee and Digital Currency Trade Association (DCTA).