Global regulators target blockchain-based ‘decentralised finance’

Global authorities have taken the first step to bring decentralised finance under regulatory oversight after rapid growth in the blockchain-based alternative to the traditional financial system.

Standards setters for anti-money laundering said on Thursday that creators, owners and operators of decentralised finance services should comply with rules designed to combat money laundering and terrorism financing. The Financial Action Task Force, or FATF, urged national regulators to apply standards to individuals who “maintain control or sufficient influence” over DeFi apps, it said in a report.

The guidance from FATF, an intergovernmental body based in Paris, is the first effort by global authorities to address the rapidly expanding world of decentralised finance, which has grown fivefold this year to $100bn locked up in projects, according to data group DeFi Pulse.

Crypto traders sometimes lend coins to DeFi schemes in return for interest payments, a process known as “staking”. The strategy can provide juicy returns, but investors also face serious risks such as losing all of their capital.

But the move leaves room for manoeuvre for DeFi project operators because the body has no powers to enforce or police the new guidance.

FATF’s proposals have been repeatedly delayed as authorities struggle to find ways to gain oversight of the new industry, where instead of boards and senior management preprogrammed algorithms run organisations. The new standards indicate that authorities will attempt to clamp down on the people behind these algorithms as a way of exercising oversight.

The report said some projects were more centralised than their marketing would suggest and could be classed as so-called virtual asset service providers, which would bring them under anti-money laundering rules.

“It seems quite common for DeFi arrangements to call themselves decentralised when they actually include a person with control or sufficient influence, and jurisdictions should apply the definition without respect to self-description,” the report said.

“Automating a process that has been designed to provide covered services for a business does not relieve the controlling party of its obligations,” it added.

Goldman Sachs analysts last week described the DeFi industry as “an experimental and unregulated alternative financial system” rife with scams and hacks.

“[It] will pose a challenge for policymakers concerned about consumer protection and other social goals,” a separate report by the bank said.

Weekly newsletter

For the latest news and views on fintech from the FT’s network of correspondents around the world, sign up to our weekly newsletter #fintechFT

Sign up here with one click

The DeFi market has faced hacks that exploit poorly tested software. On Wednesday, a hacker stole around $130m from lending service Cream Finance — the third time this year the company has been targeted. In August, a hacker took $600m of digital tokens from Poly Network — only to later return it. DeversiFi erroneously paid out a $24m fee for a $100,000 deposit after a glitch occurred in some little-tested software code.

David Carlisle, director of policy and regulatory affairs at data company Elliptic, said FATF “is laying down the gauntlet to regulators across the world”.

“By sweeping virtual assets into the regulatory frameworks designed for mainstream finance, the FATF is acknowledging virtual assets are too big to ignore,” he said.

The report also urged regulators to take a closer look at stablecoins, digital assets pegged to currencies such as the dollar, because many could also be labelled as virtual asset service providers and come under the existing rules. Stablecoins had “greater potential for mass adoption” because they are freely exchangeable and liquid, making them more attractive to criminals, the report said.