DeFi Could Be Divided Into Regulated and Unregulated Sectors

Decentralized finance (DeFI) could get split into regulated and unregulated segments as watchdogs determine the sector’s risk, according to a report by Fitch Ratings, the New York-based credit rating agency.

DeFi has been loosely defined as a global ecosystem of web applications and eWallets that leverage smart contracts stored on public blockchains, instead of relying on centralized intermediaries like banks, stock exchanges or brokers.

“We expect many providers to submit to regulation to support their market credibility, but some may look to operate outside rules-based ecosystems so that they can be more innovative,” the report said.

The 9-page survey, “Primer on DeFi: Risks and Regulations,” described DeFi as particularly vulnerable to cybercrime, scams and market manipulation. Researchers reported more than $7.7 billion of digital assets were stolen by cybercriminals last year, up 81% over 2020, as more consumers were attracted by the hype around soaring token values.

So called rug pull scams, where developers abandon projects and take customers’ funds, are prevalent, as is phishing, the survey found.

“The manipulation of token prices is another threat,” the report said. “The DeFi sector is still at an early stage of development and Fitch expects it to face further exploitation and risks as it evolves.

China has essentially banned the use of DeFi and private digital assets, and Russia is debating whether to take a similar approach.

See also: Crypto Regulation in Russia is Still an Unresolved Matter 

Still, the survey said many countries are expected to view DeFi more favorably, allowing it to evolve but with more regulation.

“DeFi presents limited risks to the mainstream financial system,” the report said. “Barring stablecoins, it is largely separate and is not yet systemic in size, and banks’ and insurance companies’ links to DeFi are not material.”

Still, as DeFi expands and matures, Fitch said it expects its links with the mainstream financial system to rise. Over time, this would lead to increased systemic risk from DeFi to the mainstream system, the survey added.