Sergei Kondratenko: Changes in the DeFi market as a result of tightening regulation

Fintech expert Sergei Kondratenko says the DeFi route is forcing traditional financial service providers to reconsider the long-term sustainability of their business models and look for possible synergies with DeFi. The specialist states that, at the moment, the participation of DeFi in the financial market is limited and the risks associated with them are still insignificant. However, with the development of DeFi, they may increase. In this case, regulators should already be involved in the process and seek mutually beneficial compromises.

Sergei Kondratenko is a recognised specialist in a wide range of e-commerce services with experience for many years. Now, Sergei is the owner and leader of a group of companies engaged not only in different segments of e-commerce, but also successfully operating in different jurisdictions, represented on all continents of the world. The main goal is to drive new traffic, create and deliver an online experience that will endear users to the brand and turn visitors into customers while maximising overall profitability of the online business.

Sergei Kondratenko: international discussion on DeFi regulation, development scenarios

Currently, there is no common position among regulators and experts regarding the optimal approaches to DeFi. As Sergei Kondratenko notes, there are many scenarios for achieving a balance between the development of DeFi and the effective management of associated risks. He believes that within the framework of the current international discussion, the introduction of any of the approaches is possible. The expert suggests considering several scenarios for the development of events.

“Ignoring” DeFi

Many countries are taking a neutral approach to DeFi. But this happens until there is a threat to financial stability.

The neutral scenario, according to Sergei Kondratenko, also does not exclude “initiatives from below.” He says some protocols are already voluntarily seeking to comply with financial regulation. For example, AAVE, a decentralised protocol for lending and borrowing on the Ethereum blockchain, has developed client identification (KYC) rules for onboarding banks.

The expert points out the risks of the “ignore” scenario, including the likelihood of an uncontrolled outflow of capital from traditional finance to the “gray” zone. In addition, questions are raised about the lack of protection for consumers and investors and the lack of standardisation in this area.

Loyal regulation 

This involves the development of voluntary standards and recommendations for market participants. At the same time, activities are being carried out to inform consumers and investors regarding the operating principles, mechanisms and risks of DeFi. At the same time, Sergei Kondratenko draws attention to the fact that issues of money laundering, combating the financing of terrorism and compliance with international financial standards also imply compliance with norms.

Strict control 

This involves introducing regulation in all areas of DeFi similar to existing financial controls. In some cases, the possibility of banning DeFi is even being considered in case of high risks.

Still, Sergei Kondratenko believes that due to the nature of DeFi, it is quite difficult to comply with mandatory regulatory rules. There is a risk that capital will move not only to the “gray” zone but also to the “black” zone, with less likelihood of returning to the legal phase. In addition, DeFi as a phenomenon may lose its development potential.

Conclusions and compromises: Forecasts for the development of DeFi in the world of finance - Sergei Kondratenko

International practice shows that the main obstacle to control over DeFi is its functional features. Taking these into account, Sergei Kondratenko proposes ways to solve the interaction of regulators with DeFi.

Due to the lack of a single point of entry into DeFi, regulators cannot effectively monitor traditional admissions, oversight and liability mechanisms.

A possible solution to this challenge is to define a DeFi gateway. These are the convergence points between DeFi and traditional and centralised finance. These gates are usually represented by organised exchange platforms - exchanges. They are easier to identify and regulate.

At the same time, Sergei Kondratenko notes that this decision concerns only the external sphere of DeFi and internal operations and flows remain without supervision.

In this case, the compromise solution would be to “re-centralise” DeFi. This involves an obligation for the protocol community to identify a node (access point) that will be responsible for interacting with the regulator. Such nodes may include protocol developers, governance token holders, or other authorised entities.

The multiple options for anonymity, governance and composition in the DeFi space present challenges for identifying individual participants in a protocol. Even when identifying stakeholders, there is no guaranteed method for identifying the protocol itself or entire “holdings” as regulated entities.

"One possible solution to this issue could be to provide the regulator with the opportunity to participate in systemically important protocols. This will allow him to implement automated compliance conditions and enter reports into smart contracts,” says Sergei Kondratenko.

In addition, given the limitlessness of DeFi, an urgent task is to resolve the issue of determining the jurisdiction where the regulator will be involved in a specific protocol.

A fintech specialist notes that establishing mandatory requirements for smart contracts is being considered as an alternative solution. These include periodic auditing of their code by external independent parties. The standardisation of smart contracts is also discussed. To prevent conflicts of interest, Sergei Kondratenko proposes to create a public supervisory body. He will be responsible for monitoring operations and issuing appropriate recommendations or warnings.

The global and geographically uncertain nature of DeFi entails legal uncertainty and makes regulatory policy difficult to apply. One solution to this problem could be specific rules for DeFi gates. Sergei Kondratenko notes that they involve exchange platforms and the introduction of recommendations for internal DeFi participants. This approach will preserve some degree of autonomy and flexibility for DeFi but regulators will also have control tools.

Additionally, to address the global challenge of DeFi, possible scenarios for the development of international cooperation in this context are explored. This is where the regulators themselves, as well as the engineering and software communities – DeFi stakeholders – need to enter into a common dialogue. The expert suggests that such a discussion could contribute to the formation of standards, procedures and principles that will ensure more effective coordination in the field of global regulation of DeFi.

What do we have?

The lack of uniform international practice and standard approaches to regulating DeFi creates difficulties in choosing optimal strategies for regulating them.

"As we see, international and national regulators are generally of the opinion that at the current stage, it is advisable to adapt existing regulations and supervision to DeFi. This may include the use of loyal recommendations for the organisation and the use of protocols in the DeFi field", comments Sergei Kondratenko.

As a result, the active development of DeFi requires further exploration of opportunities and risks, as well as constant updating of regulations by industry dynamics.