In order to issue a MiCA license, the European Commission may soon mandate protocols for DeFi industry participation.

New regulations may soon be imposed on decentralized finance protocols in Europe as the European Commission conducts an assessment of the area. 

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By December 30, 2024, the European Commission is required by the Markets in Crypto-Assets (MiCA), the regulatory framework overseeing digital assets in the region, to produce a report assessing the decentralized finance market and the viability of sector-specific regulations.

We have initiated several actions to prepare for this report. For example, we are conducting research regarding embedded supervision.” As of yet, no policy decisions have been made,” a spokesperson for the Commission informed Cointelegraph.

The objective of the report is to investigate the regulatory aspects of decentralized systems, with a specific focus on those lacking a distinct issuer or service provider. “A crucial element of this evaluation will involve an examination of the regulatory framework governing the lending and borrowing of crypto-assets, which is a fundamental operation in the DeFi sector,” explained Maxim Galash, CEO of CoinChange Financials.

Blockchain-based decentralized technologies facilitate the transition from conventional, centralized financial systems to peer-to-peer financing in DeFi. Decentralized systems function in the absence of regulatory intermediaries, such as banks or financial services providers, which are frequently the subject of traditional finance laws.

A prospective novel regulation has engendered apprehensions regarding the legal feasibility of certain cryptocurrency initiatives. The regulations may impose licensing requirements on certain DeFi interfaces, including decentralized exchanges, according to MakerDAO co-founder Rune Christensen.

“This would render DeFi frontends that are currently feasible on conventional internet domains unfeasible.” Full-KYC online frontends or completely decentralized, locally-downloaded frontends would be feasible. He composed, “Sad.”

Heard today that there’s a good chance all EU national financial regulators will interpret DeFi frontends to require a MiCA license. This would make DeFi frontends on normal internet domains, as we know them today, impossible. Only fully decentralized, local, downloaded frontends…

— Rune (@RuneKek) April 3, 2024

Likewise, Nathan Catania, a partner at XReg Consulting, is of the opinion that, in due course, a DeFi regulation will be imposed on all applications that are not completely decentralized, including DeFi frontends. Catania argues that the MiCA regulation lacks a clear definition of decentralization, and the scope of DeFi regulations would be substantially contingent upon the criteria employed to ascertain the notion.

“We may perceive even protocols lacking sufficient decentralization as conducting CASP services, such as the exchange of crypto-assets for one another.” Additionally, front-ends encompass functions such as order transmission and reception on behalf of third parties. As a result, the answer may depend on the level of stringency that regulators want to maintain in their enforcement.

As per the MiCA regulation, a crypto-asset service provider (CASP) is any organization that offers third-party services pertaining to digital assets. Such services may include custodial purses, exchange services, and transfer services.

Professional service is one of the most important factors that regulators may consider when determining the degree of decentralization, according to Catania.

“A front-end that merely provides users with an interface to access DeFi without tampering with users’ funds and without charging a fee is less likely to be at risk than one that imposes an additional fee, and even in that case, legal and technical considerations must be taken into account to determine whether that activity should be licensed under MiCA.”

An alternative avenue for DeFi regulation could involve the Financial Action Task Force (FATF).

Galash of Coinchange stated that the FATF suggests classifying entities or individuals with substantial control or influence over DeFi arrangements as Virtual Asset Service Providers (VASPs) under specific conditions. Galash wrote, “This classification remains valid despite the apparent decentralization of the arrangements, highlighting the intricate nature of defining and regulating DeFi activities.”

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According to DefiLlama data, there has been an observed increase in the total value locked (TVL) in DeFi protocols.

Catania stated, “The crucial question is whether the DeFi arrangement is merely a technological arrangement or whether a controlling party is actually behind it that can affect user value.”

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