Regulators Focus On DeFi But Differ On Emphasis

United States cites risks while France sees opportunity

Banque de France headquarters in Paris

Compiled by the Oliver Wyman Forum

The US government cites some decentralized finance protocols and design as a national security risk while French authorities put the accent on the opportunity of DeFi innovation. Meanwhile, Bitcoin led a rebound in cryptoasset prices in the first quarter of 2023. These are among the notable recent developments in the future of money.

Policy Front

US Plans Tighter Rules To Control DeFi Risks

Decentralized finance, or DeFi, poses a risk to US national security through cybersecurity vulnerabilities, ransomware, and other criminal activities, and exploits by state-backed actors like North Korea, the US Treasury asserted on April 6 in its first risk assessment report on DeFi.

Bad actors are using DeFi services to transfer and launder the proceeds of illicit activities, exploiting vulnerabilities in anti-money laundering (AML) and countering the financing of terrorism (CFT) rules and enforcement regimes as well as the technology underpinning DeFi services, the report said. US authorities will work with international partners and multilateral organizations to address illicit finance risks associated with DeFi, it said.

The report also recommended strengthening AML/CFT supervision and enforcement to increase compliance by virtual asset firms and closing any gaps that allow certain DeFi services to fall outside the regulatory perimeter. The report also said the government would promote private-sector efforts to improve real-time analytics and monitoring, and to develop tools including zero-knowledge proofs to check AML compliance without disclosing personal information. That effective endorsement of a crypto-based solution was taken as a win by some in the industry, The Defiant reported.

French Central Banker Makes Case For DeFi Innovation

The Banque de France aims to develop new regulations designed to foster the secure development of decentralized finance and to use DeFi to encourage tokenized finance and improve cross-border payments, First Deputy Governor Denis Beau said in an April 4 speech in Singapore.

French and European authorities should seek to develop a regulatory framework adapted to DeFi rather than replicate existing rules, he said. In doing so, authorities should evaluate whether public blockchains can provide adequate security for financial services, and how to regulate access to DeFi to protect investors, especially individuals.

The central bank is monitoring DeFi not only to guard against financial stability risks but because it believes DeFi’s innovative potential could serve the development of tokenized financial markets. He cited the central bank’s ongoing experiment called Project Mariana with the central banks of Singapore and Switzerland to use automated market makers, a DeFi tool, to facilitate cross-border exchanges of central bank digital currencies, or CBDCs.

IMF Says Failures Underscore Need For Digital Asset Regulation

Recent failures of cryptoasset firms and banks with links to the digital assets ecosystem underscore the need for comprehensive regulation of the sector, the International Monetary Fund (IMF) said in its Global Financial Stability Report, published on April 11.

The spillover of instability from the collapse of Silicon Valley Bank into the crypto ecosystem and the demise of Signature Bank because of concerns about its footprint in that ecosystem “add to questions about the viability of digital assets and reinforce the need for appropriate regulation,” the IMF report said. It called for strict prudential requirements for stablecoins as well as for entities carrying out multiple functions, such as exchange and custody operations.

Separately, the European Systemic Risk Board said authorities needed the capacity to monitor potential spillovers between traditional financial institutions and markets and the digital assets ecosystem. The board, which will publish a report on cryptoassets and decentralized finance in the second quarter of this year, also cited the need to identify and assess risks from crypto conglomerates and from leverage using digital assets.

United Kingdom Plans New Effort To Fight Crypto Crime

The UK government will strengthen its anti-money laundering powers and its ability to seize cryptoassets associated with illicit activity as part of a new three-year Economic Crime Plan published on March 30.

The plan calls for creating multi-agency cells to improve law enforcement authorities’ ability to crack down on economic crime and seize cryptoassets. The aim is to “protect consumers and grow the economy by robustly regulating cryptoasset activities” and to make the UK "an attractive destination for cryptoassets and cryptoasset innovation in the world," the plan states.

Market Developments

Bitcoin Leads Crypto’s First-quarter Rebound

Cryptoassets recovered sharply in the first quarter with Bitcoin and Ether leading the way, data provider Coin Metrics reported on April 4.

Bitcoin rose 72% in the three months ended March 31, to more than $28,000, while Ether rose 50% to a little over $1,800. Their gains boosted the market capitalization of all cryptocurrencies back above $1 trillion. The market and its two largest cryptocurrencies remain more than 50% below their all-time highs of November 2021. But the recent gains, despite the backdrop of a banking crisis that included the collapse of Silicon Valley Bank (SVB) and the agreed acquisition of Credit Suisse by UBS, “appeared to vindicate BTC’s original raison d'être as an alternative financial asset born from the ashes of the great financial crisis,” Coin Metric’s State of the Network report said.

The quarter also saw a shakeup of the stablecoin market, with declines in the supply of Circle’s USDC and Binance USD (BUSD) only partly offset by a rise in supply of Tether. New York regulators ordered Paxos Trust Company to stop minting BUSD while USDC temporarily lost its peg to the dollar after the collapse of SVB, where Circle had deposited some of its cash reserves.

European Banks To Develop Digital Bond Platform

French investment bank Credit Agricole CIB and Sweden’s Skandinaviska Enskilda Banken announced on April 3 that they would develop a blockchain-based platform for trading digital bonds. The platform will use a protocol that rewards validators that minimize their energy consumption.

The announcement came several days after a lawyer for Brussels-based settlement house Euroclear said it aimed to launch a platform for trading digital securities with distributed ledger technology as soon as this year.

Disney Abandons The Metaverse, But Not Marketers

Walt Disney has eliminated its next-generation storytelling and consumer-experiences unit, which was developing the firm’s metaverse strategy, as part of a broader cost-cutting initiative, the Wall Street Journal reported on March 28.

Disney joins a number of companies that have scaled back their metaverse ambitions, including Microsoft and Facebook parent Meta. By contrast, many consumer companies plan to spend more money to develop their presence in the metaverse. In a recent survey, nearly half of consumer brand marketers said they would increase their metaverse budgets in 2023 compared with 12% who said they would spend less.

Legal Beat

Report Details Management Failures Behind FTX Collapse

The failure of the FTX exchange group was rooted in “hubris, incompetence, and greed,” according to report released on April 9 by the firm’s new management led by CEO John J. Ray III. 

The report provided new details about the lack of controls and risk management at the firm. It claimed that expenses and invoices were submitted on the Slack messaging app and approved by emoji; that most company assets were held in hot wallets connected to the internet and vulnerable to hacking; and that founder and former CEO Sam Bankman-Fried described FTX’s related hedge fund Alameda Research as “hilariously beyond any threshold of any auditor being able to even get partially through an audit.”

Separately, US prosecutors accused Bankman-Fried of paying a $40 million bribe to Chinese government officials to regain access to assets that had been frozen by Chinese law enforcement authorities, according to a revised indictment filed in federal court on March 28.

Crypto Platform Beaxy Closes After SEC Lawsuit

The Beaxy cryptocurrency closed down on March 29 after the US Securities and Exchange Commission (SEC) charged the firm and its executives with failing to register as a securities exchange, broker, and clearing agency. It was the first such action the SEC had taken against a digital currency platform.

The SEC also accused Beaxy Digital Ltd. of illegally raising $8 million through the offering of an unregistered security, its BXY token, and alleged that founder Artak Hamazaspyan misappropriated at least $900,000 for personal use.