What DeFi Must Sacrifice to Appease Regulators

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Decentralized Finance (DeFi) has emerged as a revolutionary force in the financial industry. When traditional banks narrowly avoided a systemic bank run, and centralized exchanges (CEX) collapsed spectacularly, DeFi kept working, providing trustless financial services to people around the globe.

Markus Maier is the founder and managing director of Violet, a privacy-focused DeFi platform.

Success, however, brought with it bad actors and illicit financial transactions that troubled regulators worldwide. An unusually successful algorithmic stablecoin soared and then collapsed, whipping out billions in dollars of capital and the loss of retail enthusiasm. Hackers stole nearly $4 billion by exploiting crypto protocols in 2022 alone (with North Korea as the prominent perpetrator). To say there’s been a loss of regulatory goodwill is an understatement – the U.S. Treasury Department now considers DeFi a national security threat.

These problems have kept most traditional financial institutions out of DeFi, which is detrimental to long-term growth and adoption of crypto. In the depth of crypto winter, the industry must find a solution to spark the next cycle and bring mass adoption.

The solution is called the “internet financial system,” or IFS, which combines the best of DeFi and traditional finance (TradFi) in one unified network. An idea championed first by Chris Burniske, IFS is built on open crypto rails and preserves blockchain’s most important attributes such as decentralized settlement, self-custody, transparency and composability.

However, the IFS tries to be genuinely inclusive, enabling the billions of people already part of TradFi and financial institutions to benefit from on-chain innovation. Connecting crypto to TradFi will not only bring more users, but also unlock trillions of assets that are currently trapped in these siloed financial systems.

To achieve this feat, the IFS must square the circle: It must be built on top of decentralized architecture while still mapping TradFi compliance and national regulatory requirements (all without giving up on privacy). It’s a monumental effort that requires new tech, standards and laws. Thankfully, this second revolution has already begun, charging ahead on three fronts:

Consumers, institutions and regulators demand more compliant, more secure and regulatory-friendly decentralized services – and that’s precisely what we will continue striving to build.

Solving regulatory and compliance concerns in a privacy-protective way will usher in a new era where the IFS delivers on DeFi’s original promises – running all financial applications on-chain and enabling new use cases. As a result, we will make tokenized real-world assets more liquid and composable, benefit from cheaper and faster remittances, and make finance as a whole more robust and accessible.

We invite everyone to join this collective effort, which needs the best and brightest minds from various disciplines: crypto, tech, law, policy, finance and more. It will be about breaking new ground, making some compromises and delivering the future of finance.

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