When worlds collide: DeFi meets TradFi

So too in the emerging world of alternate finance. The world of AI, Web 3.0, DeFi, NFTs and crypto assets. Part of the mission of these developments of course is to change the rules. Why should banks be at the heart of payments? Why should nations be the only entities that can create currencies?

“Central banks are looking at not just intervening in the [cryptocurrency] market but participating in it.”

Some rules, however, are immutable.

One of those rules is the rule of bistability of regulation: when innovation is small and interesting, regulators do nothing. But at a certain point, when that innovation becomes significant, regulators suddenly act, changing the world. And often this happens just when the second and third waves of investors and proselytisers are looking to cash in.

That is exactly the era we are entering today. Cryptocurrencies are registering such volumes that securities regulators are very interested and central banks are looking at not just intervening in the market but participating in it.

Necessary intervention

NFTs – non-fungible tokens, particularly popular in an emerging art market – face much greater scrutiny as do crypto-assets more generally.

There is a reason for this that goes beyond regulators and central bankers being killjoys: there is always a tension between innovation and stability and when system stability – which underpins the basic function of the real economy – is threatened, intervention is necessary.

In Australia we have just seen the Australian Securities and Investments Commission (ASIC) issue a guidance note on the obligations of so-called “finfluencers” – influencers who provide financial opinions on social media – which has had seismic repercussions on those in the sector who now face jail terms for providing inappropriate advice or providing certain advice without a licence.

ASIC chairman Joe Longo made this clear in a speech on ASIC’s priorities emphasising a focus on “addressing the deceptive promotion of riskier asset classes such as crypto” and “disrupting investment ‘gamification’ on digital platforms”.

On a more macro level however it is increasingly clear you can longer enter a Web 3.0 world of bizzaro finance and not expect the presence of a regulatory avatar.

Timely and coordinated policy

The latest, and probably toughest, line came from the international securities regulator IOSCO – the International Organization of Securities Commissions whose members represent 95 per cent of the world’s securities regulators.

In a report, the agency noted risks from decentralised finance (DeFi) “are quickly evolving as the crypto-based markets grow to the point where they are ‘cloning’ mainstream financial markets”.

IOSCO will set up a new task force to help members “take timely and coordinated policy action to appropriately address the risks arising from this fast-growing area”.

This is the regulatory equivalent of “nice place you’ve got here, shame if something happened to it”.

IOSCO – and other regulators – don’t doubt “the potential benefits and ‘novel’ financial products and services” DeFi brings. The issue is, in IOSCO’s view, many of these “mirror” conventional financial markets but, critically, with far weaker regulation, poorer governance and greater risks.

One significant risk is the pseudo democracy of these alternate worlds. Supposedly free of the tyranny of governments and regulators, the rules – and there are rules – of the decentralised universe are typically set by a vote. But the vote inevitably will skew towards those with the most power in the networks.