If you follow our Medium page, you have probably noticed we like to write about safety, regulations and the practical and philosophical pros and cons of centralization vs decentralization. And if you know anything about our project you understand why.
These are topics essential to what we do here at Probinex, and we want us and our fans and clients to be on the same page in regard to the why and how of our actions. This article will be no different. We’ll delve into a topic many of you are probably familiar with, but in context that might be fairly new. How do we approach the topic of safety, centralization and legislation when it comes to an entire field of commerce based on trustless automated transactions? How do projects and websites that serve countless legions of anonymous users through algorithmic processes even begin to think about implementing safety protocols or identity verification? You might have guessed it, we’re gonna talk about DeFi.
2021 was the year of DeFi — decentralised finance. Coming into existence around 2017, but sort of hibernating and developing, last year various DeFi projects mushroomed all over the internet and their rise (and in some cases fall) was rocket-fuelled.
This new field of blockchain products is based on dApps — essentially computer programs running on a blockchain (mostly Ethereum but also Binance Smart Chain, and other, lesser-known networks) as if the whole network was a single computer. These programs never stop as long as there’s at least one computer connected to the network and what’s more, once “released into the wild”, so to speak, work independently. Anyone can interact with them and providing the right input will always yield the programmed output. People who used a service whose provider went bankrupt and couldn’t keep their servers running will understand what a huge advantage this is.
Notably, Bitcoin and its forks do not support dApps, so the current trend also encourages the outflow of money from the Bitcoin-based networks to the Ethereum-based ones. Whether that will finally lead to the dethroning of Bitcoin remains to be seen.
But how are immortal programs running wild in the cloud related to the future of finance? More closely than you might think. DeFi projects allow users to do all kinds of complicated stuff, such as trading, lending and taking loans, investing and much more, all trustlessly. What does that mean exactly? It means that the dApp is acting as an intermediary to all the parties approaching it and ensuring they fulfil all the necessary requirements. In other words, you don’t need to know the person you are lending to, and they don’t need to know you. There’s no need for you to trust each other. And as we’ve mentioned, these services work nonstop, which is something no bank can offer you.
Stand by, technical difficulties
Alright, so the dApps are the common ground, they ensure the necessary conditions are met. But who watches the watcher? To quote Shakespeare’s Hamlet “Aye, there’s the rub!” The governments and their regulatory organs will want to impose their own rules and regulations, such as the nearly universal AML (anti-money laundering) guidelines and KYC (know your customer) protocols. And official institutions rarely care about the underlying mechanisms of the services and products they try to regulate, they simply state the conditions and ban anyone not complying.
So how can DeFi comply? From here on out, we will assume it does wish to comply, because, as we’ve stated in previous articles, the age of unregulated rogue cryptoprojects is over. We at Probinex believe that anything that’ll be here in five years will be regulated to some extent. That being said, how do you enforce regulation without a central authority? The alpha and omega of all laws is “who do you sue, when things go wrong?” but since the dApps just run on their own, there’s no provider to blame and the developers are largely unknown. There are several ways the industry could go though. Let’s see:
Wallets as “crypto-passports”
Wallets such as MetaMask, Trust Wallet or WalletConnect already act as digital passports of sorts. From a code’s point of view, there’s no difference between a human user and decentralised program. They are both just accounts, interacting in a series of transactions. So, whether you want to use a DEX (decentralized exchange) or profit from yield farming, a dApp-based website will ask you to “connect your wallet” to both authorize you and enable you to use its services. Imagine it as your driver’s licence also being your car keys. This offers regulators a relatively easy (at least from a technical standpoint) option: forget about the dApps and simply regulate wallet providers. Today, anyone can make a wallet, but we might wake up to a future where creating MetaMask entails the same hurdles registering for a Binance or Kraken account does: sending your proof of address, of income, of identity etc.
Token of trust
Alternative approach is trusted, government-regulated third parties providing KYCs and issuing an NFT (non-fungible token) in return. This token would signify that the person carrying it is verified, but also protect the users’ privacy by not providing any sensitive information. It will also save everyone’s time, since there won’t be a need for users to do their KYC repeatedly for each service they wish to use. This option is also notably similar to the “bank-identity” concept launched in the Czech Republic. There, people can use their internet banking credentials to log into government services without any further steps, simply because the government declared these banks a trusted third party. In the cryptosphere, companies such as Everest are actively developing this solution and it will be interesting to watch their further efforts.
Finally, there might be dApps developed which manage the entire KYC process on their own. In the future, when you connect your wallet to a decentralized service, you may be prompted to provide the same documents you would when registering for a centralized one, but instead of a real person sitting down and verifying them, the program will do it by itself. There are some issues with this option, as it would require the documents to be written into the blockchain, which would be problematic especially with data subject to change, such as permanent residence. Nevertheless, various versions of these automated KYCs are being tested and developed.
As you can see, merging safety, regulations and decentralized services is both a technical and legal hurdle, but with the DeFi space being worth over 250 billion USD, there will definitely be no shortage of smart people with smart solutions. This does not seem like a blind alley to abandon after a brief infatuation. DeFi is probably here to stay, the question is, how will it evolve to fit the new, regulated world of cryptocurrencies?