Out-Law News 1 min. read

Abu Dhabi financial watchdog weighs regulation of DeFi

Financial services regulators in the United Arab Emirates have announced that they are preparing a future regulatory framework for decentralised finance (DeFi), as the technology continues to grow in popularity.

The Financial Services Regulatory Authority (FSRA), which regulates financial services operating inside the Abu Dhabi Global Market (ADGM), issued a discussion paper (22 pages / 472KB PDF) that is said would help officials better understand the potential opportunities and risks associated with DeFi protocols.

DeFi protocols use blockchain-based technology and smart contracts to record financial transactions and transfer funds. The systems are designed to improve efficiency in markets by reducing reliance on traditional financial institutions, such as banks or stock exchanges.

Tom Bicknell, financial regulation expert at Pinsent Masons, said: “While DeFi has the potential to greatly improve efficiency in financial services, the technology remains largely unregulated across the world. As the FSRA acknowledges, its benefits mean DeFi is rapidly growing in popularity, but a continued lack of regulation could pose risks to investors, financial institutions and the wider financial system.”

The discussion paper, intended to kickstart industry discussions as to how DeFi may be regulated, sets out the FSRA’s views on the likely medium-term direction of DeFi and what a future regulatory framework might look like.

According to the document, the regulator is likely to focus on issues of transparency when deciding whether to recognise a DeFi protocol, including the track record of its controller, how its governance decisions are made and the technology underpinning the protocol. Any future regulatory framework would not tolerate anonymous participants in DeFi protocols.

The FSRA would also likely require firms engaging in DeFi activities to provide additional disclosures to their customers, such as explaining the risks associated with DeFi in clear, easily understandable language and outlining how the firm intends to use DeFi technology.

The regulator reserved the option to approve specific DeFi protocols, which would be held to a higher standard than recognised protocols. In particular, the FSRA said it might require at least one DeFi controller be based in ADGM - or that the DeFi protocol have a longer, demonstrable track record. The FSRA said it might develop a specific regulatory framework for a future approval process.

Mr Emmanuel Givanakis, CEO of the ADGM FSRA said: “We are pleased to contribute our views on DeFi and its potential future direction to the ongoing discussion in the community, in association with industry practitioners. We also look forward to collaborating and starting a dialogue with the industry that will help us make informed policy choices to address these risks and thereby realise the potential benefits of DeFi and on any future regulatory developments.”

The deadline for providing comments on the discussion paper is 30 June 2022. 

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