Addressing the Roles and Regulation of DeFi, CeFi and TradFi in UK Finance

Sean Kiernan, CEO of Greengage, recently talked to Teana Baker-Taylor, VP, Policy and Regulatory Strategy (UK and EU) at Circle, to discuss Decentralised Finance (DeFi), Centralised Finance (CeFi) and Traditional Finance (TradFi), and the roles each plays in the financial ecosystem. Specifically, they discussed how regulation might influence the pace of change and its impact on technological innovation, as well as broader governance developments in crypto assets. Last but not least they asked what the UK could be doing better to establish the right environment and conditions in which this industry can flourish.

Teana has a background in the evaluation of Distributed Ledger Technology (DLT) and associated fintech opportunities including for a large investment bank, particularly looking at the use of cryptocurrency and digital assets. Her role with Circle is focused on policy and regulatory strategy in the UK and Europe.

The role of regulation

In the light of the FTX blow up in 2022, Teana addressed the question of what good business practices look like for any company that is responsible for other people’s money, whether in the digital or traditional space. As she observed, regulatory obligations do not always equate to practising sound fiduciary governance, nor do they ensure that you have the right management in place, or an effective Board to provide the sound advice required to grow a business in an appropriate and sustainable way.

At the same time, regulatory guidance does not always provide a sufficiently clear roadmap to how you are supposed to be doing things, and indeed, may vary in and between legal jurisdictions.

The DeFi/CeFi markets are also very new, and regulators themselves do not fully understand the opportunities and risks sufficiently to create appropriate regulator guidance; specifically, most policymakers do not feel that regulating code (rather than behaviour) is within their purview. Regulating too soon and/or too heavily can also inhibit innovation, which nobody wants. Practitioners therefore have the challenge of holding fire until the regulatory environment catches up or advocating for practical and tactical support. Is it possible, for example, to program code around liquidity and volumes within digital assets and smart contracts that simply cannot be manipulated, preventing any predatory activity by ‘issuers’?

Sovereignty and utility round how one’s digital identity is secured and used is also a critical game changer. We all have digital identities already in terms of drivers’ licences and passports. But every institution uses different methods for KYC/AML and despite the focus on Open Banking, this seemingly is not changing quickly (for example, using officially-recognised ‘digital passports’ powered by Zero Knowledge Proofs), particularly in the UK and also internationally.

“The reality is that crypto has matured from birth through the toddler phase and is probably now at the kindergarten stage, where behaviours cannot be as easily attributed to being insufficiently au fait with the assets or associated technologies of a ‘newborn’.”

What could we be doing better?

The UK has a rich history in financial innovation, taking a stance many years ago to make the UK a global fintech hub and forward-thinking regulator. Post-Brexit there has perhaps been an expectation that we would capitalise on the opportunity to unbundle UK regulation from Europe, opening up more opportunity for the UK to compete and grow. Government focus and action with respect to the Financial Services and Markets Bill (FSMB) makes a number of recommendations (and tactical actions) to support its objective to be the world-leading crypto and digital assets hub which is incredibly positive. Having 27 EU member states under one regulatory regime limits regulatory arbitrage across Europe and encourages growth. The UK has an opportunity to look at European regulation and associated methodologies for overseeing these new markets to identify opportunity gaps that can be leveraged to attract business to the UK.

Much proposed and actual regulatory activity recently has been centred on stablecoins. Stablecoins are regulated within Markets in Crypto-Assets (MiCA) and will be brought into the UK regulatory perimeter within the Financial Services and Markets Bill later this year. Japan is also putting forward stablecoin regulation. As the old adage has it, the great thing about standards is that there are so many of them. Like the AML/KYC conversations a few years back, everybody agrees on the need to have robust rules and measures in place, but are still evaluating areas where jurisdictions can align on protocols or standards of best practice.

Incidents and bad actors

If there are any positives to come from the FTX situation it may be greater awareness of where and how traditional and new digital markets overlap. In the case of FTX, what occurred was not about new-fangled digital assets and technologies, but good old-fashioned bad actors doing bad things.

Ultimately it is the regulators job to protect consumers and to ensure fair markets. That said, having rules that protect consumers and abiding by those rules are not the same thing. In the case of FTX, ironically the bad actor in question was heavily involved in industry discussions around cryptoasset regulation and governance. The immediate, kneejerk response to FTX may be that formerly ‘crypto curious’ policymakers will now want to adopt a more ‘wait and see’ approach.

The reality is that crypto has matured from birth through the toddler phase and is probably now at the kindergarten stage, where behaviours cannot be as easily attributed to being insufficiently au fait with the assets or associated technologies of a ‘newborn’. The industry as a whole definitely has a better grasp of systemic and counterparty risks around stablecoins. What we need now is to support the industry through its teenage years to full maturity, with continuing and constructive engagement with market participants, policymakers and regulators.

“The UK has a rich history in financial innovation, taking a stance many years ago to make the UK a global fintech hub and forward-thinking regulator. [There is] an opportunity to look at European regulation and associated methodologies for overseeing these new markets to identify opportunity gaps that can be leveraged to attract business to the UK.”

Teana Baker-Taylor bio

Teana is VP, Policy and Regulatory Strategy (UK and EU) at Circle, responsible for UK and European market strategy, operations, business development, and government relations and regulatory affairs across the region.

She is also a non-executive director at CryptoUK and an executive director and Board Member (Global Digital Finance) at Innovate Finance where she oversees the development of the GDF Code of Conduct for the cryptoasset community and champions policymaker, regulator and industry outreach to build a shared understanding of the risks and opportunities presented by digital currencies and tokens. She previously held several critical leadership roles in traditional finance and digital assets entities, including Crypto.com and Binance.

To learn more, listen to our podcast series, The Gage Episode 13 — ‘The Role of Crypto in Finance’