DeFi Regulation

Regulation of Decentralized Finance and Smart Contract Economy

Decentralized Finance (DeFi) is a logical and at the same time groundbreaking development of blockchain technology, crypto assets and smart contracts. DeFi refers to projects that involve the decentralized provision of financial services in the broadest sense and that are not provided or made available via a central provider, but via an automated smart contract on a compatible blockchain. Examples of decentralized finance include staking or lending services that can be accessed via interaction with smart contracts. Smart contract-based decentralized exchanges (DEX), which hold various crypto assets in so-called liquidity pools ready to be exchanged without a central entity conducting the exchange activity are also widespread in DeFi. Due to the lack of a central provider, many projects raise the question of whether DeFi projects can trigger licensing obligations and, if so, who can be considered as the addressee of the licensing obligation.

Degree of Decentralization of a DeFi Service is Decisive

MiCAR generally does not address DeFi projects and systematically focuses on the regulation of centralized crypto asset service providers. Nevertheless, it is possible in individual cases that persons or companies involved in DeFi protocols also trigger regulatory licensing obligations. The decisive factor is usually the degree of actual decentralization of the service. If, for example, initiators or developers of a protocol reserve the governance of the smart contract or certain access or intervention rights, or if they receive fees from the transactions carried out via the DeFi protocol, there may be sufficient control over the DeFi protocol in individual cases, which results in the status of an operator in the regulatory sense. The degree of potential influence of the initiators of DeFi infrastructures is therefore the decisive factor for the question of regulatory responsibility and the existence of licensing obligations under MiCAR, the KWG or the WpIG. A specialist lawyer or law firm in crypto regulation can answer such questions at an early stage and therefore be very helpful when it comes to the legal structuring of DeFi projects.

Interaction with a DeFi Smart Contract May Require BaFin License

Services in the field of Decentralized Finance are often not offered in a completely decentralized manner. In many projects, there are providers who must either ultimately be regarded as the provider of a service accessible via a smart contract or provide services practically as an add-on to a DeFi service. For example, someone offering to provide smart contract-compatible wallets to users of a DEX or smart contract-based staking or lending service will be, where applicable, engaged in crypto custody which requires a license. Similarly, a company’s engagement as a market maker on a decentralized smart contract-based exchange may trigger licensing requirements and need to obtain a BaFin license prior to commencing operations. In individual cases, advice on crypto trading on decentralized exchanges may also constitute investment advice on crypto assets that requires a license. Such services can legally only be provided on the basis of a previously granted BaFin license.

The competent lawyer for questions regarding DeFi Regulation in our law firm is Attorney Lutz Auffenberg, LL.M (London).