Decentralized Finance (DeFi) is gradually redefining the landscape of modern-day investing by making traditional assets and popular financial instruments more accessible to everyone. As of writing, the total value locked (TVL) across DeFi protocols stands at $75 billion, up from $54 billion at the beginning of this year.
However, despite the promise to revolutionize finance, institutions have been reluctant to embrace DeFi-built assets, primarily because of the gap that currently exists in regulatory compliance. Apart from the advanced multi-asset platforms such as MANTRA Finance, which features a regulated DEX, there are few to no regulated options for potential investors.
In this article, we will highlight why regulatory-compliant DEXs could be the best shot for the crypto market to onboard a new wave of investors.
Before delving into the details, it is worth highlighting that the demand for regulatory-compliant DEXs is currently being driven by an emerging DeFi sub-niche dubbed ‘Real World Assets’ (RWAs), with an untapped market potential of close to $16 trillion.
Although still relatively new, RWAs are gaining significant traction, especially among traditional financial institutions that are slowly realizing the value proposition of asset tokenization. Fundamentally, asset tokenization will allow the integration of traditional assets with decentralized on-chain economies, opening up legacy markets that have long operated within siloed ecosystems.
Main Attributes of a Regulatory Compliant DEX
With so much value yet to be realized, the big question then becomes: what will it take for DEX innovators to attract the sensitive institutional market, where adherence to regulatory frameworks is a top priority?
While some DeFi die-hards will likely argue that introducing regulatory-compliant DEXs contradicts DeFi’s main ethos of decentralization, if this nascent market is to go mainstream, some compromises have to be made. Most importantly, innovators should consider some of the key elements, which could position them as regulatory-compliant.
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KYC/AML Standards and Tools: Similar to the compliance procedures in the traditional finance market, DEXs have to embrace due diligence processes that can efficiently help identify their clients as well as detect any money laundering or terror-financing activities.
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Licensing and Registration: Already, some governments, including the U.S., are pushing for DeFi platforms to register their offerings with the relevant authorities. This is essentially a call for DEXs that are targeting investors in such jurisdictions to find a way of developing regulatory-compliant modules that can be licensed.
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Regulatory Engagement: DeFi is a relatively new space, and therefore imposing Tradfi rules would be a disservice to this burgeoning sector. What better way for innovators to shape future regulations than engaging with the bodies or individuals mandated to draft crypto regulatory frameworks?
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Transparency in reporting: For DEXs to succeed in attracting institutional investors, the platforms have to be fully transparent. Luckily, this is an innate feature for public blockchains, and could be further enhanced by allowing more validators to seamlessly operate nodes as is the case on MANTRA Chain.
Setting the Stage for Regulatory-Compliant DeFi Investments
As highlighted in the introduction, most of the DEXs that exist are yet to embrace regulatory compliance features. However, this is not to say that there are no strides being made; the MANTRA Finance (MF) DEX is one of the model examples which clearly demonstrates that it is possible for DeFi innovators to build decentralized ecosystems that factor in compliance issues.
Built on the MANTRA Chain, this novel DEX will leverage the protocol’s native compliance features. Most notably, a decentralized on-chain ID (DID) feature, which will allow the DEX to provide a seamless way to conduct KYC/AML by issuing a soulbound NFT tied to each user’s identity. Ideally, these unique NFTs will be used to represent the metadata attributed to clients’, making it easier to store the data on-chain for transparency and KYC/AML verification purposes.
Additionally, MANTRA’s core infrastructure is made up of regulatory-compliant modules, which will come in handy when the DEX or other applications built on the MANTRA Chain start to pursue digital asset licenses.
“We believe that future regulation will primarily focus on the application layer, rather than the protocol layer. Therefore, it makes logical sense to build a protocol that supports a variety of regulated activities. This includes on-chain identification, permissioned access to products, and connectivity to the fiat/banking world through on/off ramps.” – MANTRA docs.
It is also worth highlighting that despite being regulatory-compliant, the MANTRA ecosystem is run through a decentralized governance (DApp) token, $OM, which will also double down as MANTRA’s Chain primary Layer-1 token following a proposal that was recently approved by the community (Sherpas).
Consequently, MANTRA is gearing up for another community proposal suggesting several changes: upgrading the $OM token to be multi-purpose, issuance of new $OM, total supply, and staking adjustments.
With the RWA market set to grow bigger in the near future, MANTRA’s DEX is currently aligned as the potential go-to platform for institutions or retail investors seeking to hedge against regulatory-compliant risks. It is also among the few DeFi projects that are building a Central Limit Order Book (CLOB) DEX, which will make it easier to match trades in the tokenized P2P market.
Conclusion
The DeFi ecosystem has come a long way since Uniswap debuted as the first DEX in 2018. Today, we’re no longer talking about experiments but exploring the alternatives that will open up the market to more participants. Of course, it goes without saying that regulation is a sensitive topic, depending on which side of the divide one stands.
However, what a majority of the crypto community can probably agree on is that for institutions and high net worth individuals to join the bandwagon, compliance issues need to be addressed. More recently, the SEC approved Bitcoin Spot ETFs, a move that has seen the largest fund manager in the world, Blackrock, buy BTC aggressively.
What if this is what DeFi needs as well? A nod from the regulators; this can only be achieved by constantly exploring the potential of a self-regulating ecosystem powered by innovations such as NFTs or modular infrastructures built from the ground up with regulatory-compliant features in mind.
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