Compliance Holds the Key to Mainstream Adoption of DeFi

Few dispute the transformative potential of decentralized finance (DeFi). The burgeoning space has proven that by lowering costs, enhancing privacy, and improving accessibility,  blockchain technology can revolutionize finance. But despite these facts being out there for years, DeFi is struggling to gain mainstream adoption.

A big part of this is regulatory compliance. Regulation has been a major talking point this year as governments around the world appear increasingly keen on formulating regulatory frameworks for digital assets. While some in the space see this as a threat to the core value proposition of DeFi, it might just be what holds the key to mainstream adoption.

But understanding that begins with understanding what mainstream adoption actually looks like.

A Vision of Mainstream Adoption

DeFi going mainstream is the dream of many investors and Web3 projects alike. One such project is Violet, which has the ambitious goal of threading the needle to find the sweet spot between regulation and decentralization.

If it is successful and DeFi does go mainstream, a significant proportion of financial activity will take place on-chain. But, such activity won’t exclusively involve cryptocurrencies. There will be traditional assets – or real-world assets (RWAs) as many in the space like to call them– like stocks, bonds, fiat, and even commodities.

Most of the world participates in these financial markets. So, when they are brought into the on-chain financial realm, this large user base will follow suit. And then, DeFi can finally be said to have achieved mainstream adoption.

Where Does Regulation Come In All This?

Outside a few outright crypto bans in some jurisdictions, DeFi has always lacked government oversight. There is no body of law regulating behavior and no centralized entity overseeing things. Instead, it is a financial system governed solely by its users. This has made DeFi censorship-resistant but unattractive to the broader financial world.

Many see this lack of censorship as a key pillar of cryptocurrency. Users can interact with each other and any protocol without interference. They get to exist in a financial system that’s free from the influence of governments and central banks.

Unfortunately, this lack of regulation has also been an Achilles heel for DeFi. Hackers have made the space their home while criminals, terrorists, and even rogue states have used it to obtain and launder funds. It has become an avenue for illicit finance. And herein lies one of the biggest hurdles to mainstream adoption.

With safety and regulatory concerns to contend with, many traditional financial institutions are leery of embracing on-chain finance. This means their customer base, which represents much of the world, doesn’t participate in DeFi.

Mass adoption will follow regulation and regulatory compliance. Having a regulated space will encourage traditional financial institutions to embrace Web3 technologies, which will bring an influx of users to on-chain finance.

Is Compliant DeFi Even Possible?

A strong case against government interference is that it goes against the foundations of blockchain-based finance. By allowing itself to be shaped by lawmakers, DeFi will lose its soul, the argument goes. Thus, many believe that a compliant on-chain financial system is impossible.

But that's not the case.

Compliant DeFi is possible. On-chain finance can get on the right side of the law while retaining its biggest value propositions, privacy and decentralization. This will be a long journey with some key steps along the way, the first of which is regulatory acceptance.

The DeFi community may be frustrated with this tack, but the only way to ensure the growth of decentralized finance is if stakeholders collaborate with policymakers.

This is because the best solutions to illicit finance can only arise within DeFi itself. It's only by presenting these solutions to regulators that policymakers can craft smart, workable anti-money laundering (AML) guidelines.

From here, the next trick is implementing compliance. On-chain finance needs to find a way to ensure AML compliance.

One way, and perhaps the best way to do this is through programmable compliance. This is where guidelines are implemented programmatically in protocols. AML laws can be coded into the smart contracts powering on-chain finance, eliminating the need for centralization. Such smart contracts will be responsible for handling AML checks automatically.

But, most importantly, this should not come at the cost of user privacy, even with strict know-your-customer rules (KYC). Smart contracts should not require or expose personal data on the blockchain.

Fortunately, the technology to ensure on-chain compliance is available, and some concepts prove it works. Violet is a blockchain infrastructure service that helps blockchain projects become compliant with crypto regulations around the world through privacy-preserving credentials.

One such project is Mauve, a fully AML-compliant decentralized exchange (DEX) for RWAs. Mauve is only accessible to users who have passed AML checks. But being a DEX, it is non-custodial and users interact with it with only their wallet addresses, proving that compliant on-chain finance is possible.

The Future is Compliant

Regulation is coming to crypto and it will likely be what pushes on-chain finance to the mainstream. Those worried that DeFi will cease being DeFi when this happens can rest easy. The technology to ensure on-chain finance retains privacy and decentralization with regulatory compliance is available and viable.