The Association for Financial Markets in Europe (AFME) is urging European regulators to include decentralized finance (DeFi) in the Markets in Crypto Assets (MiCA) regulations, cautioning against potential risks that could undermine the effectiveness of the regulatory frameworks if Defi is excluded.

The MiCA regulations, poised as the first comprehensive crypto legislation, are due to come into effect in December 2024. However, the legislative framework currently bypasses emerging financial sectors like DeFi and nonfungible tokens (NFTs).

In a whitepaper titled “Decentralised Finance – Principles for building a robust digital economy,” AFME warns that this exclusion could inadvertently engender risks to financial stability and cause unforeseen consequences. Despite the current inconsequential overlap between traditional finance (TradFi) and DeFi, AFME urges that this interaction should be actively monitored and managed.

According to the AFME, DeFi represents significant innovation within the financial ecosystem. The body views the burgeoning DeFi efforts as “outsourced innovation and research and development labs for the formal financial system.”

Building a consistent and comprehensive regulatory approach

AFME, an industry advocacy group championing wholesale market participants in Europe, proposes that the European Union develop a clear classification system, or taxonomy, for DeFi activities and digital assets. Such a taxonomy would facilitate the formulation of a comprehensive regulatory solution to tackle the unique challenges presented by DeFi.

In terms of governance within the decentralized ecosystem of DeFi, the trade body advocates for a consistent regulatory framework incorporating different levels of centralization. It further encourages a risk-based approach, underscoring the need for regulation to reflect the varying risk levels inherent in different DeFi activities.

The paper serves as an initial exploration of technical issues associated with this new realm of digital finance, along with preliminary proposals on how to address DeFi from a regulatory standpoint. AFME emphasizes that its request isn’t intended as a conclusive solution. Instead, it aims to foster dialogue across the industry to formulate innovative policy solutions for DeFi, involving both the public and private sectors.

With MiCA currently in the consultation stage, the European Union is set to launch a three-part consultation process starting in July. Also, the insights and suggestions garnered will be subject to approval by the European Commission, European Parliament, and European Council, thus setting the stage for potential legislative evolution that will shape the future of the DeFi landscape in Europe.