One of the biggest complaints about the traditional banking system is Mom and Pop investors do not receive the same returns or opportunities as big institutional money.

Decentralised platforms such as Compound Finance attempt to level the playing field by allowing small investors to lend their crypto and receive returns closer to what the banks receive when they lend out deposits received from their banking customers.

Given Defi is still in its infancy in 2021, there are risks which are still being identified and fixed.  The question is whether it should be left to Compound and other industry participants to sort out or be subject to increased Government regulation.

DeFi Founders Debate Whether to Resist or Embrace Regulation

Top DeFi founders and VCs engaged in  a lively debate on how the sector should be regulated and do business with traditional institutions during a panel called Rise of Resistance at the LA Blockchain Summit on Nov. 3.

Regulation is a critical issue that’s dividing the DeFi community. On one side are those who want to resist the rollout of what they consider overbearing oversight. On the other side are those who believe regulation is inevitable and embracing compliance is the wiser course.

Derek Alia, the co-founder of Arbitrum-based derivatives exchange FutureSwap, asserted the DeFi sector should strive to work closely with lawmakers.

“Ultimately we want to work with regulators as much as possible. Regulation at some point will approach DeFi,” he said. “I think the best thing would just be cooperation to make sure that we harness as much innovation in this space. I think the best thing the regulators could do is have an open discussion and try to understand what’s going on [in DeFi] so we can address the concerns.”

Alia also urged DeFi leaders to help regulators “understand there are some built-in protections already here and things are very clear and transparent,” while also being “very clear about the risks” associated with the industry.

Money Laundering

Alex Davis, the founder of Mavryk Finance and CIO of Tezos Israel, rejected criticisms of DeFi’s lack of regulation and consumer protections. “DeFi is the consumer protection,” he said.

“The banks are the ones who hurt their customers and the banks are the ones who are facilitating money laundering,” Davis said, emphasizing that “the government wants to track your $600 payment where the United States government wants to know if your $700 NFT purchase is terrorism financing.”

Davis described the existing know-your-customer (KYC) and anti-money laundering (AML) apparatus regulating the legacy financial sector as a “dramatic failure.” “I really hope that DeFi kind of drives home [that] we don’t need these tyrannical laws to be able to send value to one another for businesses to thrive,” he said.

Bilal El Alamy, the co-founder and CEO of digital security neobank Equisafe acknowledged the slow pace of the bureaucratic process and other challenges faced by regulators seeking to keep abreast of DeFi’s growth and evolution.

“The banks are the ones who hurt their customers and the banks are the ones who are facilitating money laundering.”

Alex Davis

“It’s really hard work to discuss with [regulators] because there is a lot of processing at their place, then even more than corporates. However, I don’t see that we don’t need to talk to them.”

Looking forward, El Alamy predicts that two distinct sectors will emerge within DeFi, “a super retail market of DeFi and then also banks.”

Framework Ventures co-founder Michael Anderson argued that despite DeFi’s “counterculture” and “anti-finance” roots, the sector should work towards “bridg[ing] the gap between fintech and DeFi.”

“Where we go from here is really being able to have financial products that have inclusion with financial institutions and having them built into the system is actually where I think DeFi needs to go,” he said.

Open-source Finance

Anderson offered support for U.S. Securities and Exchange (SEC) Commissioner Hester Peirce’s proposed three-year safe-harbor for projects seeking to launch a digital token.

“That would be the opening of the aperture lens in terms of what companies and other organizations DAOs would be able to launch,” he said. “I think that would be the change agent that would affect the most.”

Anderson also asserted that institutions “are going to be the ones that bring all the value.” “I actually think DeFi is probably not the best way of describing what we’re talking about,” he said. “‘Open-source finance’ might be the better way of describing it.”

Challenging the notion that legacy institutional adoption is needed to ensure DeFi’s growth, Davis said: ”What if DeFi becomes ‘the institutions’? We will see the next JP Morgan Chase be a DeFi protocol.”

While he described the introduction of a safe-harbor as a positive “beginning step,” he said the SEC’s investor protection mandate limits the opportunities available to retail investors.

Free Capitalist System

“The SEC is there in order to quote-unquote protect investors, yet what they actually do is they keep out 99% of the people from opportunity and they’re just protecting the wealthy accredited investors, ” he said.

“The upside potential is all in the early rounds. And yet investors are only given IPOs that investors can’t even get into IPOs,” Davis continued.

“A retail investor doesn’t get into an IPO. They get it to buy once it hits the public market and every institution in which rich, wealthy individual investors get to dump on the open market.”

“Commerce really needs to be free and we don’t have a free capitalist system,” Davis added.