The evolution of digital banking has a precise name, Decentralized Finance (more commonly known as DeFi), defined briefly as “a way to provide financial services to users through smart contracts.”
Decentralized Finance poses a great challenge to traditional banking institutions, as this system guarantees access to financial services to anyone with an internet connection.
DeFi platforms offer their services through so-called dApps, i.e., applications based on blockchain infrastructure and focused on the use of cryptocurrencies. More specifically, decentralized finance is that application that focuses on offering financial services (using cryptocurrencies), such as flash loans, short or long-term deposit accounts (staking), and savings management.
The ongoing disruption is becoming increasingly profound for the international banking and financial system, so much so that currently, according to DeFi Pulse, the capital locked up in the form of tokens, i.e., the capital invested through Decentralized Finance, is currently worth about $14 billion.
The interoperability and accessibility features of decentralized finance services have the potential to create an inclusive and global financial market, making current geopolitical balances, regulations, and national practices obsolete.
For these reasons, states and financial institutions worldwide are moving quickly to develop so-called CBDCs (Central Bank Digital Currencies); for example, the case of the Bank of France, the launch of the digital Yuan by the Bank of China, the Swedish e-krona by Sveriges Riksbank, and the development of the Nigerian eNaira.
Before analyzing the regulatory context within which the subjects offering decentralized finance services operate, it is necessary to point out that there are differences between DeFi (decentralized finance) and CeFi (centralized finance) services.
In centralized finance (CeFi), all cryptocurrency orders are managed by a central entity, and the user does not have a private key that gives access to the wallet; therefore, in practice, the user is not really the owner of the funds.
In decentralized finance (DeFi), on the other hand, orders are placed on automated applications built on blockchain infrastructures. In this case, the user owns the pair of keys (public and private) of the digital wallet and is the only entity that can manage the funds.
The determining difference between centralized and decentralized finance is the involvement of an exchange. Therefore, in centralized finance, the system is governed by exchanges, while in decentralized finance, the system depends on the technology used (blockchain infrastructure). Due to the involvement of exchanges in CeFi, users transfer their risk to these entities, which are responsible for keeping users’ funds safe while managing them at the same time. In the DeFi world, these intermediaries are cut out, and transactions take place in the “hope” that smart contract protocols will work well.
At this point, it is necessary to delve into which aspects of Italian banking and financial law are raised with DeFi.
These innovative finance models undermine traditional structures, and that is why it is necessary to find moments of balance to allow operators to use them; this is done through the establishment of tables – authorities – operators – legislators. In other words, what needs to be sought is a model of coexistence between the two finances.
As previously mentioned, some DeFi applications provide staking, which involves locking in invested capital for a specified period of time and simultaneously increasing the capital with significantly higher annual gains compared to traditional banking/financial returns. Alternatively, other dApps provide flash cryptocurrency loans without requiring the range of guarantees required by traditional banking entities. This brief illustration of the services offered by decentralized finance leads to the conclusion that such entities offer services to the public by collecting consumer savings.
It should be noted that, with respect to raising capital by appealing to public savings, the Consolidated Banking Act (T.U.B.) and the Consolidated Financial Act (T.U.F.) subordinate the professional exercise of financial intermediary activity by “authorized subjects” other than banks to the granting of an authorization by the competent authority, which verifies the existence of the requirements required from time to time depending on the specific activity, with particular reference to the corporate form, minimum capital to be maintained for the duration of the company, and organizational structure. CONSOB and the Bank of Italy, therefore, exercise continuous supervision over intermediaries with regard to “transparency and correctness of behavior” and with regard to “risk containment and patrimonial stability” (art. 5, paragraphs 3 and 2, T.U.F.).
Having said that, the Bank of Italy’s Provision of November 8, 2016, which refers to the CICR Deliberation of 2005, defines more precisely what is meant by the collection of savings. Therefore, according to the Bank of Italy, “collection of savings” means “the activity of acquiring funds with the obligation of reimbursement, both in the form of deposits and in other forms.”
Furthermore, the Bank of Italy states in the same provision that “the collection of savings from the public is prohibited for subjects other than banks, subject to the exceptions provided for in Article 11, paragraph 4, of the TUB.”
Therefore, we can exclude that decentralized finance platforms offering services fall within the definition of the collection of savings because we could frame such activities within the same Article 11, paragraph 4.
Article 11, paragraph 4, letter c, of the TUB states that the prohibition referred to in paragraph 2 (of the same article) does not apply to collection made in accordance with the Civil Code through bonds, debt securities or other financial instruments. This means that, in the event that cryptocurrencies were defined as financial instruments, there would be no problem with using DeFi dApps. It should be noted that this is just one of the many possible interpretive paths.
The impasse is represented by the fact that there is no precise and uniform definition of what a cryptocurrency or token represents, and therefore we cannot assume that such entities can be considered financial instruments. The only definition of cryptocurrency that is suggested here is that provided by the Fifth EU Anti-Money Laundering Directive, which defines cryptocurrency as “a digital representation of value that is not issued or guaranteed by a central bank or a public authority.” Therefore, it is understood that under these assumptions, it is not possible to precisely frame the activities of DeFi platforms at a regulatory level (followed by MiFID II – a broad definitional section).
The impasse is represented by the lack of a precise and unified definition of what constitutes a cryptocurrency or token, and therefore, it cannot be taken for granted that such entities can be considered financial instruments. The only definition of a cryptocurrency that is suggested here is the one provided by the European Anti-Money Laundering Directive V, which defines a cryptocurrency as a “digital representation of value that is not issued or guaranteed by a central bank or public authority”. Therefore, with these assumptions, it is not possible to precisely frame the activity of DeFi platforms from a regulatory point of view (followed by: MiFID II – extensive definitional section).
That being said, it is clear to everyone that decentralized finance platforms offer these services without any legal guarantee and without having received any authorization to carry out such activities. According to the dedicated rules of the TUB and TUF, such operations are carried out under the control of Consob and are subject to administrative discipline aimed at ensuring the correctness of information and equal treatment of savers. A particular aspect in the matter of appealing to public savings is given by Consob Regulations, which indicate the content and methods of the information prospectus, the fairness rules that the offerors, issuers, and intermediaries entrusted with the completion of the transaction must comply with, as well as the methods of carrying out and the duration of the same.
To date, we do not have the means to define the nature of these subjects based on their activity, and in the silence of the Italian and European legislator on the subject, the technological and financial revolution proceeds undisturbed with the interested platforms continuing their work without any restriction and/or limitation, despite the repeated computer attacks (and legal actions) suffered by them. Just to give an example, Messari estimates that in 2019 at least $285 million were stolen from the DeFi platforms’ coffers only regarding the Ethereum network, which, as we know, represents only a portion of the wide range of DeFi applications.
The caudine fork implemented by DeFi platforms towards the banking world has increased the pressures of the traditional financial world towards the subjects offering this type of service.
It seems, therefore, that the banking institutions are seeing themselves deprived of the “centralized” power they have maintained for centuries and, moreover, those who are trying to digitize, implementing new tools – such as allowing the purchase of cryptocurrencies within their applications – remain anchored to the rigid and stringent regulations of the traditional banking world.
Therefore, either the platforms/companies that offer such services will be attempted to be assimilated into traditional entities, perhaps by issuing a specific license to carry out activities typical of a banking/financial institution; or, it is hoped that there will be a swift regulation by the European Union of the industrial world of crypto finance (followed by: MiFID II art.).
Certainly, the news of the entry into force of the decree regulating the operations and powers of the FinTech Committee as a steering committee established at the Ministry of Economy and Finance (MEF), as well as the conditions and methods for carrying out experimentation in Italy of techno-finance activities (FinTech), represents an important step forward for the digitization of the country. For the first time, in fact, Italy has equipped itself with a regulatory Sandbox, i.e., a protected space dedicated to digital experimentation in the banking, financial, and insurance sectors. The same is happening at the European level with the provision of the Pilot MiFID regime – also a testing tool for market operators adopted to bring fintech activities towards regulatory and normative compliance.
Such interventions lead towards two directions: the first is a greater focus by market actors on offering DeFi services, especially regarding user experience in using these tools, given the high margin of error (by the user themselves), the immutability of actions, and above all the security of systems. The second direction, as mentioned earlier, is represented by a rethinking of financial and banking regulations (especially those dedicated to controls by competent authorities) following the experiments presented.
In conclusion, it is important for new figures, as well as new financial applications, to be brought within legal forms and instruments already known by the law. However, for the moment, users, both because they can use financial services with ease and because they are intrigued by financial innovation, prefer the simplicity of action, exchange, and value management rather than system security.
Market and Data
_old_Become an author
Wallet
