EU Seeks to Regulate Decentralized Finance Amid Governance Concerns

The European Commission has initiated a public consultation on whether to extend its landmark crypto rulebook, Markets in Crypto Assets (MiCA), to cover decentralized finance (DeFi) protocols. The current framework excludes services provided in a 'fully decentralized manner without any intermediary,' meaning they are exempt from regulatory supervision.

However, regulators have raised concerns that DeFi has grown into significant financial infrastructure, used by both retail and institutional players, and may pose operational, money laundering, or terrorist financing risks. The Commission is seeking input on six criteria for assessing whether a DeFi software is 'not fully decentralized' and subject to regulation.

The proposed criteria include examining the existence of an identifiable intermediary providing a crypto-asset service, presence of control by an identifiable person or group over key functionalities, and significant concentration of governance power. If adopted, these criteria would subject protocols with concentrated governance power, administrative keys held by someone, or an identifiable operator providing services to MiCA's scope.

The consultation also explores the possibility of requiring certification of DeFi protocols, imposing due diligence obligations on intermediaries connecting users to DeFi, or mandating blockchain analytics to flag illicit flows. However, the language used in the consultation is vague, leaving room for interpretation.