“We are con­stant­ly re­fin­ing our ad­min­is­tra­tive prac­tice”

Erscheinung:03.11.2023 | Topic Fintechs"We are constantly refining our administrative practice"

Birgit Rodolphe, Chief Executive Director of Resolution and Prevention of Money Laundering, discusses the most important aspects of regulating decentralised financial services (DeFi) and BaFin's approach.

Ms Rodolphe, the developers of DeFi services claim that their activities do not require authorisation from financial supervisory authorities. They argue that they create innovative technologies that are distributed online. In their view, the existing laws were crafted for the traditional financial market and do not apply here. Do you share this view?

No, I think that conclusion is wrong. While the majority of our supervisory laws were created before DeFi even existed, this legislation pursues two core objectives that are especially relevant for DeFi services: ensuring a stable and transparent financial system, and protecting consumers. In particular, we see significant deficiencies in DeFi services in terms of consumer protection.

What's more, DeFi services may make use of innovative technologies and, in a few regards, be completely different from anything we have seen before in the traditional financial market. But the way they work is not fundamentally different. They offer the chance to use financial products and services we already know from the traditional financial market. The only difference is that there is no company acting as service provider, i.e. there are no intermediaries.

Oftentimes, DeFi services are not completely decentralised and it is possible to find a provider. If a group or institution oversees the project and shares in the profits, these actors should clearly be considered the operators from a supervisory perspective. Our supervisory law then applies in cases like this, of course. The provider is subject to authorisation requirements, and we can deploy conventional supervisory tools such as audits.

What line of approach does BaFin take?

We have a two-step procedure for DeFi services. First, we look at whether the DeFi business model in question is comparable to traditional financial market services that require authorisation from BaFin. Examples of this include platforms that invest clients' money like a fund or enable trading in financial instruments. If we find the DeFi business model comparable, the next step is to see if we can identify an operator and whether the offer is targeted at the German market.

If we determine that a DeFi service meets these criteria but that the provider is operating without our authorisation, our supervisors can take various measures. For example, they can demand information and documents relating to the specific business activities, prohibit certain activities, order the provider to wind up their activities, or issue a warning to the providers. We share information about such measures on our website and in newsletters.

DeFi is a highly dynamic field. Do you take this into account in your supervisory practice?

Yes, we are certainly following the latest developments in this area and constantly refining our administrative practice with regard to DeFi services. To name an example, we concluded that the aggregation and preparation of offers from liquidity pools can be considered investment broking.

Liquidity pools are smart contracts in which investors deposit crypto assets that are then available to other users as liquidity for exchanging various tokens. Providers who compile exchange offers and rates from these pools in a particularly clear manner and advertise exchange transactions can be deemed to be deliberately and conclusively appealing to investor willingness. This is especially true when trades can be carried out with a single click and providers forward the purchase orders for users. In cases like this, we classify the provider's activities as investment broking, which means they are providing financial services and require authorisation from BaFin.

Do you think we might even need a DeFi-specific regulation in the future?

We have to continue observing DeFi first. The German legislature has yet to amend the Banking Act (Kreditwesengesetz) or other supervisory laws with new rules for DeFi services. One reason for this may be that such services have not enjoyed widespread use in Germany thus far. From a regulatory point of view, these innovations are currently more of a technological issue.

Another reason is probably the adoption of the EU Markets in Crypto Assets Regulation (MiCAR), key parts of which will already take effect in mid-2024. Among other things, this Regulation introduces EU-wide rules for issuing crypto assets and related services.

Like our existing national legislation, MiCAR only applies to offers with an identifiable central operator. It will not cover completely decentralised services. We will therefore continue to identify developers or governance token holders that act as operators, since they are subject to the MiCAR rules.

The need for a new, DeFi-specific regulation in the future will depend on how DeFi develops and what impact MiCAR has on the market overall as it harmonises the statutory rules.

You mentioned that a central operator can be identified for most DeFi applications. Many services are therefore decentralised in name only. But there is also an increasing number of truly decentralised services. Which options do supervisory authorities have in a decentralised market?

As supervisors, we fundamentally pursue the same objectives in a decentralised market as in the traditional financial market. As I mentioned, financial stability and consumer protection are our top priorities. We have various tools at our disposal for achieving these goals. When it comes to truly decentralised services with no operator, though, our options are quite limited. In such cases, BaFin can only warn consumers about problematic offers and try to raise awareness among users - via our website, for example.

Supervision of decentralised markets is a complex topic that is still evolving. Supervisory authorities are following this development and working on suitable instruments and strategies to minimise the risks for both consumers and the financial system.

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