Can we save DeFi from being Centralized?

DeFi - Addressing the Limitations of Traditional Finance.

DeFi, or Decentralized Finance, aims to tackle several problems users face with traditional financial systems:

Limited Access: Traditional finance often excludes people due to geographical location, credit history, or minimum balance requirements. DeFi, built on blockchain technology, offers permissionless access, meaning anyone with an internet connection can participate.

Lack of Transparency: Traditional financial systems can be opaque, with complex fee structures and hidden charges. DeFi promotes transparency through smart contracts, which automate transactions based on predetermined rules visible on a public blockchain.

Centralized Control: Traditional finance is controlled by institutions like banks and governments. DeFi empowers users by giving them control over their assets. Users hold their funds in crypto wallets, eliminating the need for intermediaries.

Inefficiency: Traditional financial processes can be slow and cumbersome, with transactions taking days to settle. DeFi leverages blockchain technology to facilitate faster and more efficient transactions.

These limitations create problems for a broad range of users:

The Unbanked: Millions of people globally lack access to traditional banking services. DeFi offers them a secure and alternative way to manage their finances.

Underbanked Users: Individuals with a limited credit history or living in areas with constrained financial services can take advantage of DeFi's inclusive characteristics.

Those Seeking Transparency: Users who value clear and upfront fees and control over their assets find DeFi's focus on smart contracts and self-custody appealing

Those Frustrated with Slow Transactions: DeFi caters to users who need faster and more streamlined financial transactions.

By addressing these limitations, DeFi opens up a world of financial possibilities for a wider audience, promoting financial inclusion and user empowerment.

Regulation:

The EU’s Markets in Crypto-Assets Regulation (MiCA), which will come into full force by the end of 2024, will require DeFi protocols to adhere to the same licensing and Know Your Customer (KYC) requirements as traditional financial services firms — a burden many DeFi protocols may be unable or unwilling to bear. https://www.merklescience.com/blog/is-defi-truly-exempt-from-mica-regulations

Only fully decentralized, local, downloaded frontends or full-KYC online frontends would be possible. This leaves DeFi protocols with a choice: Either pivot to a somewhat centralized “hybrid finance” (HyFi) model to comply with EU regulations or decentralize entirely. 

"True" DeFi is exempt from MiCA: Within the actual EU regulation, fully decentralized protocols are exempt from falling into the MiCA requirements, as mentioned in Recital 22:

The immediate question raised by this section of MiCA is what precisely is meant by “without an intermediary” and “in a fully decentralized manner”?

As MiCA is expected to be fully implemented by the end of 2024, DeFi protocols in Europe must choose between completely decentralizing to bypass regulations or implementing KYC measures similar to other centralized financial service providers.

For those who embrace decentralization, regulations like MiCA in Europe will establish clearer boundaries. This new regulatory framework will offer more clarity on constructing genuinely decentralized applications following regulatory requirements.

Many DeFi protocols will need to critically evaluate their operations to guarantee their platforms are genuinely decentralized and comply with legal standards. The DeFi sector can adopt various strategies to maintain decentralization, with one key approach being the decentralization of website front ends. Proponents of decentralization might soon witness DeFi evolving into something more akin to traditional finance, the very sector they aimed to challenge.

DeFi still needs to comply to attract institutional investors:

DeFi DApps need to walk a line between implementing enough AML procedures to attract TradFi liquidity and not becoming a target for regulatory action.

Decentralized Identities (DiDs) could transform KYC/AML compliance. However, for DiDs to be practical, they must be universally adopted, a process that could take a significant amount of time.

ReDeFi Implementation:

Let's discuss the difference between ReDeFi- TRIO DeFi KYC and Uniswap v4 DeFI KYC Hook. 

Uniswap v4 allows specific exchange pools to introduce KYC checks: 

 This specific hook allows for a KYC procedure. So, you can add this to a pool. Now, everybody who wants to take part in a pool with this hook must undergo a KYC first. A KYC procedure is the ‘Know Your Customer’ procedure. Among others, it requires you to provide an official, government-issued ID. Currently, this hook seems ideal for US-enabled pools. It allows for KYC or a whitelist application. The latter is for users who want to join such a liquidity pool.  

From the user's viewpoint, this centralization by the liquidity pool provider renders DeX indistinguishable from CeX (centralized exchange). The entire promise of DeFi is being undermined!

The ReDeFi approach is to use a TRIO utility KYC token. Its utility comes from the condition that if you own this utility token, your KYC was completed. Each participating DeFi app will check the utility token balance of the account when submitting the DeFI transaction. If the balance is positive - then the account belongs to the TRIO user, whose KYC was performed in advance. There is compliance within the decentralization of financial apps. For ReDeFi -all you need is to add a simple balance query to the DeFi Smart Contract. 

The main distinction is that the application stays decentralized while also being compliant! DeFi is preserved, and Oracles are unnecessary!

DeFi operators should not overlook the importance of AML compliance. As regulations and regulatory expectations evolve, integrating robust AML/KYC measures from the outset will be crucial.