European, US and other regulatory agencies are busy detailing how to designate a decentralized exchange (DEX) as a “broker”, trading agent, or similar entity that influences and cooperates with each other. .. The United States That presidential order On the development of responsible digital assets, as the European Union did in a recent review of financial stability and integration. And it’s publicly accessible.
Behind the scenes, regulatory whispers are growing. Has anyone noticed in the last two months that all the requirements of Know Your Customer (KYC) have been imposed on small centralized exchanges in exotic locations? That was the canary in the mine. With the above designation and cooperation, DEX will soon begin to feel the heat of the regulator.
Yes, regulations are imminent. The main reason DEX cannot withstand future storms is that it has been declared incapable of identifying the contributing users using the liquidity pool. In the traditional financial world, providing services without proper KYC procedures is not a big deal. By not tracking identities, emerging Russian conglomerates could use Hawala’s payment services to anonymously move millions of dollars leading up to the war in Ukraine, so regulators legitimately talk about DEX. I am concerned. To most DEX enthusiasts, KYC sounds like an insult, or at least it sounds like DEX is basically impossible. But is that true?
DEX is actually pretty central
Let’s start with the structure of DEX. Then you can see that DEX is not as decentralized as you might imagine. Yes, DEX runs on smart contracts, but teams or people who upload code on-chain usually get special administrator-level privileges and privileges. In addition, known centralized teams typically handle the front end. For example, Uniswap Labs recently added the ability to scrub known hacker wallets and removed tokens from the menu. DEX claims to be pure code, but in reality there is still a more or less centralized team of developers behind this airy entity. This team can also benefit.
In addition, a closer look at how users communicate with unauthorized chains reveals a more centralized chokepoint. For example, last month MetaMask was unavailable in some regions. why? That’s because Infura, a centralized service provider whose on-chain wallets rely on the Ethereum API, has decided so. With DEX, things can always be done in the same way.
Some people say that DEX is decentralized because it is open source. This means that any community is free to fork code and build their own DEX. Of course, you can have as many DEXs as you like, but the question is which DEXs can bring more liquidity to the table and where users actually trade tokens. So, after all, what is the exchange for in the first place?
From a regulatory point of view, the entity that facilitates such transactions can be considered a “broker” or “transfer agent”, whether or not it is open source. That’s where most regulations are heading. Once so identified, DEX will be a major fire unless it complies with various requirements. This includes obtaining a license, verifying a user ID, and reporting transactions, including suspicious transactions. In the United States, you must comply with bank secrecy law and freeze your account upon request from the authorities. Without it all, DEX can fail.
Identity and KYC issues
Since DEX claims to be decentralized, it also claims that ID verification and KYC control cannot be technically implemented. However, in reality, KYC and pseudonym are not mutually exclusive from a technical point of view. Such an attitude, at best, reveals laziness or unwavering impetus for low costs, and at worst reveals the desire to profit from the movement of dirty money.
The argument that DEX cannot run KYC without creating a honeypot of personal information lacks technical merit and imagination.Multiple teams are already building identity solutions based on Zero-knowledge proofAn encryption method that allows a party to prove that they have certain data without revealing that information. For example, proof of identity can include a green checkmark to indicate that the person has passed the KYC, but does not reveal any personally identifiable information. Users can share this ID with DEX for validation purposes without the need for a centralized repository of information.
DEX is part of the puzzle when it comes to ransomware, as users do not have to pass the KYC. Hackers use DEX as the primary hub for moving bounties. The DEX team cannot explain the “source of funding” because there is no identity verification. That is, we cannot prove that the funds are not from the authorized region or money laundering. Without this proof, the bank will not issue a DEX bank account. Banks need information about the source of their funds so that they are not fined or their licenses are revoked. If DeFi is easily used for criminal activity, it will be a bad name for cryptography, further away from mainstream adaptation.
DEX also has its own single-purpose software suite, Automated Market Making (AMM). This allows liquidity providers to match buyers and sellers to obtain or determine the price of a particular asset. It’s not general-purpose software that can be leveraged for multiple use cases, as is the case with BitTorrent’s P2P protocol, which moves bits quickly and efficiently for Twitter, Facebook, Microsoft, and video pirates. AMM has a single purpose and benefits the team.
You can get some protection from cybercrime by checking your user ID and making sure your money and tokens are not illegal. This makes DeFi safer for users and more feasible for regulators and policy makers. To survive, DEX must eventually acknowledge this and employ some level of identity verification and prevention of money laundering.
By implementing some of these solutions, DEX can still fulfill its DeFi promise. They can remain open to provide liquidity, earn fees, and avoid relying on banks and other centralized entities to remain pseudonyms.
If DEX chooses to ignore regulatory pressures, it can end in one of two ways. More legitimate platforms can continue to adapt to increasing government surveillance and increasing demand for cryptography from more mainstream investors who require ease of use and security, thereby killing stubborn DEX. DEX that ends up or cannot adapt will move to a distant gray market jurisdiction, tax shelter and unregulated cash-like economy.
There is good reason to believe that the former is a much more likely scenario. It’s time to risk DEX growing with the rest of us or being regulated to die with the more gloomy ghosts of the crypto past.
This article does not contain any investment advice or recommendations. All investment and transaction movements carry risks and readers need to do their own research when making decisions.
The views, ideas and opinions expressed herein are for the author only and do not necessarily reflect or express the views or opinions of Cointelegraph.
Bob Reed Is the current CEO and co-founder of Everest, a fintech company that leverages blockchain technology to enable more secure and comprehensive multi-currency accounts, digital / biometric IDs, payment platforms and eMoney platforms. As a licensed and registered financial institution, Everest provides end-to-end financial solutions and promotes regulatory compliance related to eKYC / AML, digital identity, and money transfers. He was an advisor to Kai Labs, BitTorrent’s general manager of licensing, and vice president of strategy and business development for Neulion and DivX.