The U.S. has a bewildering system of banking regulation. The Federal Reserve, Federal Deposit Insurance Corp. (FDIC) and Office of the Comptroller of the Currency (OCC) are all involved in regulating banks, as are more than 50 state financial departments. Credit unions are regulated by the National Credit Union Administration.
One of these, perhaps a state financial department like the New York State Department of Financial Services, is likely to send a notification to blockchain-based banks. If they want to provide banking services in U.S. meatspace, the notice will say, they must get bank charters and submit to regulatory supervision.
America’s bank regulation probably won’t fit MakerDAO very well – it’s designed for 20th-century banks with physical locations and loan officers, not banks that are built on a layer of automated smart contracts. Perhaps lawmakers will devise a special blockchain bank charter. But that will take time, engagement and patience.
DeFi enthusiasts often laugh at the talk of regulation. Any bank regulator that attempts to exercise authority over the collection of smart contracts and stakeholders that calls itself MakerDAO will inevitably fail, they say. The whole point of being on a decentralized protocol, after all, is to avoid being controlled.
And there is certainly some truth to that. But even if a bank is decentralized enough to ignore a government order to get a bank charter, there’s a good chance it would comply anyway. Refuse and MakerDAO would be operating illegally. No more fix and flips. It would have to retreat back to the censorship-resistant safety of the blockchain and its relatively small clientele of pseudonymous cryptocurrency speculators. Submitting to regulation means a ticket to the biggest market in the world: Main Street America.
Other big DeFi applications such as decentralized exchange Uniswap or lending market Compound may soon face the same sort of difficult choice as MakerDAO. They can either stay safely rooted in their rules-free financial zone or get more real-world relevance, but at the price of regulation.
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Financial regulation is often criticized. It adds costs. It forces financial institutions to cut off unprofitable customers. It favors incumbents. It reduces innovation. Much of that is true.
On the other hand, regulation emerges through a democratic process. We impose onerous capital requirements and leverage ratios on banks, because burnt by the credit crisis, we are hoping to avoid another crisis. Banks that use decentralization as a means for evading rules are acting undemocratically.
Significant amounts of electricity are being used to secure the Ethereum blockchain. That ensures that Ethereum, and everything built on it, remains open and censorship resistant. But if DeFi tools like MakerDAO choose to become regulated, censorship-resistance is pretty much cancelled. Is there a point to being a regulated bank on an expensive and open blockchain?
For now, MakerDAO will keep on pushing into real-world loans. But expect many of these complicated issues to bubble up in the next few years