The debate over how to regulate decentralized finance (DeFi) is intensifying, with the U.S.-based DeFi Education Fund (DEF) urging the United Kingdom’s Financial Conduct Authority (FCA) to adopt a narrow definition of “control” when finalizing new rules for crypto asset activities. The advocacy group argues that regulation should focus on entities with unilateral authority over user funds or transactions, rather than developers who contribute to decentralized protocols.
The DEF’s response, shared exclusively with CoinDesk on , comes as the FCA nears the conclusion of its consultation on proposed crypto rules – CP25/40 – which began in December. The regulator had sought feedback on its proposals until , covering areas including market abuse, crypto trading platforms, staking, lending, borrowing, and decentralized finance itself.
At the heart of the DEF’s argument is the distinction between possessing control and merely contributing to a system. The group contends that software developers should not be held to the same regulatory standards as centralized intermediaries unless they have the power to unilaterally control user assets or transactions. “Control should be the determinative factor,” the DEF stated, warning that applying traditional financial regulations to automated protocols could be “structurally incompatible.”
This position reflects a broader concern within the DeFi community that overly broad regulations could stifle innovation and effectively shut down decentralized protocols. The FCA’s proposals, as they stand, could potentially subject developers to requirements typically reserved for regulated financial institutions, including trading platform rules, prudential requirements, and comprehensive anti-money laundering (AML) regulations.
The FCA, however, has emphasized its commitment to both protecting consumers and fostering innovation. David Geale, executive director for payments and digital finance at the FCA, stated upon announcing the consultation that “Regulation is coming, and we want to get it right.” He added that the FCA’s “goal is to have a regime that protects consumers, supports innovation and promotes trust.”
The DEF’s intervention highlights the complexities of applying existing regulatory frameworks to the novel structures of DeFi. Traditional financial regulations are built around identifiable intermediaries – entities that have direct control over customer funds and transactions. DeFi protocols, by design, aim to minimize or eliminate such intermediaries, relying instead on code and consensus mechanisms to govern operations.
The FCA has been actively preparing for the implementation of a new crypto asset regulatory regime expected to take effect in 2027. In January, the regulator published information for firms seeking to offer crypto-related services in the UK, outlining the activities that will be regulated, the standards firms must meet, and the process for authorization and supervision. This included details on a gateway for firms entering the market and transitional provisions for existing firms.
The DEF’s argument centers on the operational powers that define control. The group stresses that regulators should focus on entities with the ability to initiate or block transactions, or to modify protocol parameters. Software developers, they argue, typically lack custody over assets and therefore should not be subject to the same regulatory burdens as those who do.
The FCA’s approach is part of a broader global effort to regulate the rapidly evolving crypto asset space. Regulators worldwide are grappling with how to balance the potential benefits of innovation with the need to protect investors and maintain financial stability. The UK’s approach is being closely watched, as it could set a precedent for other jurisdictions.
The DEF’s call for a narrow definition of control is likely to resonate with other DeFi advocacy groups and industry participants who fear that overly restrictive regulations could stifle the growth of the sector. The coming months will be crucial as the FCA reviews the feedback received during the consultation period and finalizes its rules. The outcome will have significant implications for the future of DeFi in the UK and potentially beyond.
The debate underscores the fundamental challenge of regulating a technology designed to be decentralized and resistant to traditional forms of control. Finding the right balance between fostering innovation and protecting consumers will be a key test for regulators as they navigate the evolving landscape of digital finance.
