Liechtenstein is increasingly looking at Defi regulations. Protocols take note. Thomas Dünser spoke to Handelsblatt about Liechtenstein’s regulatory approach.

Decentralized Finance (Defi) is growing. It stands for decentralized, mostly blockchain-based, applications that offer financial services and products. One example is cryptocurrency lending, where borrowers can get a loan denominated in cryptocurrencies, and savers can give their money into a crypto savings account and earn interest on it.

What these Defi applications have in common is that they don’t need a centralized actor anymore. Instead of a private company, a blockchain-based protocol will organize all value exchanges via smart contacts. The challenge for many of these Defi protocols is that current laws and legislation were not written with Defi in mind and are thus not suitable to govern these ideas.

Liechtenstein as a frontrunner

That’s why European countries are now trying to position themselves, with Liechtenstein being one of the frontrunners. With a population of just under 40,000, Liechtenstein has long been a relevant center for the financial industry in the heart of Europe. Early on, the government has considered how cryptocurrencies and other innovations based on blockchain technology can be regulated and used. A key issue here is also the new developments in the Defi ecosystem.

In 2020, Liechtenstein introduced a new law on digital tokens, which introduces the token as a separate legal object and defines its own civil law rules. It enables the tokenization of many traditional assets, such as company shares, art, or real estate, but also leaves room for other new use cases, such as the DeFi sector.

“We have gone ahead and regulated important crypto applications as one of the first countries worldwide,” explains Thomas Dünser, Director of the Office for Financial Market Innovation of the Liechtenstein government, in an article in the German newspaper Handelsblatt. “The law lays the foundation for the token economy. We wanted to create legal certainty for the tokenization of assets, for token users, and token service providers.” Token service providers include companies that help set up the tokens and engage in trading and custody.

“The topic of DeFi is becoming increasingly important,” Dünser says. “Decentralized financial services and organizations raise corporate and liability law issues. DeFi is fundamentally different from the previous way of thinking in financial market law. Policymakers and regulators need to respond to this.”

One example: Financial supervisors often works with companies to mediate for the stakeholders involved in disputes. “But who is the central point of contact in a decentralized financial application?” asks Dünser. This is where regulation needs to evolve, he said.

First successes

The law has so far been a success. Fifty-two crypto companies were assisted by the Office for Financial Market Innovation in 2020 alone in setting up shop in Liechtenstein and building their business. Ten received the new token registration from the Financial Market Authority (FMA). 134 others showed interest in Liechtenstein.

But regulation is not just a helper but can also be a threat to Defi protocols. “DeFi founders often say that more regulation would provide more clarity. In reality, however, regulation has so far been an existential threat to truly decentralized projects in many cases,” says Kai Kuljurgis, founder of the crypto investment platform Coindex. “A project consistently following the principles of the DeFi idea is, after all, trying to develop the hitherto centrally organized financial system in a new and decentralized way.”

Dünser addresses the issue. “We have to answer the question of how the overriding goals of financial market regulation can be implemented in a decentralized system, such as consumer protection,” he says.

He says one future approach is to use DeFi principles in supervision to increase its effectiveness and reduce costs. “Perhaps supervision will also soon become decentralized,” says Dünser. “Then regulatory decisions could be mapped into smart contracts, for example.” Whatever the future holds, “Liechtenstein will continue to be at the forefront of developments,” he believes.

That message is taken quite seriously in the industry. Liechtenstein is a “pioneer” in the DeFi field, Kuljurgis confirms. He says the principality has comparatively clear regulatory frameworks, promising start-up and business conditions, and government support programs. “In addition, access to the European market is comparatively easy.”

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