The Monetary Authority of Singapore published a framework on June 26 detailing the benefits of decentralized finance (DeFi) and how it can fit into the financial system of the world.

The regulator believes that private blockchain networks are the best option for financial market infrastructure due to their centralized nature.

The regulator’s report — titled “Project Guardian: Enabling Open & Interoperable Networks‘ — was published in collaboration with the Bank for International Settlements, as well as a number of high-profile global lenders — including HSBC and JP Morgan, among others.

Project Guardian’s “foundational principle” is to establish “open and interoperable private networks” that enable tokenized asset exchange via DeFi protocols. These networks will only be accessible by trusted parties that are selected via regulatory mechanisms to eliminate the risk of illicit financial activity.

The project also intends to establish best practices for tokenizing financial assets like equities, fixed income, foreign exchange, and investment funds.

Public networks are risky

The watchdog said in the report that digital assets and distributed ledger technology have become a potential “alternative financial infrastructure.” However, there is a distinct lack of understanding about their opportunities, risks and limitations due to their “nascency.”

The regulator argued in the report that private networks are superior to public ones due to the high level of risks present in the latter and the controllability of the former. The regulator used Ethereum (ETH) as an example of a public network.

According to the report, public networks are inherently vulnerable to illegal activity due to the lack of a centralized governing body and their open nature, which means anyone can become a validator and interact with the network without needing regulatory approval.

Furthermore, the “nascency” of public networks means that many protocols are incapable of supporting “enterprise-grade requirements.”

On the other hand, private networks allow regulators and controlling bodies to be more “selective” and only allow trusted parties to participate in the ecosystem, which significantly reduces the risk of fraudulent and illicit financial activity, according to the watchdog.

Regulating DeFi

The report also highlighted the challenges in regulating the DeFi and overall crypto industry and how to best tackle them.

According to the report, one of the biggest hurdles in regulating the sector is the cross-border nature of the industry and how trades can be subject to rules in multiple jurisdictions. This over-complication is further exacerbated by the fact that laws and regulations for the crypto industry are at an early development stage.

The report said these issues could only be resolved via concerted international collaboration and urged countries to take a unified approach in creating rules for the industry that is cognizant of these challenges.

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