UK Crypto Regulation Must Embrace DeFi: Paradigm Responds to the FCA

Crypto is global. Even as America moves closer to legislation on stablecoins and market structure, the rest of the world is also charging ahead. Embracing DeFi is not optional; it's a prerequisite for remaining competitive in the future of global finance.

The UK has, over multiple administrations, expressed its ambition to be a global hub for digital asset innovation. This dream will manifest or dissipate depending on how the Financial Conduct Authority (FCA) approaches decentralized finance (DeFi). Last week, Paradigm submitted a response on the FCA’s Discussion Paper 25/1 on regulating cryptoasset activities, highlighting crucial steps to ensure DeFi can flourish in the United Kingdom.

We believe in the immense potential for DeFi to transform traditional financial (TradFi) markets by reducing costs, streamlining operational efficiency, and bolstering transparency. The data speaks for itself: our recent research shows over two-thirds of TradFi firms are exploring DeFi solutions to overcome their existing inefficiencies.

Despite this clear opportunity to streamline market operations, ambiguous or overly restrictive regulations continue to hold TradFi back from further engaging with DeFi. For a country like the United Kingdom that is seeking increased productivity and economic gains from crypto, there is a golden chance to set an example.

Our feedback to the FCA emphasized two ways to foster a competitive and innovation-friendly environment for DeFi:

1. Clearer Regulatory Boundaries Around Decentralization

We believe clearer guidance is needed on what constitutes sufficient decentralization. A precise framework, reflective of global regulatory developments, would provide much-needed certainty for innovators and investors alike.

Decentralization should be assessed by:

• Absence of privileged access or administrative keys.
• Transparent, onchain governance decisions.
• Clear controls on smart contract upgrades
• Broad, decentralized validator nodes.

Instead of punitive measures for edge cases, the FCA should adopt an inquisitive approach, seeking to learn and adapt regulatory guidance jointly with industry stakeholders.

2. Lean into Public-Private Partnerships for Ongoing Policy Development

Regulating DeFi effectively requires a dynamic and inclusive approach. We recommend the FCA establish public-private working groups specifically focused on decentralization thresholds, bringing together traditional financial institutions, centralized exchanges, and DeFi protocols.

These groups should actively develop:

• Clear, practical frameworks for assessing decentralization.
• Voluntary industry-led initiatives, such as transparent disclosures, self-certification mechanisms, and open-source compliance tools.

Such proactive and coordinated efforts would ensure regulations remain adaptive, fostering innovation while safeguarding consumer protection.

By embracing DeFi thoughtfully and in partnership with the private sector, the FCA can set the stage for substantial growth in both the crypto and TradFi sectors. More importantly, they can be for the world what has been missing thus far on DeFi: a guiding light for how countries can support DeFi’s tremendous potential through policy. Paradigm looks forward to continuing our engagement with the FCA and supporting the growth of the UK's thriving crypto ecosystem.

Read our full response to the FCA here.