Is Fintech Sprawling out of the Regulatory Frameworks?

Emerging financial technologies bring enormous value, such as metaverse, blockchain, cryptocurrencies, alternative payments, cloud computing and AI, and the list goes on, regulators around the world, on the other hand, are wondering how to keep an eye on the equally enormous risks that such novel services are bringing while ensuring flexible innovation.

Has fintech sprawled out of the regulatory framework?

People in the financial sector have been discussing whether the existing regulatory framework is lagging behind the development of fintech, since the technologies are now representing the birth of a new era, a new instrument of entrepreneurship; opening up new investable asset classes, and a new manner of making financial decisions.

Take AI for instance, just recently in June, Spain's CaixaBank is teaming up with Microsoft on an AI innovation laboratory​ that will, among other things, focus on building a work environment in the metaverse.

The AI technology is designed to lower of costs of making predictions and judgments. A downside to AI's reliance on data for forecasts is that it stifles innovation because it prioritizes short-term incremental fixes over longer-term, more human-focused innovations and novel ideas.

Then there is blockchain, a decentralized way of storage, and Fazzaco has had a discussion on whether we are early or late in its life​, and finance is highly centralized, financial services and institutions stand to gain the most from blockchain's cost-reduction features. The adoption of blockchain technology and non-fungible tokens—digital certificates that represent an exclusive right to ownership—by financial services might ultimately lower client fees and the costs associated with authenticating transactions.

However, some experts believe that if blockchain technology becomes extensively used, it may also be used as a substitute for currencies that are backed by governments, which would make it more difficult for nations to enact monetary policy and maintain economic stability. Additionally, widespread acceptance can give the companies that create digital currencies, like Facebook (now known as Meta), an excessive amount of power over markets and central banks.

Therefore, regulators are advised to first comprehend the economic aims underpinning financial innovations in order to appreciate the regulatory needs and problems of fintech. Just last week, EU Passed the landmark MiCA Crypto Authorization Law.

Risks, the shadow of new financial technologies

Decentralized Finance, or DeFi, also lowers costs by removing intermediaries or managers often involved in financial transactions, combines the advancements driving AI and blockchain.

DeFi transactions, on the other hand, let parties design intricate financial transactions that may be carried out without the aid of a middleman and then securely stored on the blockchain. This enables "headless" financial institutions, a structure that provides more complicated and personalized services for individual customers and is more transparent and generative of parties' confidence.

While it saves money, DeFi still doesn't make a perfect replacement for conventional financial intermediation because to a number of concerns, such as the lack of deposit insurance, unstable prices, cyber risk, and coding flaws.

It is like a shadow that you cannot run away from, and to some people, it makes the new technologies unfit to the existing regulatory frameworks because of those hazards.

Relevant studies and opinions

In the United States, there is a general AI regulation that involves early stages of the technology in specific sectors, such as how FDA handles health-related AI, Department of Transportation governs self-driving vehicles, etc. But financial applications of AI have not made it to a top concern among U.S. regulators.

To clean up and explain the use of client data in AI, the U.S. Securities and Exchange Commission (SEC) has taken enforcement actions in the financial sector. With the adoption of SEC's "Howey test", a number of digital assets are now subject to the agency's enforcement authority and fall under its regulatory scope.

However, many DeFi platforms can avoid SEC supervision by demonstrating adequate decentralization, which may cause regulatory confusion, according to Jillian Grennan, a finance professor at Duke University's Fuqua School of Business, in a recent study.

Grennan talks about a safe harbor plan that would give new cryptocurrency asset issuers three years to construct a sufficiently decentralized platform to avoid security classification and regulatory oversight in the early going. This would promote industry growth while allowing for oversight under the right conditions.

However, as customers attempt to litigate unmet user expectations, legal conflicts between people who enter into smart contracts on blockchain platforms create very classic contract law and consumer protection legal difficulties, according to Grennan.