Decentralized Finance (DeFi) versus Traditional Finance in India: RegulatoryChallenges, Emerging Opportunities, and Security Risk Governance
Keywords:
Blockchain governance; Fintech that operates independently; potential threats to the security of FinTech; Indian financial inclusion FinTech regulations Revolutionising traditional finance with smart contractsAbstract
The conventional financial system in India, which oversees assets worth more than ₹220 trillion and provides services to more than 500 million account holders, is facing a new challenge from the fast expansion of blockchain-based decentralised finance (DeFi) protocols. This is an unprecedented turning point in the country's financial ecosystem. There are pressing concerns regarding the regulatory framework, systemic opportunities, and security governance frameworks suitable for India's specific socioeconomic situation as a result of the clash between two paradigms: one based on centralised intermediation and regulatory legibility, and the other on algorithmic governance and permissionless access. The distributional, regulatory, and security aspects unique to big developing federal economies have been largely ignored in the existing research on DeFi, which mostly focuses on Western financial markets. By utilising a comparative analytical framework that is applied to India from 2017 to 2023, this paper fills that gap. It does this by utilising blockchain transaction data from Chainalysis [8], regulatory filings to the Reserve Bank of India (RBI) and Securities and Exchange Board of India (SEBI), and primary regulatory gap indices that are constructed from FATF mutual assessment reports. We found five main things. To start with, there is a governance gap that increases systemic risk without enough supervision capability since India's DeFi regulatory framework is structurally four to six years behind its risk exposure profile. Furthermore, contrary to common belief, the majority of India's DeFi prospects lie in the areas of financial inclusion, efficient cross-border remittances, and tokenisation of sovereign assets, rather than in speculative trading. Finally, ordinary investors in India's DeFi ecosystem are more vulnerable than institutional players due to smart contract weaknesses and rug pull dynamics. Fourth, there was a policy divergence between revenue aims and systemic risk management since a 30% flat tax on virtual digital assets in 2022 reduced criminal transaction volumes but had no corresponding effect on lawful DeFi activities. Fifthly, the most institutionally viable route forward for proportional DeFi supervision in India would be to adopt a model similar to the MiCA architecture that the European Union has implemented, which would combine the macroprudential mandate of the Reserve Bank of India with the market conduct framework of the Securities and Exchange Board of India. In order to calibrate DeFi policy in developing market federations, this research proposes a novel Regulatory Opportunity Security (ROS) triangular structure.
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