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European regulators pushed to scrap smart contract laws that would kill DeFi

European regulators pushed to scrap smart contract laws that would kill DeFi
Smart contracts underpinning decentralised protocols may face harsh restrictions under Europe's Data Act
  • The European Union may enforce onerous provisions on decentralised protocols that rely on smart contracts if regulators don’t clarify the scope of the Data Act.
  • The crypto industry is driving a final push in the final stage of negotiations between the European institutions.

Europe’s blockchain industry is making a final push to prevent laws that would crush smart contracts that underpin decentralised protocols.

The Data Act, in negotiations set to conclude at the end of June, aims to regulate data shared between smart devices within Internet-of-Things networks.

The decentralised finance sector worries that the legal texts — with an article dedicated to regulation of smart contracts — do not clearly enough indicate the scope.

Advocates including the European Crypto Initiative are asking policymakers to heed to the danger of spilling over to blockchain developers. Such a spillover could, in effect, kill DeFi in the bloc.

“The worst-case scenario is whether we would even be able to use public blockchains for using smart contracts while complying with the Data Act requirements,” Marina Markezic, executive director of the European Crypto Initiative, told DL News.

Europe shouldn’t “shoot itself in the foot by inadvertently damaging innovation and technological development in the broader blockchain industry,” the trade association said in a policy paper sent to over 100 decision-makers, and seen by DL News.

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Mixed signals from the EU

A source close to the negotiations told DL News that the European institutions hoped to promote the use of smart contracts through the Data Act and do not intend to regulate ledger technology. The industry’s concerns will be addressed as negotiations continue in the coming weeks, the source said.

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A European Commission spokesperson, however, said that the controversial article on smart contract regulation is neutral to technology.

“It sets high level requirements for smart contracts, whether or not they are based on blockchain technology or a more traditional database,” the spokesperson said, adding that the commission will be ready to support the European Parliament and European Council as they continue negotiations.

‘It is a more delicate political situation, there might be more precaution from negotiators during trilogues to strike the right balance’

Meeri Toivanen, specialist at Sitra

In the final stretch of the legislative process, the three European institutions leading the negotiations have each reached their own stance on the Data Act. The European Parliament passed a vote on its adoption of its text on 14 March. Now, together with the European Council and Commission, regulators need to reach a final political agreement during so-called trilogues.

The final stretch of negotiations

The next trilogue meeting is on 23 May, which will try to solve most of the outlying issues with the Data Act text, according to another EU official. Another meeting is scheduled for the end of June, just before the six-month rotating presidency of the European Council reaches an end.

If the file isn’t concluded by then, it may see bigger delays. Spain is due to take over from Sweden’s term on 1 July. Once trilogues conclude, the Data Act will need to see a final vote from the Parliament’s plenary and approval from Council’s members.

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“It is a more delicate political situation. There might be more precaution from negotiators during trilogues to strike the right balance,” Meeri Toivanen, specialist at the Finnish innovation fund Sitra, which works closely with Web3 stakeholders, told DL News.

The European Crypto Initiative and other organisations had informed policymakers of their concerns, this the “biggest organised effort so far,” said Markezic. The group hopes that “any future plans for data sharing will take into consideration the inherently different nature of smart contracts.”

Rules for smart contracts

Alarm bells went off for the industry with Article 30, which includes “essential requirements regarding smart contracts for data sharing.” If passed, the law would require smart contracts to be designed in a way that allows for them to be terminated or interrupted. Lawmakers would have to specify when such action would be allowed.

Termination features, which oppose the nature of blockchain-based smart contracts, “necessitate a single point of failure for the safe termination and interruption of smart contracts, which increases the risk of potential vulnerabilities being exploited,” according to the EUCI paper.

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Smart contracts would also need to be “protected through rigorous access control mechanisms at the governance and smart contract layers,” the bill reads.

The Data Act is part of the European Unions’s strategy for data and was proposed by the Commission in February 2022.