DeFi Regulations: Where US regulators should draw the line

DeFi Regulations: Where US regulators should draw the line

Given the decentralized nature and growth of Decentralized Finance (DeFi), regulators have had to deal with a problem for a long time.

The United States regulators focused their attention in 2022 on the emerging area, paying particular attention to ending the anonymity of the ecosystem.

DeFi protocols enable users to trade, lend and borrow digital assets directly without the need for intermediaries. The majority of DeFi ecosystems are decentralized, with most projects being managed by smart contracts and autonomous decentralized organizations (DAOs). DeFi protocols do not require traders to know their customers (KYC), so it is possible for them to trade anonymously.

In June, a leaked copy of a U.S. bill draft showed key concerns for regulators. It included DeFi stablecoins (DAOs), crypto exchanges and DAOs. With the intent to ban anonymous projects, the draft bill placed a particular emphasis on user protection. Any crypto platform or service provider must register legally in the United States under the bill, regardless of whether it is a DAO protocol or DeFi protocol.

Principal at Aquanow’s institutional infrastructure and liquidity provider Aquanow Sebastien Davies attributed the regressive approach to regulators’ ineptness about technology. Cointelegraph was told by Davies that incidents like the sanctioning of Tornado Cash customers after their application was added to the Specially Designated Nationals List produced by the Office of Foreign Assets Control show a lack of technical understanding. He explained:

“I believe policymakers wanted to convey that developers/users who completely obscure transaction history will find it difficult and they are willing to take swift action. Although officials may eventually change their mind, the precedent will not be lost. To avoid such shocks, participants in the digital economy must continue to communicate with regulators.

A second discussion paper, released by the U.S. Federal Reserve Board in August, stated that DeFi products still pose risks to financial stability even though they make up a small portion of the global financial market. DeFi’s resistance against censorship was overstated. Transparency could be a competitive disadvantage to institutional investors and an invitation to wrongdoing.

Budding projects will be driven out by forced legislation

Experts agree that regulators’ concerns about user protection are understandable. However, experts say this shouldn’t be at the expense of innovation and progress. The U.S. would fall behind if it focuses only on collecting data and creating barriers that prevent innovation.

Hugo Volz Oliveira is the secretary of The New Economy Institute, a non-profit organization that develops digital economy policy recommendations. He explained to Cointelegraph why regulators are not focusing on eliminating anonymous projects with their current approach. He stated:

“Take for instance the fact that regulators and policymakers continue to insist on eliminating anonymous cryptocurrency projects and teams. They are de facto trying choking this industry by targeting its builders.” This won’t work for the more complex projects being developed in accordance with the ethos of this community.

He said that it is possible that North American legislators will succeed in driving the majority of the crypto industry out of North America. He stated, “This is also problematic because the rest of the globe still needs large nation states to stand up against the bullying by FATF and other undemocratic organizations that seem more interested in preserving their monopoly power than in fostering an innovation-based approach.”

The U.S. Federal Bureau of Investigation issued a new warning to investors in DeFi platforms on Aug. 30. They were targeted with $1.6 million in exploits in 2022. Cybercriminals are exploiting “investors’ increased interest” in cryptocurrency and “the complexity and open-source nature of DeFi platforms.”

#FBI warns cyber criminals are exploiting weaknesses in Decentralized Finance (DeFi) platforms to steal cryptocurrency investors. Contact your local FBI field office, or IC if you suspect you have been victim to this. Learn more:
— FBI (@FBI), August 29, 2022

Decentralization is an important aspect of the DeFi ecosystem. However, criminals may take advantage of it in order to process illicit transactions. It is important to remember that laundering via crypto has been proven to be more risky because they can be tracked and blocked. Even after years of theft, criminals still manage to launder their money.

A mindset shift is required for DeFi regulation

The topic of crypto regulations is a hot topic in mainstream industry. This is because, aside from some states that have specific crypto-centered laws there is no one rule book for crypto operators in the United States. Regulating a niche crypto market could prove difficult if there isn’t enough clarity.

Jackson Mueller, the director of policy relations and government relations at Securrency (a blockchain-based regulatory and financial technology developer), told Cointelegraph there is a growing interest from policymakers in the DeFi space.

They are currently unsure whether to continue to use long-standing, but arguably inappropriate regulatory regimes or to consider developing appropriate and responsible frameworks outside of the regulatory box. He explained:

“Policymakers will never be happy with a system that is based on anonymity. This is why KYC regulations and Anti-Money Laundering are required. This obviously raises privacy and level playing field concerns. However, modern technologies that can be deployed today can greatly protect an individual’s privacy without limiting the potential for DeFi services or propelling opaque market opportunities. Regulated DeFi does not have to be an absurdity. Both can and should co-exist.

The U.S. Securities and Exchange Commission (SEC), released a new proposal in February this year. It highlighted the SEC’s lack of knowledge of the space. The proposal seeks to amend the Securities Exchange Act (SEC) definition of “exchange”. All platforms that have a threshold amount of transactions would need to register as exchanges under the amendment.

Many DeFi projects are at risk from the proposal, as they are not managed centrally. Having to register as an exchange for DeFi could spell doom. Hester Peirce (the SEC commissioner and a well-known crypto advocate) was one of the first to point out the flawed proposal. She said that it could be extended to more types “trading mechanisms”, including possibly DeFi protocols.

Multiple warnings and proposals from U.S. federal agencies point to a tough approach that many experts don’t believe will work.

“DeFi regulation demands a paradigm shift. It is no longer about being reactive. Instead, it must shift towards preventative measures and support the constructive development of the industry.” Instead of being reactive, regulation should be reimagined to support the constructive development and shift towards preventative measures.

Global DCA has been working on this topic to create and design a self-regulatory body that engages with diverse stakeholders in the digital assets ecosystem. These perspectives and insights will be “reflected back into a framework of self-regulation that may help to advance the market integrity and consumer safety.”

Eric Chen, CEO of Injective Labs and co-founder, said that ecosystem stakeholders should be involved in regulatory discussions.

“I believe regulators should have opener conversations with founders and companies of Web3. This dialogue would allow both sides to achieve more rapid regulatory clarity. Many people may not be aware that the early Web2 space was subject to an opaque regulatory structure. This was corrected over time when regulators and founders started to collaborate to create proper guidelines.

Regulators should be concerned about any new technology that gains mass acceptance. Their approach is crucial to determine if the technology can be used for good or if it should be banned because of some bad actors. Experts in the industry believe that the current approach of regulating DeFi markets under existing financial laws could prove to be disastrous for the emerging industry. They suggest that we have a dialogue to find a better way forward.

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Amy Jimenez

Amy Jimenez– Services My name is Amy Jimenez, and I am the main writer behind the"" for the ground-breaking and most fragile bits of knowledge into the most recent news in the services sector. I began my voyage of work as an autonomous investment advisor. I had around 4 years of involvement in this field. I am a free soul so; my energy for investigating the world has taken me to the countries over the globe and allowed me to report for a part of the best news affiliations. At present, I am a full-time manager as experienced in the account and began to utilize my capacities.

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