US Securities and Exchange Commission (SEC) Chairman Gary Gensler says DeFi is a misnomer and isn’t immune to regulation.
Former MIT blockchain professor Gary Gensler, who has been Chair of the SEC since April of this year, stated earlier this month that DeFi projects, which exist on Ethereum and other smart contract trading platforms, have features that are similar to the types of entities that the SEC oversees, which could make the space subject to the same regulation that non-DeFi cryptocurrency platforms are trying to avoid.
This came during a difficult August for the DeFi sector, after the Senate’s bipartisan Infrastructure Bill was approved, with a dangerously broad definition of crypto brokers onboard which may include DeFi entities, and at a minimum creates new regulatory frameworks for authorities to go after the crypto industry. The DeFi sector could be set for further turbulence when the Financial Action Task Force (FATF) updates its virtual asset guidance in Q4 of 2021.
How Decentralized Is DeFi Really?
Decentralized Finance (DeFi) products have revolutionized the finance space by eliminating the middleman that usually sets the rules and takes a fee in traditional commerce settings. DeFi users are able to trade and lend online without the requirement of an intermediary.
Developers on these peer-to-peer networks write the code that automates transactions and then supposedly step away from the project. This has led DeFi stakeholders to argue that this decentralized feature should exclude it from SEC regulatory oversight.
However, Gensler has stated in an interview with The Wall Street Journal that the “Decentralized” in “Decentralized Finance” might be misplaced due to the fact that there are financial gains involved for platform participants.
Gensler says that “projects that reward participants with valuable digital tokens or similar incentives could cross a line into activity that should be regulated, no matter how “decentralized” they say they are”.
Gensler elaborates by saying that “these platforms facilitate something that might be decentralized in some aspects but highly centralized in other aspects.” He states that there is a core group of people that are not only writing the open-source software but also have governance and fees and that “there’s some incentive structure for those promoters and sponsors in the middle of this”.
Regulation Could Defeat the Purpose of DeFi
Due to its decentralized nature, DeFi instruments have eliminated lengthy application processes usually associated with trading and money lending in the centralized traditional finance world. In addition to this, it has allowed people who would usually not even have a foot in the door because of low credit scores or a criminal record, for example, the ability to participate in this space.
This nascent digital asset technology seems like manna from heaven for these participants. But, the unregulated nature of the DeFi space that makes it so appealing in these instances may be about to change with Gensler’s latest announcement.
Poly Network Hack Raises More DeFi Questions
These comments have come after the audacious Poly Network hack that temporarily relieved the DeFi network of $600 million dollars worth of tokens earlier this month, making it the biggest digital currency hack so far. The compromise of the network’s security is part of the latest in a surge of DeFi platform hacks that have contributed to a 270% increase in 2021 so far.
Giving weight to Gensler’s comment on DeFi’s contradictory title, the aftermath of the Poly hack saw the network’s team stepping in to mitigate the result of the breach, including the decision to offer the hacker a $500,000 bounty for the return of the funds, and a job position at the exchange. Moreover, the manner in which the hacker eventually returned nearly all the funds after realizing there was no way for him to escape identification, also set off alarm bells for some about the degree of centralization that actually exists in DeFi.
. In light of this, Gensler has intimated that the primary concern of the SEC is the safety and security of the public, both from cryptocurrency market manipulation and from scams and fraud in the digital asset space.
Gensler’s Stance on Crypto in General
This is not the first time that Gensler, a blockchain expert, has gone after the DeFi space of late. He also recently stated that DeFi platforms could be facilitating the sale of unregistered securities and could be in breach of securities, commodities, and banking legislation. Beyond DeFi, he also opined that Bitcoin is a speculative asset that required that the SEC take measures to protect against fraud and manipulation.
Although, in theory, regulating the DeFi domain entirely could be easier said than done if there are actually any truly decentralized platforms that operate according to a community rather than committee governance in existence, there would be no figureheads to prosecute nor any means to shut it down.
This comes at a time when the US Congress is in continued discussions about the state of digital currency regulation, which has recently included a misalignment of views in the tax treatment of non-custodial digital asset services and other crypto asset service providers (CASPs). With Gensler continuing to give insights into his approach to the regulation of the digital asset space, the industry is better able to predict how the SEC might choose to modulate the ecosystem in the future.