The latest news has left the decentralized finance community in a collective fetal position. Responding to the threat of increased regulatory oversight, leading decentralized exchange Uniswap recently restricted the trading of certain tokens. Earlier in July, Dan M. Berkovitz, chairman of the Commodity Futures Trading Commission (CFTC), said that DeFi derivatives platforms might contravene the Commodity Exchange Act (CEA):
“Not only do I think that unlicensed DeFi markets for derivative instruments are a bad idea, but I also do not see how they are legal under the CEA.”
Be ready, DeFi — More is coming
Yet, as long as DeFi agonizes over these looming regulations, it risks ignoring an imminent and existential regulatory challenge that has yet to make headlines.
Crypto-related policies and regulations tend to come in three flavors:
- The first, such as the infrastructure bill, aims to raise revenue and enable the Internal Revenue Service to collect taxes.
- The second seeks to ensure safe and sound markets for investors. Such legislation includes the U.S. Securities Exchange Act, which empowers the Securities and Exchange Commission (the enforcer of the famous Howey test that determines whether an asset is a security) to regulate securities markets, and the Commodities Exchange Act, which gives the CFTC the power to regulate derivatives markets.
- The third flavor of regulation focuses on Anti-Money Laundering (AML) and Counter-Terrorism Financing (CFT). The U.S. Bank Secrecy Act, for instance, empowers the U.S. Treasury’s Financial Crimes Enforcement Network to ensure companies have a robust AML/CFT program, including explicit Know Your Customer requirements.
Global standards for these regulations are set by the Financial Action Task Force (FATF), an intergovernmental organization created by the G7 to align AML and CFT efforts. Those who work in DeFi need to understand and abide by these regulatory regimes, which are not meant to burden businesses but to prevent transactions with profound national security consequences such as terrorist attacks, human and narcotics trafficking.
DeFi and AML/CFT
Here is where DeFi is on shaky ground, as many of its developers are convinced that AML/CFT regulations do not apply to them. For instance, Uniswap argues that since it does not control the funds within its protocol, it is a software development studio and thus not liable under AML/CFT requirements. While I understand this position, it imperils our industry and sells it short.
First, if DeFi developers aren’t liable, who is? The more logical party may be liquidity providers (LPs). After all, it is their capital in each pool that is the counterparty to each trade. While crypto-native LPs tend to shrug off this responsibility, traditional institutions and their personally liable officers need to know they are not inadvertently facilitating illegal transactions before allocating funds on behalf of their investors. Institutional capital will surely be required to catalyze the next phase of DeFi’s growth, so the DeFi community must find a way to offer regulators and traditional banks a clear-cut solution.
Second, laws change as quickly as security risks. Consider the Patriot Act, which became law not two months after 9/11 and added AML/CFT protocols to the Bank Secrecy Act. President Franklin Roosevelt likewise ordered the internment of Japanese-Americans less than three months after the Pearl Harbor attack.
Governments rarely allow bureaucratic red tape or legal hurdles to get in the way when it comes to national security. DeFi has yet to have a critical moment of…
Read More: cointelegraph.com