The Monsters I created or: Defi under increased regulatory pressure

Regulators are desperately trying to tame the "monster" Cefi and incumbent financial industry created itself back in 2008 - We remember Financial Crisis > Bitcoin > Ethereum > Smartcontracts > Defi > DAO > ...

After CFTC s Dan Berkovitz, SEC's Hester Pierce and others before, this time it is SEC Chair Gensler to call for Defi supervision, concretely Defi-platforms to register with the SEC.

But how is it that a completely decentralized financial architecture, operating via decentralized autonomous organizations ("DAO") and open source software, can and should be subject to supervision?

  • It is true that public interests such as investor or AML protection must apply equally to Cefi and Defi
  • Gensler's point is also correct that many of today's projects referred to as Defi are ultimately centralized systems, simply controlled by new instead of incumbent actors
  • So where Defi is on it, Defi is not always in it or according to Gensler: DeFi is “a bit of a misnomer”
  • As a consequence, Cefi projects packaged as Defi will be regulated, e.g. Investor protection via SEC registration or AML protection via applying the FATF travel rules for Virtual Asset Service Providers (VASP) which also could include decentralized exchanges, which in fact are centralized. 

So far so good. But what is not yet solved here and cause for concern: How are the centralizing aspects

1) to be defined concisely enough ?

2) ... and to be sanctioned effectively in the event of a violation ?

If the regulatory framework is defined too broadly, there is a risk of undermining the Defi innovation power from the outset and throwing the baby out with the bathwater, so to speak. Cost effects, efficiency gains and ultimately financial autonomy for the population would be lost. 

How are those responsible in Cefi / Defi hybrids ultimately to be identified and, if necessary, held accountable? The more Defi is actually present in the hybrid, the more difficult it will be to assign responsibilities to specific actors. In concrete terms: If a system is controlled by DAOs, i.e. code-based organizations, and open source software is used, does one really want to pick out the individual software developer and hold him or her responsible for the lack of alternatives? This would easily expose the state to the accusation of arbitrariness.

Depending on how these questions are answered, this can at best even accelerate the innovation power for real defi projects, or otherwise bring them to a standstill, at worst.

Careful consideration by the legislature is needed here, as is a fundamental understanding of the subject. This will not be possible without the involvement of experts from industry and research.

For the sake of a more efficient and autonomous financial world, let us hope that the gaps here can be solved in a balanced and timely manner, not only in the U.S., but also in Europe, which is already on the way with its #MiCA or the laws already enacted, blockchain law in Liechtenstein or #DLT framework law in Switzerland. All of them have not yet solved the formulated questions, though, in an effective way.

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