5th September 2021 > > Decentralised finance.

tl;dr

Regulation of decentralied finance (DeFi) is a quandary.

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Curious Cryptos’ Commentary – Regulation of Decentralised Finance (DeFi)

DeFi was invented – practically speaking - aeons ago, spring 2020, as a response to what was seen as an increasing centralisation of crypto activity within traditional exchanges, and as a potential means of avoiding the developing regulatory landscape.

The first of these objectives is laudable – it speaks directly to the core ethos of BTC and cryptos.

The second of these objectives is childish, elitist and guaranteed to fail.

All DeFi applications, run from a website, simply require a user to log in using a crypto wallet, typically an online one such as MetaMask but Ledger Nano is my preferred solution where possible.

There is no need for a user to register their identity or existence in any shape or form. You do not have a username, nor do you have a password to interact with DeFi. Your crypto based wallet, which signs transactions using your private key, is all that is required.

In theory, this means that all the Know Your Customer (KYC) regulations are made redundant, allowing for the movement of crypto assets in a totally anonymous fashion.

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In practise, this isn’t what is happening for two key reasons.

The first reason is that fiat on and off ramps are by definition centralised.

There is a body of opinion which believes that cryptos will revolutionise finance to that extent that they will entirely replace fiat in the near future. That view of the world must put aside the awkward fact that 1 billion people do not have a mobile phone, and more than 2 billion people cannot access the internet. Replacement of fiat by cryptos would lead to even greater disenfranchisement of the poorest in the world, an outcome none of us wants to see.

Fortunately, I have a very firmly held belief that cryptos are complementary to fiat.

If I am right, this means that you cannot avoid interacting with a centralised exchange at various points of your crypto journey.

The second reason is the one we discussed recently with respect to the Uniswap Foundation (see CCC 21st August 2021).

Uniswap is one of the first, and currently the largest decentralised exchange with a 24-hour trading volume of around $1.5bn (see, we still use fiat for reference …)

Management of the decentralised exchange Uniswap is performed by the centralised Uniswap Foundation. After the SEC recently warned that tokenised stocks fall under its regulatory remit, the Uniswap Foundation delisted all such trading pairs from Uniswap.

This act was essentially a public admission that despite all the decentralised claims made about Uniswap, they are all hogwash because of the control that the Uniswap Foundation has been shown to be able to exert.

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The SEC has taken notice and has initiated a probe into Uniswap Foundation and Uniswap Labs, the software development arm of this organisation.

The implications of this development are quite profound. The regulatory problems thrown up by the relationship between these different parts of the Uniswap organisation are not trivial and are completely unique and original from anything seen before.

Gary Gensler, Chair of the SEC, will need to think hard and tread carefully, because a more traditional heavy-handed approach will simply drive all DeFi business out of the US. He might be better off going back to the day job and worrying about when he is finally going to get around to approving his very first BTC ETF.

This is a key test of the US appetite to maintain its global lead in the regulation of crypto business and will have a material impact on its share of the tax dollars on offer.