US Regulators Target “DeFi” or Decentralized Finance
The US Securities and Exchange Commission (SEC) would like to intensify its scrutiny of decentralized finance, also known as “DeFi”, as the market for blockchain-based financial services continues to grow.
Decentralized finance presents a panoply of opportunities but also poses greater risks, particularly to smaller and less professional investors, and this brings it into the spotlight for SEC attention, SEC Commissioner Caroline A. Crenshaw said in a statement that was also published in The International Journal of Blockchain Law.
Fundamental to DeFi is the use of decentralized applications, or dApps that run on blockchains, that enable investors to obtain an asset or loan after putting up collateral. Others allow people to deposit a digital asset in return for investment gains. In many cases, borrowed assets are involved, as are web-based tools that help users identify, or invest in, typically high-yielding DeFi instruments. In some cases, users earn fees in exchange for supplying liquidity or market making. Typically, central financial intermediaries such as brokerages, exchanges, or banks are not involved and instead offerers use blockchain-based smart contracts, often Ethereum.
Given that investing is often at the core of DeFi activity, this brings it under the SEC’s jurisdiction. The DeFi market is currently supervised to some degree by the Department of Justice, the Financial Criminal Enforcement Network, the Internal Revenue Service, and the SEC. Some DeFi participants, activities, and assets fall within the SEC’s jurisdiction as they involve securities and securities-related conduct.
However, the SEC says no DeFi participants have registered with the agency, even though they have been encouraged to do so. Other issues that need to be addressed are that there are always projects that do not invest in compliance or adequate internal controls and such unregulated activity typically involves some market participants attempting to victimize others. In addition, wealthy investors and insiders with access to information tend to obtain advantage over smaller investors.
More notably, Crenshaw say, DeFi investing is not transparent and market manipulation is difficult to detect, given the nature of the market. But rather than expanding the scope of the SEC’s enforcement program to the DeFi segment, Crenshaw prefers a greater emphasis on voluntarily compliance programs. Stopping short of calling for greater regulation, she says cooperation for the moment is the best approach.