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SEC shares views on DeFi risks, regulation and opportunities
On November 9, 2021, Commissioner Caroline A. Crenshaw of the US Securities and Exchange Commission (SEC) offered views on the status of decentralized finance (DeFi) regulation in an article published in The International Blockchain Law Journal. While DeFi has the potential to optimize transaction speed, costs and customization, the Commissioner argues that it mimics traditional financial services offerings and products. As such, DeFi is analogous to offerings and services already under SEC jurisdiction. Therefore, Crenshaw expects the ecosystem to face challenges comparable to traditional financial markets. According to Crenshaw:
- “Unless necessary, there will be projects that do not invest in compliance or adequate internal controls;
- when the potential financial rewards are large enough, some individuals will victimize others, and the likelihood of this happening tends to increase as the likelihood of getting caught and the severity of potential sanctions decrease; and
- Absent mandatory disclosure requirements, information asymmetry is likely to favor wealthy investors and insiders at the expense of the smallest investors and those with the least access to information.”
The commissioner notes that DeFI projects lack risk disclosure standards and provide too little information for investors to properly assess risk, and cites this as a reason for decreasing investor confidence and participation. In the long term, the Commissioner argues that regulatory frameworks facilitate the flourishing of markets. Those responsible for regulating these markets are the same authorities encountered in traditional finance, including the Justice Department, the Treasury Department, and the SEC. However, at the time of the Commissioner’s statement, no DeFi participants were registered with the SEC. The Commission aims to increase engagement with market participants and reminds that development teams can establish a connection with A strategic hub for innovation and financial technology to clarify their regulatory requirements.
Commissioner Crenshaw offered a stark warning: Non-compliant projects face enforcement action. For example, in 2021. DeFi Money Market has received a termination order for offering and selling more than $30 million in securities in an unregistered offering while misleading investors on the project. Still, the SEC encourages innovators to reach out to discuss regulatory changes that can enable DeFi innovation. As it stands, the Commissioner has identified two issues that the DeFi ecosystem needs to address to ensure markets are fair for all investors:
- Lack of transparency regarding the operational arrangements of DeFi projects: projects are often launched by professional investors, which can affect project management. The statement claims that they are rarely published in plain English and put retail investors at a disadvantage. More importantly, the commissioner stated, “It is not reasonable to build a financial system that requires investors to also be sophisticated interpreters of complex code.”
- Like other blockchain-based projects, DeFi transactions are pseudonymous: although transactions are public and immutable, not knowing who is behind an address or transaction raises concerns about market manipulation. Indeed, trading volume can be inflated by one entity transacting with itself. This hinders the ability of investors to obtain reliable information before making a decision. The commission emphasizes that in traditional financial markets, investors have agreed to give up a certain degree of privacy in order to benefit from regulated markets with less manipulation and fraud. The SEC expects DeFI projects that overcome the hurdle of pseudonymity to be more likely to succeed.
The announcement concludes that some DeFi projects already fit the SEC’s jurisdiction. When this is the case, developers should comply with existing regulations. Furthermore, the SEC expects ecosystem collaboration to find solutions that fit this new technology. In addition to “profitability, speed of development and innovation”, the Commissioner is pressing developers to contribute to a financial system where “investors have access to material data that can be applied, and it should be a system that reduces the potential for manipulative behaviour”.
As regulators begin to scrutinize the DeFi space more closely, DeFi developers and participants will need to prepare to comply with regulatory requirements. Schedule a demo to learn how Elliptic can help your business comply with existing anti-money laundering and terrorist financing regulations and manage the risks associated with DeFi.
OFAC adds sanctioned entities
On November 8, 2021, the US Treasury Department announced new sanctions against the crypto-asset business that was used to launder the proceeds of the ransomware attack. The Treasury estimated that ransomware payouts reached $590 million during the first half of 2021. It noted that non-compliant exchanges were increasingly targeted by cyber criminals to launder the proceeds of crime. To counter this threat, the Treasury has sanctioned Chatexa Latvian crypto-asset exchange used to launder ransomware proceeds, as well as three of its partners. Two more Ukrainian individuals were added to the list for their involvement in ransomware attacks that generated more than $200 million in crypto assets. The Treasury reiterated that “financial institutions and other persons engaged in certain transactions or activities with sanctioned entities and individuals may expose themselves to sanctions or be subject to enforcement actions.” Read our coverage of last week’s sanctions here and learn more about how Elliptic can verify your cryptoasset transactions in real-time to limit your exposure to sanctioned entities.
Sweden is considering limiting proof of mining operations citing environmental concerns
The Swedish Financial Supervisory Authority (SFSA) and the Swedish Environmental Protection Agency (SEPA) have concluded that cryptoassets based on proof-of-work (POW) protocols such as Bitcoin threaten Sweden’s ability to meet the Paris Agreement on climate change. Due to the rise in cryptoasset prices in recent weeks, block encryption puzzles are becoming more complex and require more computing power. As a consequence, the demand for electricity has increased. SFSA and SEPA mention that cryptoasset miners are increasingly moving to the Nordic region thanks to the availability of renewable energy. However, the authorities claim that this clean energy is being diverted from “essential services”. They suggest that lawmakers (including the European Commission) consider a tax on energy-intensive Bitcoin production, a ban on POW mining, and disclosure requirements for companies that trade or invest in crypto assets using the protocol. However, the SFSA and SEPA recognize that there is a risk of encouraging the relocation of businesses to less restrictive jurisdictions.
As with recent regulatory announcements about tax treatment and macroprudential regulation cryptoassets, this development shows that the authorities are approaching all aspects of the ecosystem.
Singapore Clarifies Central Bank Access to Crypto Assets, DeFi and Digital Currencies
Ravi Menon, Director General of the Monetary Authority of Singapore (MAS) on 9 November 2021. crypto asset statement, DeFi and digital currencies of the Central Bank at the Singapore Fintech Festival. In his speech, he stated that MAS does not view cryptoassets as money and reminded the industry that cryptoasset businesses are subject to licensing and oversight requirements due to AML/CFT risks. However, Menon recognized the potential benefit that blockchain technology could bring to the economy and highlighted a particular interest in the reserve-backed crypto-asset.
His statement also referred to Central Bank Digital Currencies (CBDCs), stating that MAS sees benefits in issuing wholesale digital currency aimed at banks to improve reserve management and transform cross-border payments. Referring to retail CBDC (a digital Singapore dollar available to everyone), he said MAS does not see the development of CBDC as urgent. He argued that cash will continue to be relevant for the foreseeable future, Singapore’s payment system is sufficiently efficient and inclusive, and the replacement of the Singapore dollar by foreign CBDCs is not currently considered a threat. Nevertheless, Menon announced the launch of Project Orchid to work on the technical requirements needed to issue CBDC if MAS decides to launch a retail CBDC. He also reminded the meeting participants of a number of MAS initiatives, among them COSMICa platform for financial institutions to exchange data related to high risk and illicit activities using their own systems.
UK Statement on CBDCs
On 9 November 2021, Her Majesty’s Treasury (HMT) and the Bank of England (BoE) announced the next steps in Central Bank Digital Currency (CBDC) research. This follows the creation of the connection CBDC Taskforce HMT and BoE in April 2021. In 2022, both agencies will launch a public consultation to assess the benefits and implications of the CBDC, as well as begin high-level design planning. HMT and BoE note that no decision has been made to introduce CBDCs in the UK. If regulators decide to develop a CBDC after their 2022 consultation, the announcement suggests it would be launched in the second half of the decade at the earliest. HMT and BoE spokesmen said they look forward to an open discussion on this topic with all interested parties.
