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Leading policymakers and financial sector watchdogs have warned of the importance of addressing financial crime risks in decentralized finance (DeFi), adding to a growing chorus of voices seeking to expand regulatory oversight into the DeFi space.
In a statement released on May 13 ahead of the Group of Seven (G7) summit in Japan, G7 finance ministers indicated that controlling the risk of DeFi financial crime is a top international priority.
The G7 said: “In light of growing threats from illicit activities, particularly by state actors – including the theft of cryptoassets to finance proliferation, ransomware attacks, terrorist financing and sanctions evasion – we support the initiatives of the Financial Action Task Force (FATF) […] and its work on emerging risks, including DeFi arrangements.”
The above statement refers to the updated guidelines on virtual assets in which the FATF – the global anti-money laundering and countering the financing of terrorism (AML/CFT) standard setter – states that countries should take steps to regulate and with influence and control over DeFi arrangements.
The FATF’s focus on DeFi has accelerated over the past 18 months as financial sector watchdogs have expressed growing concerns about illicit financing in the DeFi space – and in particular concerns about DeFi cyber theft and money laundering cases involving North Korean cybercriminals.
Citing the FATF’s work on DeFi in its statement, the G7 makes it clear that curbing such illegal activity is not just a technical problem, but an increasingly important issue of international security.
As the G7 sounded the alarm about the need for regulatory action on DeFi, the crypto czar at America’s top law enforcement agency also warned about North Korea’s activities in the DeFi space. In an interview with Financial Times On May 15, Eun Young Choi – Director of the National Cryptocurrency Enforcement Team (NCET) at the US Department of Justice (DoJ) – described the hacking and theft of the DeFi protocol in North Korea as an increasingly important issue for US enforcement agencies.
These warnings about the need to crack down on illicit activities in DeFi follow a report on the same topic published by the US Treasury Department on April 6. In its first DeFi Illicit Funding Risk Assessment, the Ministry of Finance highlighted the need to extend AML/CFT oversight to protocols and services in the DeFi space.
Acknowledging that the lack of traditional intermediaries in the DeFi space creates certain challenges for the enforcement of regulations, the Ministry of Finance has made it clear that the rapid growth of the DeFi space makes it imperative to ensure that the risk of financial crime is controlled.
In that risk assessment, the Treasury Department also noted the risks of not only hacking and theft by cybercriminals in the DeFi space, but also the potential for illegal actors to launder funds through services such as decentralized exchanges (DEX) and cross-chain bridges. .
To learn more about these types of risks related to the DeFi space, read Elliptic’s report on the state of cross-chain crime.
A British parliamentary committee wants cryptocurrencies to be regulated as gambling
UK lawmakers reject Prime Minister Rishi Sunak’s government proposals for crypto regulation.
In a report issued on May 17, the UK Parliament’s Treasury Committee expressed concern that the UK government’s plan to regulate crypto-assets within pre-existing financial services frameworks threatens to harm consumers. According to the Committee’s view, the high risk and volatility of crypto-assets require that they be regulated by gambling rules.
As the report states: “The Committee is also concerned that regulating consumer cryptocurrency trading as a financial service – as proposed by the government – will create a ‘halo’ effect, leading consumers to believe that this activity is safe and secure, when it is not.”
The Committee’s position reflects the hostile and skeptical attitude among certain Members of Parliament about cryptocurrencies. This contrasts with the view of policymakers at HM Treasury – which is currently being consulted on the proposed regulatory framework – that regulating crypto markets within financial services regulation is the best way to balance the need to protect consumers while ensuring the UK remains competitive with other jurisdictions such as which are the EU, the UAE and others that seek to create highly regulated but innovative regulatory regimes.
For its part, HM Treasury has indicated that it has no intention of backing away from its plans to bring crypto under financial services regulation. In response to the Committee’s report, it stated that “The risks posed by cryptocurrency are typical of those that exist in traditional financial services and their financial services regulation – not gambling regulation – has experience in mitigating them.” Crypto offers opportunities, but we are taking an agile approach to strong market regulation, addressing the most pressing risks first in a way that promotes innovation.”
HM Treasury has no obligation to consider the recommendations in the Committee’s report, so it seems likely that its current proposals will continue apace. However, the view from Parliament reveals that there are still crypto skeptics among some prominent policy makers in the UK.
EU ministers put their stamp of approval on MiCA
Finance ministers from across the European Union have unanimously voted in favor of the EU’s landmark Markets in Crypto Assets (MiCA) regulation, sending MiCA further on its way to finalisation.
On May 17, the EU’s Economic and Financial Affairs Council – which includes finance members from all 27 of the bloc’s members – approved the MiCA and accompanying EU amendments on cryptocurrency-related fund transfers. Together, the measures will provide the EU with a comprehensive framework for regulating the crypto market and requiring crypto companies to comply with measures such as the data sharing requirement of the Travel Rules.
The May 17 vote was effectively a seal, coming just three weeks after the European Parliament voted overwhelmingly to adopt MiCA on April 20. MiCA will officially become EU law this summer, when it is expected to be published in Official Journal of the European Union. Various provisions of MiCA will come into effect from mid-July 2024 to January 2025.
Switzerland has concluded enforcement measures for unauthorized ICOs
Swiss regulators have taken enforcement action against issuers of initial coin offerings (ICOs). In a press release dated May 17, the Swiss Financial Market Supervisory Authority (FINMA) indicated that, starting in May 2022, it is conducting enforcement proceedings against the Dohrnii Foundation, which launched an ICO in spring 2021 for a token it created known as DHN.
According to FINMA, the Dohrnii Foundation raised approximately CHF 3 million ($3.3 million) from several hundred investors; however, since the token was used to generate investment, it would have been registered as a securities offering with FINMA, which the Dohrnii Foundation and its founder failed to do.
FINMA’s press release indicates that the Dohrnii Foundation not only neglected to obtain authorization for its ICO, but also ignored FINMA’s cease and desist order to stop further token sales. However, FINMA had the last laugh: The Dohrnii Foundation has since entered bankruptcy as a result of the indebtedness and is in the process of being dissolved, allowing FINMA to complete its enforcement case.
The SEC seeks to revise the size of the LBRY penalty
Speaking of enforcement, the US Securities and Exchange Commission (SEC) has taken steps to reduce the size of the penalties it seeks in a key enforcement case. On May 12, the SEC filed a brief in federal court in New Hampshire seeking to reduce the size of the fine imposed on LBRY, a decentralized social networking and video sharing protocol, from $22 million to $111,000.
In November 2022, a judge in New Hampshire ruled in favor of the SEC, finding that the token issuance by LBRY – LBC – constituted an unregistered sale of a security. At the time, some analysts suggested that the SEC’s victory in the case represented a setback for the industry in light of other pending legal cases, such as the SEC’s lawsuit against Ripple, regarding the application of securities laws to the crypto space .
At the time LBRY was found to have violated securities laws, the SEC requested that the court impose a $22 million civil penalty on LBRY. In last week’s filing, the SEC asked that the penalty be significantly reduced to $111,000 for a simple reason: Since the SEC’s lawsuit against LBRY was launched, LBRY has run out of funds and is effectively shutting down. The SEC’s revised request for a proposed fine reflects what the agency believes LBRY can still pay to resolve its violations.
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