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Financial watchdogs in France and Hong Kong have indicated that decentralized finance (DeFi) services will face increasing pressure to meet regulatory requirements, following on from similar recent statements from the US.
On April 11, the French Authority for Prudential Supervision and Resolution (ACPR), which operates under the French central bank, published a report on DeFi. In it, the ACPR highlights what it sees as some of the main risks associated with the DeFi space and considers potential regulatory approaches to address those risks and associated challenges.
According to the ACPR, DeFi presents risks that mirror those present in parts of the traditional financial sector, including volatility risks, risks arising from product complexity and risks posed to consumers due to loss of capital. The report also outlines the threats related to financial crime – such as money laundering – that are present in the DeFi space and that require the implementation of anti-money laundering and countering the financing of terrorism (AML/CFT) measures.
In ACPR’s view, addressing these risks through regulation requires the development of certain approaches specific to the nature of the DeFi space. For example, it is proposed that smart contracts be subject to a certification framework that assesses the security of the underlying code as well as the sufficiency of governance arrangements. Smart contract certification would have to be routinely reviewed and could be revoked.
Additionally, the ACPR points out that while many developers and others associated with DeFi services claim that their products are decentralized, there are often individuals or entities that exercise significant control and influence over DeFi services. The ACPR believes that those exercising control over DeFi arrangements – including through Decentralized Autonomous Organizations (DAOs) – should face requirements to register with the appropriate financial supervisors.
On April 12, a senior regulator in Hong Kong offered views that also reflect the view that DeFi cannot completely escape regulatory oversight. Commenting at the Web3 Festival in Hong Kong, Keith Choy – who is interim head of intermediaries at Hong Kong’s Securities and Futures Commission (SFC) – stated that DeFi services may already face registration requirements with the SFC.
According to Choy, the provision of automated trading services involving the transfer of securities or futures already regulated by the SFC, and DeFi services available to users in Hong Kong, would require a license from those exercising control over the platform.
These views on DeFi from France and Hong Kong come just a week after the US Treasury released its assessment of the risk of illicit financing for DeFi. In that report, the Treasury argued that the proliferation of money laundering, sanctions and other financial crime activities requires AML/CFT laws to apply to more services in the DeFi space.
This growing regulatory focus on bringing oversight to activities in the DeFi space underscores the need for regulated businesses to use blockchain analytics solutions equipped with holistic screening capabilities, which can enable detection of money laundering through DeFi services, such as decentralized exchanges and DeFi bridges.
DeFi projects faced further signs of pressure from US regulators last week, as well in the form of an important update from the Securities and Exchange Commission (SEC). On April 14, the regulator announced it was reopening a proposed rule that would expand the definition of an exchange to ensure that new types of securities trading platforms are subject to SEC oversight.
SEC Chairman Gary Gensler issued a statement saying the proposed revised definition would “include communication protocols in crypto markets” – an apparent reference to the DeFi protocols that enable securities trading, and a further hint that an attempt to regulate the DeFi space is imminent.
To learn more about the financial crime issues impacting the space, read Elliptic’s DeFi report.
The SEC’s advisory board encourages further enforcement as it seeks to strengthen the crypto team
If the crypto industry was holding out hope that the intense pressure from the SEC might slow down, the past two weeks have brought bad news on that front. On April 6, the SEC’s Investor Advisory Committee (IAC)—an advisory board made up of outside experts—sent a letter to SEC Chairman Gary Gensler outlining its views on cryptoassets.
The letter expresses significant concern over the extent of investor losses in the crypto markets over the past year and expresses the view that most, if not all, cryptoassets are securities that are likely to fall under the SEC’s jurisdiction.
Contrary to industry calls for less enforcement and more involvement, the IAC said the SEC “should continue to be aggressive in bringing enforcement actions against companies that violate federal securities laws in the crypto space, including issuers, custodians and those acting as unregistered platforms that offer trading in crypto-asset investments”. The letter also encourages the SEC to seek additional resources from the US Congress to ensure it can expand its enforcement and oversight activities in the crypto space.
Related to this last point, the SEC also recently posted a job posting for an attorney in its Crypto Assets and Cyber Unit (CACU), an indication that the agency is continuing to strengthen its enforcement capabilities in a new unit it launched last year.
OFAC lists Bitcoin address of fentanyl trafficker amid crackdown on fentanyl support networks
On April 14, the US Treasury’s Office of Foreign Assets Control (OFAC) imposed sanctions on fentanyl traffickers with implications for the crypto space. Specifically, OFAC added Wang Honfei of the People’s Republic of China (PRC) and an associated crypto address to the list of Specially Designated Nationals (SDN).
This enforcement action relates to Wang Hongfei’s involvement with Wuhan Shuokang Biological Technology Co., Ltd (WSBT), a PRC-Guatemala-based company charged with supplying precursor chemicals to drug cartels in Mexico for the production of illegal fentanyl destined for the U.S. market.
The Elliptic team quickly conducted research and updated our monitoring tools so that compliance teams can immediately identify exposure to an address on the OFAC SDN list.
The move is part of an effort by the Biden administration to focus more attention on cracking down on the illegal financial networks of fentanyl traffickers. On April 11, the White House released a fact sheet outlining the administration’s plans to step up pressure on fentanyl trafficking networks as concerns remain about the deadly opioid’s impact.
Among the measures the administration plans to combat fentanyl trafficking networks are “efforts to disrupt the illicit financial activities that finance these criminals.” The fact sheet suggests that further sanctions from the US Treasury’s Office of Foreign Assets Control (OFAC) are among the measures the administration will rely on to target traffickers.
As we previously noted, OFAC has already targeted a number of individuals and entities involved in the fentanyl trade with sanctions measures, which have included listing crypto addresses of traffickers on OFAC’s list of Specially Designated Nationals and Blocked Persons (SDN list). The latest announcement from the White House suggests that crypto companies and financial institutions should expect to have to ensure compliance with further sanctions related to the fentanyl trade.
Crypto exchange staff in South Korea arrested
Employees of South Korean crypto exchange Coinone were arrested on April 10 on charges of accepting bribes to ensure tokens were listed on their platform.
News of the arrests comes less than two weeks after South Korean regulators announced that they had identified numerous deficiencies in the fight against money laundering and terrorist financing among South Korean crypto exchanges.
Sanctions Compliance with the law
