A New Chapter in Encryption Regulation: The Empire Strikes Back

The latest news puts the decentralized financial community in a collective fetus state. Responding to the threat of increased regulation, recently led the decentralized exchange Uniswap Restrict trading of certain tokensIn early July, the Chairman of the Commodity Futures Trading Commission (CFTC) Dan M. Berkovitz stated that DeFi derivatives platform may violate Commodity Exchange Act (CEA):

“Not only do I think the unlicensed DeFi market for derivatives is a bad idea, but I don’t think how they are legal under the CEA.”

The most worrying is the initial version of the US Senate’s $1 trillion infrastructure bill, which will Create impossible tax compliance requirements For crypto companies.

related: The Senate Infrastructure Bill is not perfect, but is the intention correct?

Get ready, DeFi — more is coming

However, as long as DeFi is distressed by these imminent regulations, it is likely to ignore the imminent and existing regulatory challenges that have not yet made headlines.

Policies and regulations related to encryption are often divided into three types:

  • The first, such as the Infrastructure Act, aims to increase revenue and enable the IRS to collect taxes.
  • The second goal is to ensure a safe and sound market for investors. Such legislation includes the US Securities Exchange Act, which authorizes the Securities and Exchange Commission (the executor of the famous Howey test to determine whether assets are securities) to regulate the securities market, and the Commodity Exchange Act, which gives the CFTC the power to regulate the derivatives market.
  • The third type of regulation focuses on anti-money laundering (AML) and counter-terrorism financing (CFT). For example, the U.S. Bank Secrecy Act authorizes the Financial Crimes Enforcement Network of the U.S. Department of the Treasury to ensure that the company has a strong AML/CFT program, including a clear “know your customer” requirement.

related: U.S. updates its cryptocurrency AML/CFT laws

Global standards for these regulations Set by the Financial Action Task Force (FATF), an intergovernmental organization created by G7 to coordinate the work of AML and CFT. People working in DeFi need to understand and comply with these regulatory systems. These systems are not meant to burden companies, but to prevent transactions with serious national security consequences, such as terrorist attacks, human and drug trafficking.

DeFi and AML/CFT

This is where DeFi is unstable, because many of its developers are convinced that AML/CFT regulations do not apply to them. For example, Uniswap argues that since it does not control the funds in its agreement, it is a software development studio and therefore does not bear any responsibility under AML/CFT requirements. Although I understand this position, it endangers our industry and shorts it.

related: Draft FATF guidelines for DeFi compliance

First, if DeFi developers are not responsible, then who? The more logical party might be the liquidity provider (LP). After all, their capital in each pool is the counterparty to each transaction. Although encrypted local LPs tend not to bear this responsibility, traditional institutions and their individual responsible personnel need to know that they will not inadvertently promote illegal transactions before allocating funds on behalf of investors. Institutional capital is definitely needed to catalyze the next phase of DeFi growth, so the DeFi community must find a way to provide clear solutions for regulators and traditional banks.

Second, legal changes are as fast as security risks. Take the Patriot Act as an example, which became law less than two months after 9/11 and added the AML/CFT agreement to the Bank Secrecy Act. Less than three months after the Pearl Harbor attack, President Franklin Roosevelt also ordered the detention of Japanese Americans.

The government rarely allows bureaucratic red tape or legal obstacles to hinder national security. DeFi has not yet appeared at a critical moment that is critical to national security, but such a passing ceremony is not unimaginable—especially DeFi poses a threat to traditional finance.only Look at the $4.4 million paid In Bitcoin (Bitcoin) To end the ransomware attack in May. Major geopolitical security incidents related to DEX transactions may not be a problem, but a matter of time.

Third, as an industry, we have an ethical obligation. You may be familiar with the saying that we are building a “safe, transparent and strong financial infrastructure to provide support to users all over the world.” These should not be just empty talk: realizing this vision requires doing everything we can to ban any financing that may be related to the black market, terrorist financiers, drug cartels, or other problematic entities.

related: Bitcoin can no longer be regarded as an untraceable “criminal token”

Getting there is not easy. For example, the requirement to know your customers may prompt traders to accept the less compliant and possibly less secure DeFi agreements issued by anonymous developers.

However, practical and effective AML/CFT protection measures can be deployed at the protocol level. In my company, we built our first DEX with an on-chain blacklist. This means that any address marked by the Office of Foreign Assets Control cannot be traded on our DEX.

This protective measure has no impact on the user experience of daily traders, most of them may not know this, but it is very effective in preventing problematic transactions. Whenever possible, developers can easily implement such technical solutions. But as long as the leading DEX and the de facto industry model indicate that they are not liable, they are unlikely to do so.

If AML/CFT requirements are not accepted, DeFi will never become mainstream. More importantly, if the DeFi community fails to self-regulate, the government will certainly complete this work for us—and much more.only Look at the infrastructure bill, Designed to make DeFi developers responsible for users’ lack of tax compliance. The hastily written AML/CFT legislation for encryption may be even weaker.

Self-discipline is an ethical behavior, and it has the added benefit of ensuring the long-term survival of the industry. Another option is to wait for a more stringent compliance hammer. The choice is ours.

This article does not contain investment advice or recommendations. Every investment and trading action involves risks, and readers should research on their own when making a decision.

The views, thoughts, and opinions expressed here are only those of the author, and do not necessarily reflect or represent the views and opinions of Cointelegraph.

Mark Lurie He is the CEO of Shipyard Software Inc., which developed the Clipper exchange and is supported by Polychain, 0x Labs, 1inch Network and other members of the DeFi community. Mark is a former investor in FJLabs and Bessemer Venture Partners and holds MBA and BA degrees from Harvard University.