SEC Oversight Hearing
On Tuesday, the Senate Committee on Banking, Housing, and Urban Affairs conducted a hearing on the Oversight of the U.S. Securities and Exchange Commission, where Gary Gensler, the chair of the Securities and Exchange Commission (SEC), testified as a witness.
Representing popular sentiment, Ranking Member Tim Scott (R-SC) addressed Chair Gensler by stating that “It is clear under this administration, and under your time as SEC Chairman, that regulation, not innovation, is the preferred medicine for every perceived policy injury. This should not be the case.”
Senator Bill Hagerty (R-TN) opened a discussion about Bitcoin ETFs by asking Chair Gensler to “explain what the SEC needs to see in a filing to approve a spot Bitcoin ETF and what questions do you still need to answer from issuers about the market and or market infrastructure to allow this to happen?” Chair Gensler responded with a generic answer that the SEC is “still reviewing that decision” and is “looking forward to staff recommendation.”
Diving into a more detailed analysis related to custody, Senator Cynthia Lummis (R-WY) pointed out that Staff Accounting Bulletin No.1 (SAB) “prevents banks from offering crypto asset custody because it requires the assets to be backed one for one by US dollars. And if that standard were applied to legacy custody banks like BMI Mellon, they would have to have trillions in regulatory capital. So that prevents the most heavily regulated financial institutions in the country from offering (crypto) custody. So if your ultimate goal is to provide real consumer protection, shouldn't the SEC withdraw SAB 101 to allow banks to provide custody?” In response, Chair Gensler said the SEC does not speak to how crypto is backed and argued that banks could treat crypto as “a liability but they also have the crypto as an asset.”
What does this mean?
The hearing demonstrated an increasing awareness among senators of the SEC's trend for selective enforcement and regulatory crackdown on the digital assets industry. This hearing also marks efforts to increase regulatory clarity regarding the crypto ecosystem and craft innovation-friendly mandates.
CFTC Issues Orders Against Three DeFi Protocols for Offering Digital Asset Derivatives Trading
Last week the Commodity Futures Trading Commission (CFTC) announced legal actions against three DeFi protocols: Opyn, Inc., ZeroEx, Inc. (0x), and Deridex, Inc.
According to the CFTC, Opyn and Deridex failed to register as a Swap Execution Facility (SEF) or Designated Contract Market (DCM) — regulatory classifications for trading platforms — and didn't have the required customer identification programs to comply with the Bank Secrecy Act. Additionally, all three companies were charged for illegally offering leveraged and margined retail commodity transactions. Opyn, 0x, and Deridex settled the various charges and were ordered to pay penalties of $250,000, $200,000, and $100,000 respectively, and to cease and desist from violating the Commodity Exchange Act and CFTC regulations.
Commissioner Summer K. Mersinger dissented, arguing that the CFTC has not previously enforced against decentralized software, and that the cases show a shift from the CFTC's earlier stance of engaging stakeholders and crafting principles-based regulation. She highlighted that the Commission’s Orders in these cases “give no indication that customer funds have been misappropriated or that any market participants have been victimized by the DeFi protocols.” Instead of "enforcement first," she called for a balanced regulatory approach through public engagement, rulemaking, and other tools.
What does this mean?
The CFTC’s enforcement against 0x directly contradicts last week’s US District Court’s opinion in favor of Uniswap labs by holding 0x liable for the actions of a third party. Indeed, the “leveraged tokens” that led to a CFTC enforcement action against 0x were developed and issued by a third party. 0x was held liable for simply developing and deploying the collection of smart contracts on the Ethereum blockchain.
However, in the Risley v. Uniswap order, the court dismissed a lawsuit against Uniswap Labs on several grounds, including that “it defies logic that a drafter of computer code underlying a particular software platform could be liable… for a third party’s misuse of that platform.” This is the opposite conclusion drawn by the CFTC in imposing its authority on developers of decentralized software — which, as Commissioner Mersinger explained, is “an area that has not previously been the subject of a CFTC enforcement action.”
The CFTC’s enforcement actions against the developers behind three DeFi protocols poses a hostile sign to entrepreneurs in the industry especially because it does not seem the CFTC engaged with the DeFi community before taking such drastic action. As Commissioner Mersinger pointed out, this conduct ran against the CFTC’s acknowledgement in its 2022-2026 Strategic Plan that “innovations such as DeFi require extensive stakeholder engagement.” Absent a transparent notice-and-comment process to set the rules and additional stakeholder engagement envisioned by the Commission, innovators who want to comply with the law continue to face significant regulatory uncertainty.
IOSCO DeFi Consultation Report
Last week, the Board of the International Organization of Securities Commissions (IOSCO) authored a “Policy Recommendations for Decentralized Finance” consultation report. The report includes nine recommendations for global securities commissions to consider and adopt in regulating DeFi.
The policy recommendations include conducting a comprehensive analysis of DeFi; identifying conflicts of interest within DeFi products and services; mandating DeFi products and service providers identify and manage inherent risks with operations and the technology — which would include adhering to traditional financial standards; mandating disclosures; creating robust powers to oversee and enforce regulation in DeFi; cooperating across borders and sharing vital information with other jurisdictions; and analyzing the interconnectedness between DeFi products and services, the broader crypto market, and traditional financial markets.
Importantly, the consultation recommends pinpointing the individuals and entities who have control or significant “influence” over a DeFi protocol. The consultation suggests that this would be anyone who designs or maintains a protocol, as well as those who have financial, economic, and legal control — which, according to the consultation, could include developers, founders, foundations, DAOs, governance token holders, etc.
Additionally, the consultation recommends that securities commissions regulate DeFi under IOSCO standards that ensure regulatory outcomes consistent with that of traditional finance. This would require applying both existing and new frameworks — frameworks that would encompass standards and laws related to issuers, exchanges, market intermediaries, and other financial entities.
What does this mean?
The SEC led the effort to write this report. Therefore it’s sadly unsurprising the report’s conclusion is “centralize, shut down, or get out,” which is the policy that the SEC and CFTC have unilaterally adopted with respect to decentralized networks on behalf of the United States.
And don’t forget to mint your DEF commemorative NFT! The funds from this mint will allow DEF to supercharge our efforts, continue to advocate on behalf of the DeFi community, and push back against “regulation by enforcement” and the incredible agency overreach that we have seen over the past year.