DeFi’s regulatory challenges: SEC’s Peirce and CFTC’s Berkovitz discuss

US SEC Chair Gary Gensler warned that many DeFi projects may not be as decentralized as they claim in a recent WSJ interview.

CFTC Commissioner Dan Berkovitz did not pull his punches on DeFi in a recent speech:

“A system without intermediaries is a Hobbesian marketplace with each person looking out for themselves.  Caveat emptor—‘let the buyer beware.’

Not only do I think that unlicensed DeFi markets for derivative instruments are a bad idea, I also do not see how they are legal under the [Commodities Exchange Act].” 

SEC Commissioner Peirce has struck a much softer tone on DeFi, proposing a safe harbour to shield early-stage DeFi projects from securities laws for a few years.

We might have expected fireworks when Berkovitz and Peirce both aired their views on DeFi and regulation in a joint panel discussion. The discussion showed both Commissioners came to the stage from very different starting points. Notwithstanding some minor tussles between the SEC and CFTC about their respective perimeters on crypto-asset enforcement, the chat between the two commissioners was very cordial.

Commissioner Peirce repeated her concerns that the SEC is regulating by enforcement, rather than providing upfront guidance to the DeFi industry.

‘DeFi is a little bit more difficult to reconcile with our regulatory framework because of the lack of a central intermediary – if it truly is DeFi,’ she said. ‘If DeFi can successfully get rid of that central counterparty then I think we need to have a conversation about whether we want to build our regulatory framework in a way that recognizes the unique features of DeFi, the unique advantages of Defi and that is something that we are still very much in the early stages of thinking about [at the SEC].’

Commissioner Berkovitz started from the opposite position: he reiterated that anything falling within the CFTC’s perimeter should follow the relevant rules.

“If you trade a product within the CFTC’s jurisdiction, you’re subject to the CFTC’s jurisdiction”. How those regulations apply to DeFi technologies ‘is something that we are looking at [at the CFTC]. There is a spectrum, there is a range from centralized finance to decentralized finance. So a lot of it will depend on the facts and circumstances of the particular platform or the particular products that are being traded,’ he said.

Berkovitz’ comments emphasise what Gensler and Peirce had also mentioned: DeFi is not always as decentralized as it claims. There may be shadow centralization behind a DeFi façade. Decentralization is a spectrum, but where the cut-off point lies between something centralized and something that’s truly DeFi is the big question.

The pair also commented on the benefits of having intermediaries in the financial world. While Berkovitz reiterated the advantages of an intermediated financial system, Peirce listed potential advantages of a disintermediated system.

Without intermediaries “you are more dependent on doing your own due diligence or relying on other people in the space”, she acknowledged, yet true disintermediation in DeFi “can bring benefits of its own”.

“One of the criticisms about the financial system has been unequal access to the system. And the beauty of DeFi,” she said is that the smart contract you are interacting with in DeFi “does not care who you are. It offers the same terms to everyone and everyone can participate and everyone, if it is transparent, you can see the code. There is a beauty to understanding what the transaction is going to look like because you can track through and understand the code. There is a real draw to that.”

“I hope that whatever we do in terms of regulation does not just squelch that out that because it is a bit harder to deal with,” she added. The SEC could use its exemptive powers, she suggested, “to construct a regulatory regime [for DeFi] that makes sense”.

Berkovitz and Peirce also talked about the balancing act between enforcement and innovation. “Enforcement is just one of the tools that we have for an emerging technology,” Berkovitz said. He pointed to more informal tools at the CFTC’s disposal, such as LabCFTC’s activities or no-action letters (although those can take a lot of time to obtain).

Unsurprisingly, Peirce put greater emphasis on leaving space for innovation.

What about calls for greater legal certainty on DeFi – and for greater guidance from the SEC and CFTC?

“The flipside of providing regulatory certainty is flexibility. Certainty and flexibility is a balance that is difficult to achieve,” said Berkovitz.

Berkovitz also said there there is “good coordination” between the SEC and CFTC, with “discussions going back and forth”.

What does the future hold for DeFi?

Sticking to his key message, Berkovitz saw a bright future for DeFi projects complying with the rules.

“I believe that this technology, cryptocurrency and DeFi technology, to live up to its potential … I believe it has to be regulated and be in the regulated system. And those who work with regulators and work within the regulatory system will be successful, or can be successful. And those are the ones that we will talk about in a year or two,” he said.

“I am optimistic it can work within the regulatory system.”

View the recording of the full discussion here (starting at roughly 30min30s).

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