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US Congress held (yet another) hearing on crypto-assets, this times entitled Demystifying Crypto: Digital Assets and the Role of Government.
The four witnesses were well-known names in crypto circles, including Timothy Massad and Peter Van Valkenburgh. The hearing, which took place on 17 November, did not generate the amount of tweets that previous hearings on the topic did. Perhaps that’s a sign of a maturing debate, with few controversial statements or questions.
The testimonies may not have uncovered anything shockingly new, but that doesn’t mean they’re not worth watching or reading.
Stablecoins inevitably featured in the discussion. More interesting, and perhaps more novel, were the statements on decentralized finance (DeFi).
There’s much to unpack in the written statements of the witnesses, but I want to focus on just a few DeFi highlights.
Alexis Goldstein from the Open Markets Institute laid out concerns over crypto-asset markets in general and DeFi in particular, discussing rug-pulls, concentration of voting power, insider trading, too-good-to-be-true yield promises and more.
Although we’re well aware of these concerns in DeFi, Goldstein’s statement gives more substance to the discussion by bringing up concrete examples of venture capital firms trying to manipulate an airdrop of one of their portfolio companies, token issuers rug-pulling their own token-holders and statements from DeFi project founders suggesting their DeFi projects aren’t that decentralized after all.
A good read, in short, if you’re interested in real-life examples of DeFi challenges and risks.
Wharton’s Kevin Werbach discussed DeFi and regulatory options. Some excerpts leaned on the WEF’s DeFi Policy-Maker Toolkit (for full disclosure, I was a contributor).
Werbach gave Congress 3 suggestions on how to regulate and enforced rules in the DeFi industry: focus on (centralized) stablecoin issuers, (centralized) app platforms and token issuers.
DeFi can mitigate risks “that are a serious problem calling for regulatory involvement in traditional finance,” he wrote. “For example, with fully collateralized or over-collateralized DeFi transactions, there is not the counterparty risk that parties will not actually have the capital they claim to have. Positions are visible on the blockchain, and cryptographically secured.”
However, DeFi also generates risks “that have no analogue in the established environment”.
“DeFi squarely poses the challenge of how it may be possible regulate decentralized systems… Furthermore, if a regulator wished to take enforcement action, there would appear to be no person or firm to take action against.”
Lawmakers and regulators should not despair, however. Werbach sees these issues as “likely to be manageable in practice, if regulators adapt their approaches and focus on the objectives of legal requirements.”
He discussed “three points of contact that deserve consideration as means of addressing potential regulatory concerns about DeFi: stablecoins, app platforms, and token issuance.”
The dominant stablecoins at present are highly centralized. That gives lawmakers and regulators an entry point:
“If stablecoin operators are all treated as a virtual asset service providers subject to anti-money laundering obligations such as Know Your Customer (KYC) rules, that would provide a check that funds entering or leaving the DeFi ecosystem will associated with known, non-sanctioned individuals or entities. It would also provide an aggregation point for law enforcement agencies to monitor activity, with the assistance of sophisticated blockchain analytics tools. While this alone would not eliminate concerns about DeFi being used for criminal activity, it might ameliorate them to a material extent,” he wrote.
Second, lawmakers and enforcers can focus on centralized app platforms. Werbach gave the example of Uniswap: although the smart contract protocol for the decentralized exchange may create difficulties for law enforcement, the Uniswap app that most users rely on to interact with the exchange is operated by a centralized company.
Finally, lawmakers and regulators can focus on token issuers. The moment a token is issued is “the point at which there is likely to be some identifiable actor who must engage with the blockchain and the outside world.”
“Tokens do not appear from nowhere. Once they are issued and accessible through blockchain networks, it may be impossible to point to any entity managing them or controlling their distribution. However, there is always a point in time at which tokens are issued. And there is an entity that structured the token issuance, initiates it, and often promotes it or connects it to other deliberate activities,” Werbach wrote.