- An SEC Commissioner has released a statement on the risk and opportunities in DeFi.
- Her deep dive reveals the bodies in charge of regulating the nascent ecosystem.
- To align themselves with regulations, she suggests that projects liaise with the SEC to ensure that all rough edges are sorted out before launch.
DeFi projects are giving traditional financial institutions a run for their money with their innovative offerings yet they’re plagued by several challenges. SEC Commissioner, Caroline A. Crenshaw speaks about the risks, regulations, and opportunities that abound in decentralized finance.
The Good, The Bad, And The Ugly
Commissioner Caroline A. Crenshaw comments that DeFi offers a panoply of opportunities for investors but charges them to be wary of potential pitfalls. Her statement was first published in The International Journal of Blockchain Law, Vol. 1, Nov. 2021.
She hints at the similarities of DeFi with traditional finance and goes on to state that they could be susceptible to structural limitations. Despite its innovativeness and attempts to depart from traditional finance, Crenshaw identifies certain truths that apply to all. The first is the fact that there will always be projects that “do not invest in compliance or adequate internal controls.” Secondly, the larger the financial reward and the smaller the risk of getting caught, individuals will seek to victimize others. The third truth is the fact that rich investors and insiders will take advantage of “information asymmetries” at the expense of retail investors.
“Without a common set of conduct expectations, and a functional system to enforce those principles, markets tend toward corruption, marked by fraud, self-dealing, cartel-like activity, and information asymmetries,” Crenshaw said.
She goes on to identify the grave problem of pseudonymity that currently militates against DeFi. Since users are anonymous, Crenshaw hypothesizes that asset prices and trading volumes can be manipulated since there is no way to determine the identity of traders. These inorganic metrics will lure unsuspecting investors to invest in DeFi projects that are inherently flawed.
Come Talk To The SEC
Crenshaw went on to identify the various Federal agencies that exercise jurisdiction over DeFi in the US. She mentions the Department of Justice, the Financial Criminal Enforcement Network, the CFTC, the IRS, the SEC, and some state authorities.
To ensure compliance, Crenshaw notes that the SEC has an array of tools at its disposal including “rulemaking authority” and other reliefs. If DeFi projects are unsure whether or not their offerings fall within the SEC’s scope, Crenshaw suggests that they should reach out to the Commission for clarification.
“If a project does not fit neatly within our existing framework, before proceeding to market, that project team should come and talk to us,” she said. “The more the project team can lead that discussion with possible solutions, the better outcomes they can expect.”
She adds that the SEC would not fail to sanction non-compliant projects for investor safety. However, she claims that her preferred path for investor protection is not through enforcement.