Why is the SEC investigating DeFi?

Always looking for something to do, the SEC has now turned its attention to decentralized finance (DeFi) platforms and the people behind them. This is a massive surprise, but it does represent the start of a new era in crypto’s regulatory environment. It’s hard to know what might come out of it, but Nik De writing for Cointelegraph believes there are precedents we can base some assumptions on.

The story started last week with the SEC’s announcement that it was conducting an investigation into Uniswap Labs and a few other DeFi platforms. What the SEC didn’t make explicit is whether it is simply on an information gathering exercise, or if it is looking with a view to bringing in new regulations. De says, “Regardless, this is a pivotal, if expected, development in the regulator’s oversight of the crypto market.” Furthermore, it may be critical in determining the future of DeFi platforms.

The SEC has been making noises about DeFi for a few weeks, and has now pinpointed Uniswap Labs as a place to start. Uniswap is the leading decentralised exchange (DEX). A DEX could be described as “a robot on the internet routing trades through various pools of funds, no middleman (beyond the software) needed,” which is how De explains it. he adds, “While we don’t yet know what the regulator is specifically looking for, we can find some clues in recent history that point to how the agency might approach DeFi and enforcement actions.”

Looking at some pronouncements by the SEC chair, Gary Gensler, may help to point us in the right direction. He recently told European politicians “a lack of regulated brokers and clear-cut investor protection rules leaves “the investing public … vulnerable,” particularly to scams or other forms of abuse.”

That’s one of his concerns, but he has another: the ‘promoters and sponsors’ who write the DeFi software, because they create the governance mechanisms. It seems he is concerned about centralised players that might help create or power up DeFi projects. Regarding this, and in De’s estimation, “The SEC therefore doesn’t appear to be looking at the decentralized parts of DeFi…If a project isn’t fully decentralized in its earliest development stage, its backers may soon receive an inquiry.” He believes this is what is happening with Uniswap.

Looking further back in time, the SEC may also look at how a DeFi platform actually operates. Does it offer tokens that the SEC considers to be securities, and does it use its own order book? The case of EtherDelta, a decentralised trading platform, illustrates this. In 2018, the SEC brought charges against it based on allegations it acted as a securities trading platform. The SEC also specifically brought charges against Zachary Coburn, who founded the platform!

The upshot is: just because a platform is decentralized doesn’t mean the SEC won’t bring charges against a centralised party with a significant role in setting it up.

This will be a space to watch!

UK financial regulator warns again regulatory overreach

Charles Randall, the Chair of the United Kingdom’s Financial Conduct Authority (FCA) has warned that whilst regulators should increase consumer protection for consumers investing in crypto tokens, they should also be wary of going too far.

Randall made his comments during a speech for the Cambridge International Symposium on Economic Crime, when talking about the risks for consumers who dive into the crypto world without really knowing how to manage these risks.

Tackling crypto promotions a priority

Significantly for those crypto projects that might be considering hiring a high profile influencer to help promote their tokens, Randall tackled this head on. In particular he mentioned Kim Kardashian’s recent Instagram promotion of EthereumMax (EMAX); a brand-new token issued by “unknown developers.” He commented that this “may have been the financial promotion with the single biggest audience reach in history.” 

Whilst Randall didn’t say that EthereumMax was fraudulent, he said that he had used it as an example of the issues around influencers and paid-for advertising, pointing out that using a celebrity like Kim Kardashian meant the campaign had a massive reach and that it had the potential to mislead under-informed consumers. He emphasised that this is the kind of marketing activity that regulators should be taking greater notice of in the interest of consumers, because “many consumers remain blind to the financial risks they are courting by trusting influencer endorsements and savvy online token campaigns.”

Randall went on to tell the audience that 2.3 million UK citizens own crypto and that 14% of them had bought it using a credit card, which in his view was a worrying scenario. Moreover, 12% of the UK’s crypto holders mistakenly believe the FCA, or the Financial Services Compensation Scheme, would protect them should things go wrong, according to the FCA’s research.

Don’t strangle crypto with excessive regulation

However, Randall appeared to be wary of too much regulation in the case of cryptocurrencies. As he said, the British consumer had multiple opportunities to invest in other unregulated speculative activities — from gold and foreign currencies to Pokemon cards — despite there being “no shortage of consumer harm in many of those markets.” He said:

“So why should we regulate purely speculative digital tokens? And if we do regulate these tokens, will this lead people to think that they are bona fide investments? That is, will the involvement of the FCA give them a ’halo effect’ that raises unrealistic expectations of consumer protection?”

Stablecoins and security tokens offer useful ideas

The FCA currently regulates cryptocurrency exchanges in the UK, and has banned the sale of crypto derivatives to retail customers. Going forward, Randall proposed that its measures should focus on stablecoins and security tokens, which would be a limited intervention. He said that both of these forms of digital asset offered, “encouraging useful new ideas” for cross-border payments, financial infrastructures and financial inclusion, and should not be hampered by “overbearing red tape.” Instead, he argued for a moderate approach, in line with existing rules for other FCA-regulated entities, to ensure that token issuers and blockchain firms are solvent and transparent.

Read this before October 2021 if you’re in crypto!

For those of us who believe in the concept of decentralization that underpins Bitcoin, I believe we are shortly going to receive a shock in the form of new regulations. The wealthiest countries in the world are snapping at the heels of the crypto universe and are looking at ways they can use financial regulations to bring fintechs, exchanges and crypto owners into line.

What do governments want to restrict?

Here’s a list of ‘things’ they are planning to target:

  • Peer-to-peer transactions
  • Stablecoins
  • Private wallets (phone, desktop, cold storage)
  • Privacy (privacy coins, decentralized exchanges, TOR and I2P)
  • Former ICOs & future projects (NFTs, DeFi, smart contracts, second layer solutions and more)

What is their intention?

At it’s most basic, you could say that they want to know EVERYTHING!

They want to:

  • Businesses active in crypto to be licensed and regulated like banks
  • Ensure full transparency for all transactions
  • Have the ability to freeze crypto assets belonging to persons or countries they believe are a ‘risk’
  • Force the disclosure of user information for all transactions
  • Revoke licenses of any that don’t comply with regulations.

They want control of a space that emerged precisely as a reaction to government and bank controls on money, both of which allowed a global financial crash to happen in 2008.

Why do governments suddenly want more regulations?

The answer is fear. Wesley Thysse in his document “Government Planning Worldwide Regulation of Bitcoin”, he points to one event that suddenly made them sit up and take real notice of cryptocurrencies, and that was Facebook’s 2018 announcement that it intended to create and launch a ‘so-called’ stablecoin. As Thysse says, “Until then they didn’t see cryptos as a risk to the global financial system.”

Why did Facebook’s Libra coin, as it was called at the time, send a ripple of unease through wealthy governments? Because Facebook’s billion users would have access to an instant payment system that was faster and more importantly cheaper than anything offered by the existing financial system.

Governments and the central banks huddled together in talks about what to do, and engaged an organization called Financial Action Task Force (FATF). Its goal is “to protect the integrity of the global financial system.” A real Big Brother!

FATF has already passed similar legislation for global governments, and it is the organization behind the rule insisting that all cryptocurrency exchanges that exchange fiat for crypto have the same KYC and anti-money laundering requirements as banks. What they will do now is turn their attention to all the elements of the industry outside this kind of control and as Thysse says, “declare what is, and isn’t acceptable.”

In 2018 FATF set out to control money laundering and terrorist financing, but now it is going much farther, and they are making swift progress. The document anyone in the crypto space should be looking at right now is FATF’s ‘Guidance for a risk-based approach to virtual assets and VASPS’ (GVA). This is due to be implemented in October 2021. Furthermore, it is impossible to move FATF out of its powerful position, because the organization is protected by the Vienna Conference on Diplomatic Intercourse and Immunities, which means they enjoy immunity with regard to their actions and are unburdened by the rules the rest of us must live by.

The so-called public consultation on the GVA was a farce, as they only chose the feedback that suited their agenda. They have delayed the implementation of the GVA until October, but after that expect to see their recommendations being implemented at national level, and in our legal systems. You should also note that the GVA will not apply to central bank-issued digital currencies. So, the agenda is very clear!

It may not be all bad news

As much as those dedicated to crypto may be horrified by all this, let’s take a moment to look at a possible upside: regulations may just pave the way for mass adoption, something the crypto community has long been waiting for. But at what cost? However, I urge you all to read the FATF GVA, because in just a few months it is going to start affecting your life, and most likely it won’t be in the way you would like.

Dogecoin passion could prevent government crypto bans

Dogecoin, which has existed for a few years, is not a cryptocurrency of the usual kind. It’s a fun, ‘meme’ coin and Elon Musk, Gene Simmons, The Jonas Brothers and Snoop Doge have been having some fun with it recently. However, although it has no utility, Noelle Acheson, says “it embodies two key themes impacting institutional interest in crypto assets: the role of “fundamentals,” and the likelihood of successful government bans.”

Acheson asks if fun should drive value (Dogecoin is up 1,350% in 2021, and answers her own question with, why not? She points to GameStop (yes, again!) saying that the market’s understanding of ‘value’ is shifting. Matt Levine at Bloomberg summed it up: “Money and value are coordination games; what we use for money depends on the channels that we use to coordinate social activity. Once society was mediated by governments, and we used fiat currency. Now society is mediated by Twitter and Reddit and Elon Musk, so, sure, Dogecoin.”

Even Dogecoin’s founders have no idea why its success has continued some seven years after launching it. But they can’t remove it, or close it down, because Dogecoin runs on a public, decentralized blockchain that no one controls. So, it will probably continue to exist so long as people value its fun element.

It’s about passion

GameStop and Dogecoin both exemplify what community passion can achieve, and how it may potentially block government bans on crypto. For example, India tried to ban cryptocurrencies recently, but the community mobilised, created a hashtag and rallied its members to lobby government representatives. They pointed out that the country has 10-20 million crypto users, plus 340 startups and 50,000 employees in the crypto space.

Something similar happened in Nigeria where the central bank ordered banks to close the accounts of cryptocurrency users. There was a public outcry, and the central bank had to issue a press statement “reminding the public that the rule was not new, and that it was for their own good.” The central bank had to unblock accounts of 20 people involved in the #EndSARS movement, which was about the dissolution of a federal police unit with a reputation for fierce brutality. Acheson says, “The fact that the accounts were frozen in the first place is one of the many reasons seizure-resistant cryptocurrencies are rapidly gaining in popularity amongst Nigeria’s young.” It is also the case that Nigeria is gaining recognition as Africa’s Silicon Valley, and trading crypto assets is a way of life for many young people. They have new tools to work with and a growing disrespect for institutions. Because of the central bank directive, they are simply moving from exchanges to peer-to-peer channels. As a result, the politicians have taken notice,, and some prominent voices in government have spoken out against the ban. Other countries will be watching this with interest, because as Acheson warns, “the very act of attempting to repress cryptocurrency’s use could light a fire under a generational understanding of why it’s necessary.”