DeFi Shouldn’t be Permitted to Become an Unregulated Shadow Financial Market, says Top Commodities Regulator

Unlicensed decentralized finance (DeFi) markets may be illegal in the US, said the Commodity Futures Trading Commission (CFTC) Commissioner Dan Berkovitz in a speech to the Asset Management Derivatives Forum.

For instance, DeFi markets for derivatives instruments, future contracts, may not be legal under the Commodity Exchange Act. He said,

“DeFi markets, platforms, or websites are not registered as DCMs or SEFs [swap execution facilities]. The CEA does not contain any exception from registration for digital currencies, blockchains, or ‘smart contracts.'”

The top commodities regulator also called for federal regulators to become familiar with this new technology, its potential uses and be prepared to protect the public against misuse as the sector sees “explosive growth.”

Meanwhile, he argued that intermediaries in centralized finance could be held accountable when things go wrong, but in DeFi being devoid of an intermediary, there is no one to monitor markets for fraud and manipulation, safeguard deposited funds, prevent money laundering, ensure counterparty performance or make customers whole when processes fail.

“In a pure ‘peer-to-peer’ DeFi system, none of these benefits or protections exist.”

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

As such, these DeFi markets may not provide the same protection as their centralized counterparts where regulated financial institutions are bound to protect customer funds, he said.

“We should not permit DeFi to become an unregulated shadow financial market in direct competition with regulated markets. The CFTC, together with other regulators, need to focus more attention to this growing area of concern and address regulatory violations appropriately.”

This could be taken as the first step from the regulators towards the decentralized finance space, which could gain pace over the next couple of years.

While Stephen Palley, a partner in Anderson Kill, found the commissioner's articulation of the risk and benefit of DeFi as “one of the most articulate and sensible ones,” Santiago R Santos of ParaFi Capital argued that, unlike Wall Street, blockchains, smart contracts, and DeFi are transparent and not easy manipulated.

“If CFTC is serious about bringing consumer protection & resiliency into the fin system it should embrace DeFi, not dismiss it.”

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