DeFi roundtable

Regulators and policy makers have struggled to agree on a definition of decentralized finance, but regulating this area of the crypto industry is far from impossible, panelists said at the SEC's latest crypto roundtable.

The big picture: The SEC's challenge in regulating DeFi is applying current rules aimed at intermediaries — like broker-dealers and exchanges — to a system designed to operate without them, SEC chair Paul Atkins noted.

• Panelists at the fifth crypto roundtable yesterday, titled "DeFi and the American Spirit," suggested three target areas for regulation: common activities, disclosure rules and risk identification.

With activities, the idea is to focus not on the software creators behind DeFi protocols, whose code and rules are transparent, but on the common activities taking place around them.

• "It's the only way to do it," Michael Jordan, co-founder of blockchain VC firm DBA, said. "The reason is, the technologists like myself will come up with a new way to provide the activity if we regulate the technology. If we regulate the agreement, someone will circumvent it."

With disclosure rules, panelists noted the need to focus on what might be taking place outside of public protocols.

• Jordan suggested that off-chain agreements, like market-maker deals or anything else that may distort natural activity in markets, should require disclosure.
• Gabe Shapiro, co-founder of MetaLeX, said investors and other types of operators should have all material information that they would want to have to reasonably make intelligent decisions about things.
• "Not everything in crypto is on chain," Shapiro said. "And so you have to look at where the potential conflicts of interests exist, where are the rooms for collusion, where are the ways people can break these systems, and require disclosure around those."

With risk, Rebecca Rettig, the chief legal officer of Jito Labs, identified three main types for regulators to consider: cyber risk, system management risk, and illicit finance.

• Regulators need to think about mechanisms to address those, agreed Kevin Werbach, a professor of legal studies and business ethics at the Wharton School. Regulators should catalog them and identify the ways to address these risks where necessary and identify where the laws may have to change, he said.
• Jill Gunter, with Espresso Systems, noted that blockchains increasingly operate in a "modular way," necessary for interoperability, and that regulators need to identify for rulemaking where points of control exist in the system, and where they don't.

What's next: While the SEC contemplates how it should regulate DeFi, Atkins — appointed by President Trump — said he has directed SEC staff to consider an "innovation exemption" framework that would allow registrants and non-registrants to bring on-chain products and services to market.