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The CFTC’s tech team is trying to figure out what to do about DeFi

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The Commodity Futures Trading Commission is trying to make heads or tails of the recent explosion in decentralized finance.

On Monday, the CFTC’s Technology Advisory Committee hosted a presentation called “The Growth and Regulatory Challenges of Decentralized Finance” by law professor Aaron Wright and attorney Gary DeWaal.

In large part, the presentation was a briefing on the operations of decentralized platforms like Uni, which have commanded a greater share of crypto trading and headlines since this summer.

Wright summarized the advantages of DeFi as potentially providing services for lower cost to a greater number of people by virtue of automating a number of the processes involved. Also, he noted that software tools can provide greater flexibility overall. “Another interesting benefit of decentralized financial projects is that they’re composable and interactible,” said Wright. “Developers often describe them as financial Lego blocks.”

Regarding regulatory compliance, Wright noted that DeFi developers typically don’t think of legal considerations first: “These contracts are alegal. That doesn’t mean that they are illegal. It means they are designed at a technical level, not necessarily with regulatory compliance in mind.”

There were particular concerns with “DeFi” platforms that are de facto tied to centralized entities — for example the infamous case of Chef Nomi’s control over SushiSwap.

In other potential risks, the presenters cited high technological barriers to entry, which pose a different sort of challenge despite DeFi’s ideal of being more open-access than CeFi.

In terms of tone, today’s presentation seemed fairly open to decentralized protocols that depend on, say, governance tokens that distribute votes on network decisions to a wide range of token holders. But the chronic issue of little or no registration requirements for users does open up the threat of know-your-customer and anti-money laundering violations. But then there’s liability.

DeWaal responded to the overarching question of who authorities can hold liable if a DeFi platform is functioning illegally. There’s been a great deal of speculation that we will see more legal action against software developers in the future. DeWaal noted that that’s a tough legal bar to clear.

“Generally, in the United States, software development is a protected activity under the first amendment,” said DeWaal. “As Aaron has eloquently shown, there’s many, many use cases for DeFi. But the First Amendment is not a universal bar.”

But the attorneys noted that secondary liability could threaten a wide range of people using or contributing to DeFi protocols. Among potential solutions, Wright mentioned discussions of a potential safe harbor within the virtual currencies subcommittee, saying: “A safe harbor could ensure responsible development to protect consumers’ interests without limited innovation.”



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Regulation

New York authorizes first Yen stablecoin operator in the US

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New York has given the first authorization to a stablecoin backed by the Japanese Yen to operate in the U.S.

Per a Dec. 29 announcement, the New York Department of Financial Services has granted Japanese firm GMO-Z.com a charter to handle U.S.D. and Yen-backed stablecoins in New York. 

Given New York’s status as a global center, the NYDFS is the most prominent state financial regulator in the U.S. It is also one of the most aggressive. A pass to operate in New York often opens up the rest of the country. 

GMO’s charter is as a limited liability trust company rather than a full bank, the principle difference being in authorization to handle deposits. While a stablecoin operator typically needs the ability to hold reserves of the pegged asset, GMO’s charter limits its rights to hold other kinds of deposits not central to its ability “to issue, administer, and redeem” its stablecoins. 

The right to issue such non-depository charters has been a bone of contention between state regulators like the NYDFS and national banking regulators in the U.S. 

GMO president and CEO Ken Nakamura said: “We’re breaking ground with our move to issue the first regulated JPY-pegged stablecoin, which many see as a safe haven asset.” 

The NYDFS recently made changes to its famous BitLicense, including a conditional format that buddies up newly licensed firms with existing licensees. The first conditional BitLicense went to PayPal, facilitating the launch of its new crypto services earlier this fall with the help of longstanding licensee Paxos.