DeFi must address transparency and pseudonymity
SEC Commissioner Caroline Crenshaw has highlighted the benefits of Decentralized Finance while warning of the dangers of failing to embrace a protective regulatory framework in a Nov. 9 opinion piece.
The article, DeFi Risks, Regulations, and Opportunities, is the first in the inaugural issue of “The International Journal of Blockchain Law.” In it, Crenshaw outlines her belief that the DeFi community must address issues with transparency and pseudonymity while coming into compliance with SEC rules:
“In the brave new DeFi world, to date there has not been broad adoption of regulatory frameworks that deliver important protections in other markets.”
Regarding what she sees as a lack of transparency, Crenshaw said DeFi lacks market protections, which “contributes to a two tier market in which professional investors and insiders reap outsized returns.”
Although the code for most DeFi projects is open source and all transactions are recorded on-chain, she argues that retail investors are at a disadvantage to professional investors, who have the resources to perform audits on code and development teams.
In her view, “It is not reasonable to build a financial system that demands investors also be sophisticated interpreters of complex code.”
Crenshaw also highlighted concerns about the link between pseudonymity and market manipulation. When market participants operate pseudonymously, she argued that it becomes difficult to track and mitigate manipulation through the use of bots and collusive trading. She said that investors tend to be most vulnerable to losses as a result of market manipulation since normal signals, like trading volumes and momentum, become unreliable.
Furthermore, she believes that DeFi projects should be in open discussion with the SEC to find solutions to the dilemma of resolving how pseudonymity can comply with existing rules.
The DeFi space has historically touted the ability to remain pseudonymous as a feature, rather than a burden on participants. Crenshaw, however, doesn’t believe investors prioritize it over making money:
“In moving to DeFi, I suspect most retail investors are not doing so because they seek greater privacy; they are seeking better returns than they believe they can find from other investments.”
In an October 12 speech at the SEC Speaks conference, Crenshaw suggested that existing regulatory frameworks, such as gatekeeping functions in other markets, are sufficient in protecting investors in the digital market space.
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While Crenshaw’s current criticisms of DeFi do not quite echo the bellicose sentiments from Senator Elizabeth Warren and former Commodity Futures Trading Commissioner Dan Berkovitz, they are less favorable than the approach of SEC Commissioner Hester Pierce who supports a safe harbor law that would grant network developers a three-year grace period to build a decentralized network.
