Vitalik Urges DeFi to Slow Down Integration with Traditional Finance

Ethereum Co-Founder Says Pursuit of Institutional Capital May Bring Onerous Regulation

After weeks of keeping his own counsel amid regulatory action in crypto, Vitalik Buterin, Ethereum’s co-founder and chief scientist, finally shared his thoughts on the subject over the weekend. 

His message: Buterin believes crypto isn’t ready to be  integrated into mainstream finance and should take its time to mature.

Calling his take “maybe-controversial,” Buterin said he doesn’t believe the crypto community should be pursuing institutional capital at full speed. 

Much Less Bad

“I’m actually kinda happy a lot of the ETFs are getting delayed,” Buterin said in a Twitter thread, referring to exchange traded funds for crypto. “Regulation that leaves the crypto space free to act internally but makes it harder for crypto projects to reach the mainstream is much less bad than regulation that intrudes on how crypto works internally.”

Given his standing in DeFi, Buterin’s comments are bound to stimulate debate among project founders and investors on the right pace of change in the industry. In the last six months, Washington has made good on its promise to crack down on crypto platforms for failing to register offerings with regulators and for running afoul of anti-money laundering requirements.

In October, Sam Bankman-Fried, the billionaire head of crypto exchange FTX, suggested the adoption of industry standards to placate regulators. Rune Christensen, the influential founder of MakerDAO, the No. 1 DeFi protocol, has called for the crypto lender to undergo a reorganization partly to lessen regulatory risk. 

“Vitalik is conscious that Ethereum is at risk of intense scrutiny, if big capital comes wading in too early,” Nick Bishop, the director of web3 venture studio, NotCentralised, told The Defiant. 

Bishop said many institutions invest money from retail consumers, amplifying the risk of a heavy-handed response from regulators if something goes wrong while the sector is still nascent. “Let us grow first, then engage,” he said.

Buterin also spoke out against embedding Know-Your-Customer checks into DeFi front-ends. 

Front-ends have been a focal point of crypto debate since the U.S. Treasury Department in August sanctioned addresses associated with the crypto mixing service, Tornado Cash. 

Nefarious Actors

The news prompted many prominent U.S.-based DeFi teams to restrict blacklisted wallets from accessing the front-end interfaces they maintain in a bid to comply with the sanctions. Top protocols Aave, Uniswap, Balancer, and dYdX were among the projects to restrict access to their front-ends, although the sanctioned addresses could still access said protocols using alternative front-ends.

Buterin said embedding KYC checks into front-ends will annoy regular users but do nothing to prevent nefarious actors from accessing DeFi protocols. “Hackers write custom code to interact with contracts already. Exchanges are clearly a much more sensible place to do the KYC, and that’s happening already,” he said.

Bishop agreed. “Vitalik makes a good point about the futility of KYC into DeFi. Insisting on this step for some users puts them at an even greater disadvantage vs hackers, who will never be KYC’d and will always be present in some form, in web2 and web3.”

Bishop suggested token wrappers could offer a solution to ensure DeFi users can maintain regulatory compliance while interacting with protocols. He said token wrappers, which are used to migrate coins between blockchains,  can be used to embed the restrictions required to ensure regulatory compliance in a particular jurisdiction for existing assets. 

Broad Opposition

“When a user wishes to move their token to another regulatory domicile, you burn the old wrapper and mint a new one,” Bishop said. “Zero engagement means greater danger of regulations that cannot be undone, and thus more stifling of innovation.”

Despite his broad opposition to regulatory interference in DeFi, Vitalik said limits on leverage, requirements surrounding transparent code audits, and knowledge-based tests restricting access to protocols could offer increased protections for ordinary retail users.

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Vitalik added that regulations could be designed to leverage zero-knowledge proofs so that users’ privacy is not compromised. “ZKPs offer lots of new opportunities to satisfy reg policy goals and preserve privacy at the same time,” he said.

Buterin’s regulatory prescriptions attracted support from influential figures in the crypto sector, including Binance CEO Changpeng Zhou and FTX CEO Sam Bankman-Fried.

“Generally think these are pretty reasonable!” tweeted Bankman-Fried.