Hester Peirce, commissioner at the US Securities and Exchange Commission, said decentralised finance has a lot of positive potential and that she wants the regulator to provide a framework, rather than relying on enforcement actions.
Peirce was interviewed at the Shining a Light on Digital Asset Markets 2021 conference on June 23.
DeFi, or Open Finance uses smart contacts automatically executing on distributed ledger technologies, such as blockchains, to allow any user to stake cryptocurrency as collateral on a platform and provide services such as lending or liquidity without the involvement of a traditional financial intermediary.
Peirce said: “Disintermediation can be quite helpful for financial stability and for resilience, but also for ensuring fair and easy access to financial services on the same transparent terms.”
“A lot of exciting work is going on in DeFi that will revolutionize finance and some is bound to fail,” she added. “We should be embracing the idea of building things on decentralised platforms that allow lots of people to participate.”
Safe Harbour
In April Peirce published a proposed token safe harbor on Github.
The safe harbor provides network developers with a three-year grace period within which, under certain conditions, they can facilitate participation in and the development of a functional or decentralized network, exempted from the registration provisions of the federal securities laws.
Peirce said: “The safe harbour proposal is designed to allow people to do a token distribution event without having to worry about whether they’re violating securities laws.”
They would have have to meet requirements such as providing the purchasers of tokens with certain information; updating purchasers on token economics; and an exit report after three years.
“It is unusual for a commissioner to put something like this out there but I think it made sense to try to move the conversation forward,” she added.
She continued that it was disappointing that digital assets were not included in the SEC regulatory agenda that was recently published but said the SEC could still take action such as no-action letters or issuing exemptive orders.
“My complaint has been that too much of the conversation at the Commission has flowed from enforcement action rather than being in a more constructive regulatory manner,” she added. “I think that’s something that could change given that Chair Gensler takes an interest in this area.”
The SEC has also yet to approve a Bitcoin exchange-traded fund, although crypto ETFs trade in another jurisdictions, including Canada. Pierce said she was pessimistic about how the SEC approaches authorization.
She said: “I think we can look to the experience of Canada which has crypto ETFs and see that they were able to operate through volatile periods. Our own ETPs also functioned quite well during the high volatility of March year.”
CFTC
Dan Berkovit, commissioner at the US Commodity Futures Trading Commission, said in a speech this month that unlicensed DeFi markets for derivative instruments are a bad idea, and that he cannot see how they are legal under the Commodity Exchange Act (CEA).
“The CEA requires futures contracts to be traded on a designated contract market (DCM) licensed and regulated by the CFTC,” he added. “Apart from the legality issue, in my view it is untenable to allow an unregulated, unlicensed derivatives market to compete, side-by-side, with a fully regulated and licensed derivatives market.”
Dawn Stump, CFTC Commissioner, said at the conference: “My view is that we should allow technology to develop with a focus on the potential, rather than with scepticism. We certainly have to apply some basic principles to ensure that the development isn’t running foul of our regulatory mission but should not be uncomfortable allowing market demand to drive development.”
Stump gave the example of the past development of financial futures being met with some scepticism and the initial uneasiness on the part of regulators on how to oversee an electronic order book, but markets today are almost exclusively electronic.
“New asset classes require attention and we need to surveil both the derivatives and the underlying commodities so we can properly take action against illicit activity,” she added. “My view is that it is a natural evolution in a developing market and not something to be feared.”
She stressed that the CFTC only has the power to regulate certain derivatives products, such as futures based on commodities and certain options and swaps, but does not have jurisdiction to regulate exchanges or other markets for cash commodity transactions, such as Coinbase.
Stump said: “While the CFTC has been quite active in bringing enforcement actions involving the underlying digital assets, such as with Coinbase, we must be clear why we’re doing so even while such activity is outside our regulatory purview.”
She said the definition of commodity is extremely broad can can capture assets such as Bitcoin, as well as corn, oil and gold. Stump continued that investors need regulators to provide more clear descriptions of current protections before they redesign a regime specifically for digital assets.
“The CFTC has taken many actions against those in the US who have violated our existing regulatory requirements,”she said. “We have already seen new asset classes develop inside our current structure and we just have to be nimble and thoughtful enough to achieve the intended outcome.”
Peter Kerstens, advisor at the European Commission, said the European Union decided to move forward with regulation on digital assets.
Kerstens said: “The first reason was because of a very strong request by market participants for legal clarity.”
The EU also saw market failures in the issuance of crypto assets and many fraudulent schemes.
“We also saw a market failure with certain cryptoasset service providers and conflicts of interest with exchange operators acting as agents on their own exchange,” he added. “The European Commission wanted to enable responsible innovation within a framework.
The Commission also wanted to avoid fragmentation with member states putting national regimes in place for crypto assets.
“We wanted to preserve a pan-European EU wide market for crypto assets,” he added.
