IOSCO DeFi Report; Bank of England Financial Stability Report; House Committee Seeks Data on Russian Business Interests
DEF Weekly Roundup - March 25, 2022
IOSCO DeFi Report
The International Organization of Securities Commissions (IOSCO), an international coordinating body for securities regulators, published a report this week examining DeFi. IOSCO set up a DeFi Working Group led by the U.S. Securities and Exchange Commission (SEC).
In its report, IOSCO states that “DeFi appears to present many similar risks to investors, market integrity and financial stability as do other financial products and services, and it also poses specific and unique risks and challenges for regulators to consider.” While the report’s tone is broadly (perhaps unsurprisingly) skeptical of DeFi, it acknowledges that “one primary characteristic of DeFi is its peer-to-peer nature and resulting ability… potentially to complicate the application of existing regulatory frameworks to DeFi market participants and activities….”
What does this mean?
Many aspects of the IOSCO report are noteworthy. First, the report acknowledges that inherent characteristics of DeFi protocols complicates the potential application of existing regulatory regimes. To date, regulators generally have been reluctant to question whether existing frameworks predicated on intermediated markets could be applied in the crypto-ecosystem. Whether that reticence stems from a rejection of the idea that DeFi disintermediates financial activities—in other words that DeFi represents something “new”—or not, it’s encouraging to see IOSCO shifting away from the idea that everything happening in crypto and DeFi is TradFi by a new name. Speaking of “TradFi,” this is the first report we’ve seen from an OfFiCiAl regulatory body to adopt the term, which it uses 16 times and defines as “traditional markets and entities.”
Outside of the direct policy considerations presented in the report, this is one of the most in-depth analyses of DeFi by an international organization that we have seen. The report provides coherent discussion of how Layer 2s work, what a ‘wrapped’ asset is, and more broadly all of the exciting ways DeFi market participants can interact with the blockchain. While this does not convince us that IOSCO is fully on board with DeFi or that their portrayal of DeFi is completely accurate, it does indicate that discussion with IOSCO can be conducted at a deeper level than simply explaining the basics of DeFi. The more regulators and standard setting bodies move to a deeper level of understanding DeFi, the better.
Silver-linings aside, we have some concerns about the report and its characterization of DeFi, and we are going to submit a response with our perspectives. Comments may be submitted to DeFi@iosco.org and there is no deadline.
Bank of England Financial Stability Report
The Bank of England (BoE) also released a report that covered DeFi and some of its policy implications, focusing on financial stability implications. The BoE has been one of the most active central banks on crypto issues over the past few years.
The report finds that “...cryptoassets and the technology underpinning them could reduce the cost, and increase the speed of cross-border payments by allowing transactions to take place directly between individuals (‘peer-to-peer’) and reducing the need for centralised intermediaries… Outside payments, decentralised networks used for lending could in time reduce the reliance on existing intermediaries if done safely. Furthermore, some DeFi applications could potentially benefit financial market participants in terms of speed of execution and transaction costs by removing the need for intermediaries.”
The report argues that a regulatory framework responsive to the inherent characteristics of peer-to-peer financial infrastructure is a prerequisite for these benefits to be realized. “While the existing regulatory framework should be adapted to ensure an equivalent regulatory outcome for equivalent risks, the regulatory measures used to achieve these outcomes may need to be tailored to the new technologies and platforms that underpin them,” the BoE finds.
What does this mean?
Overall, while not outright bullish, the BoE’s report is one of the most welcoming of the benefits decentralized finance and cryptocurrencies could bring to financial services we’ve seen from a traditional regulatory body.
In addition, echoing more explicitly IOSCO’s position, the BoE’s focus on accomplishing “equivalent regulatory outcome[s]” instead of on applying “existing regulatory framework[s]” is encouraging. As we’ve argued before, the point of regulatory regimes isn’t the application of them. At core, regulatory frameworks are designed to pursue policy objectives like consumer protection and financial stability. While both cars and airplanes transport people from point A to point B, we thankfully do not expect these distinct methods of transportation to meet the same regulatory standards. Instead, different frameworks are applied that both attempt to accomplish the same outcome: ensuring people can safely get to where they are going regardless of the technology they are using.
What is true in transportation is true in financial services. Vindicating policy objectives is the objective, and we’re encouraged to see the BoE explicitly state this idea in their report.
House Committee Seeks Data on Russian Business Interests
The House Financial Services Committee (HFSC) called on trade associations representing hundreds if not thousands of U.S. financial institutions to collect information on their members’ operations in Russia. Businesses based in the U.S.—especially crypto companies—have been facing intense pressure to completely withdraw from Russian markets.
Chairwoman of the committee Maxine Waters (D-CA) wrote that she has “been heartened by how many companies in the financial services industry and in corporate America have taken actions above and beyond those explicitly called for by U.S. sanctions.”
The letter requests “detailed information on the significant actions that America’s financial institutions and businesses have taken to end their relationships and engagements in Russia, with the Kremlin, and with businesses that support the Russian government,” in addition to information about companies’ sanctions compliance efforts.
What does this mean?
While not targeted at the crypto industry or DeFi developers, the letter is noteworthy given the recent intense scrutiny of the potential for sanctions evasion using digital assets (notwithstanding little evidence of this happening and several Biden administration officials downplaying the risks).
The letter clearly reflects many members’ of Congress conviction that more must be done to punish Russia via economic means for its invasion of Ukraine. Sanctions and foreign policy are typically the purview of the executive branch, but letters like these may add pressure on the Treasury Department to “do more.” The information collected could also help the committee further understand to what extent existing sanctions have curtailed economic relationships with Russia.
To us, it looks increasingly likely that the U.S. (and its allies) will implement broader sanctions on Russian individuals, entities, and economic activities. In light of this, DeFi market participants and crypto businesses would do well to prepare additional measures to meet broader sanctions obligations should the administration choose to implement more.