The decentralized finance or “DeFi” movement aspires to create a global peer-to-peer alternative to traditional financial services using permissionless distributed ledger or blockchain technology. DeFi companies have reportedly taken in billions in cryptocurrency over recent months, with some estimates placing the total amount currently “locked” in DeFi-related platforms at almost $8 billion. But financial services offered by global DeFi platforms could be subject to relevant local laws and regulations that may, if not adhered to, present regulatory enforcement risks for DeFi providers.
In the US, the US Securities and Exchange Commission (SEC) and US Commodity Futures Trading Commission (CFTC) recently took enforcement action for violations of the US securities laws and the Commodity Exchange Act against entities doing business as “Abra” which developed a blockchain-based smart contracts app advertised as a DeFi platform that provided users with synthetic investment exposure to various assets through swap contracts. DeFi platforms may also attract scrutiny from the US Treasury’s Financial Crimes Enforcement Network (FinCEN), because many allow users to transmit and/or exchange virtual currencies. FinCEN has made statements this year about ensuring compliance with its registration and other regulatory requirements – particularly with respect to non-US platforms on which US persons can transact in virtual currencies. Although to date, nascent DeFi platforms seem to have avoided publicized US regulatory scrutiny, this may change if platforms continue attracting significant capital, particularly from retail users.
In this article, we explore what DeFi is, review the recent SEC and CFTC actions against Abra, explore some of the red flags that DeFi platforms should be aware of and discuss steps that platforms can take to avoid inadvertently violating US regulatory requirements.