Legal experts from Polygon Labs and Arktouros have put forward a regulatory framework that suggests classifying truly decentralized DeFi protocols as “critical infrastructure” and placing them under the oversight of federal cybersecurity agencies in the United States. The objective of this proposal is to combat illicit financial activities in the DeFi space and strengthen the security and resilience of the financial services sector.
In a document titled “A Conceptual Framework for Combating Illicit Finance Activity in Decentralized Finance,” Rebecca Rettig and Katja Gilman from Polygon Labs, along with Michael Mosier from Arktouros, present their vision for regulating the DeFi industry. They propose designating truly decentralized DeFi protocols as critical infrastructure, to be overseen by the U.S. Treasury’s Office of Cybersecurity and Critical Infrastructure Protection (OCCIP).
Although the OCCIP is not an official financial regulator, it plays a crucial role in enhancing the security and resilience of critical infrastructure in the financial services sector. It coordinates efforts to reduce operational risk and shares valuable information about cybersecurity, threats, and vulnerabilities with finance firms, industry groups, and government partners.
The proposal suggests extending the OCCIP’s mandate to include oversight of decentralized DeFi protocols, in response to the growing concerns regarding illicit financial activities in this space.
The document acknowledges that not all DeFi protocols are genuinely decentralized. Some have significant points of centralization, which, according to the authors, should subject them to existing financial regulations. This differentiation between truly decentralized and partially centralized DeFi protocols is essential in determining the appropriate level of oversight and regulation needed to maintain the integrity of the DeFi ecosystem.
As part of the proposed legal framework, the authors recommend the creation of a new category called “critical communications transmitters.” These entities would be considered integral to genuine DeFi systems and would be required to fulfill specific obligations to protect U.S. national and economic security. Importantly, they would not be classified as “financial institutions” subject to the Bank Secrecy Act (BSA). This innovative approach seeks to balance regulatory oversight and foster innovation within the DeFi sector.
In addition to proposing oversight for DeFi protocols, the framework also emphasizes the need for separate and independent regulation for centralized finance (CeFi) and traditional finance (TradFi). This aligns with guidance provided by the Treasury’s Financial Crimes Enforcement Network (FinCEN) and aims to ensure that each sector receives appropriate regulatory scrutiny by establishing clear regulatory boundaries.
This proposal marks a shift in policy focus towards addressing illicit finance within the digital asset industry. Policymakers in Washington, D.C., are increasingly concerned about this issue, with discussions often revolving around securities and commodities laws. The framework presented in this document could serve as a starting point for a comprehensive solution to tackle the challenges posed by illicit financial activities in the DeFi space, according to crypto industry lawyer Jake Chervinsky.
The authors of the proposal emphasize the importance of not losing sight of the fundamental goal of empowering legitimate and beneficial activities within the DeFi sector. They highlight that this approach aligns with the Treasury’s mandate of promoting economic prosperity and ensuring the financial security of the United States. The proposal aims to strike a balance between safeguarding against illicit finance and fostering innovation and economic growth within the DeFi ecosystem.
