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DeFi contracts are not illegal but alegal: CFTC briefing

Developers often describe DeFi projects as financial Lego blocks, presenter Aaron Wright stated

Decentralised Finance (DeFi) has been one of 2020s biggest crypto trends. Powered by protocols that didn’t exist a few years ago, the total value and number of DeFi projects have risen dramatically in recent months.

To understand and respond to this explosion in DeFi, the Commodity Futures Trading Commission’s (CFTC) Technology Advisory Committee hosted a presentation called “The Growth and Regulatory Challenges of Decentralised Finance” by law professor Aaron Wright and attorney Gary DeWaal yesterday.

The presentation was delivered mostly in the form of a briefing on the operations of decentralised platforms which have shown greater influence in crypto trading.

Wright explained the potential of DeFi in enabling the provision of services at a lower cost for a greater number of people by the automation of processes involved. He further pointed out that software tools can contribute to an overall increase in flexibility.

“Another interesting benefit of decentralised financial projects is that they’re composable and interactable”, said Wright. “Developers often describe them as financial Lego blocks”, he added.

Wright made a few insightful observations regarding the regulatory compliance of DeFi projects by pointing out that developers typically don’t think of legal considerations first.

“These contracts are alegal. That doesn’t mean that they are illegal. It means they are designed at a technical level, not necessarily with regulatory compliance in mind”, Wright explained.

The presenters highlighted technological barriers to entry as another potential risk that can challenge the growth of DeFi despite DeFi’s ideal of being more open-access than Centralised Finance(CeFi). Further, the chronic risk to know-your-customer and anti-money laundering violation posed by little or no registration requirements for users was also discussed.

DeWaal’s briefing centred around the question of who authorities can hold liable if a DeFi platform is functioning illegally. While speculations suggest more legal action against software developers in the future, DeWaal explained that that’s a tough legal bar to clear.

“Generally, in the United States, software development is a protected activity under the first amendment”, said DeWaal. “As Aaron has eloquently shown, there’s many, many use cases for DeFi. But the First Amendment is not a universal bar”, he explained. The attorneys also noted that secondary liability can threaten a diverse population of people using or contributing to DeFi protocols.

Wright discussed possible solutions by mentioning a potential safe harbour within the virtual currencies’ subcommittee. “A safe harbour could ensure responsible development to protect consumers’ interests without limited innovation”, he concluded.

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