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CFTC Takes Aim at DeFi Privacy and Pseudonymity in New Report

Last Updated January 9, 2024 12:51 PM
Josh Adams
Last Updated January 9, 2024 12:51 PM
Key Takeaways
  • Decentralized finance (DeFi) has come under criticism from US authorities in recent years.
  • However, so far, there is relatively little regulation about the sector’s most controversial aspects.
  • A new CFTC report identifies “pseudonymity and disintermediation” of DeFi as key causes for concern.

Decentralized finance (DeFi), has managed more than five years or so with relatively little government scrutiny in the United States. However, regulators are increasingly concerned that the anonymity afforded by DeFi could enable illicit activities. 

As a result, the Commodity Futures Trading Commission (CFTC) is calling on policymakers to explore ways to identify individuals participating in decentralized systems.

A New Report Identifies DeFi Pseudonymity As a Problem

In a report  published this week, the CFTC warned that “the pseudonymity and disintermediation provided in most DeFi systems presents serious concerns for policymakers focused on ensuring AML (anti-money laundering) and countering financing of terrorism (AML/CFT) regimes are effective.”

The report argues that the lack of accountability and responsibility inherent to decentralized networks means there is “no clear route to ensuring victim recourse, defense against illicit exploitation, or the ability to insert necessary changes and controls.”

Although the CFTC report acknowledges potential “undesirable privacy violations” when evaluating options for identification requirements in DeFi, it ultimately concludes that some encroachment on pseudonymity may be necessary.

The report states that “near-term action on identity is both warranted and possible.” This suggests the CFTC believes feasible policy steps can and should be taken soon to lift the veil of anonymity in decentralized finance. This is despite industry objections over privacy. 

To address these issues, the CFTC recommends that regulators map existing DeFi systems to understand interconnections and threats. It also advises surveying the regulatory landscape to determine if DeFi activities fall under existing rules or if new frameworks are needed. Most critically, the agency calls for evaluating “options for regulating and imposing requirements for identity information discoverability and verification across layers in the ecosystem.”

This could mean imposing regulations on identity and credential providers. These would ensure the sufficient collection of customer information. Policymakers would have to balance privacy concerns against the need for accountability.

CFTC Advises Looking into Digital Identity

CFTC Commissioner Christy Goldsmith Romero explained: “From the time that I arrived at the CFTC, I have played a steady drumbeat that we need to study emerging issues related to digital assets or we could risk harmful unintended consequences.” While recognizing the benefits of DeFi, she said lack of responsibility is a “central concern” that poses risks.

The CFTC isn’t alone in its scrutiny of DeFi and crypto more broadly. A Treasury Department report  released last year also highlighted illicit financing enabled by DeFi’s anonymity. SEC Chairman Gary Gensler has repeatedly called crypto the “Wild West” and vowed to bring this market under regulation.

Regulators counter that guardrails are necessary to protect consumers and prevent crimes like money laundering. The debate around DeFi regulation encapsulates the classic tradeoff between freedom, privacy and security playing out in broader technology policy fights. This is only the first play in a longer battle.

 

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