Opportunity, but at what cost? Understanding unconventional finance risks
Welcome to the August 2021 edition of our newsletter! In this issue, we’ll examine efforts by regulators to try to manage “decentralized finance” platforms, and the risks to both customers and the fledgling institutions.
Decentralized, but not unregulated? Changing regulatory attitudes on DeFi entities
As we noted last month, the rapid use of non-bank “decentralized finance,” or DeFi, platforms has begun to gain the attention of regulators. More recently, the U.S. Securities and Exchange Commission chair, Gary Gensler, has opined that such “peer to peer lending networks exhibit some features that may make them subject to oversight, arguing that such groups do not necessarily have “know your customer” safeguards in place at banks and other regulated lenders. The risk is amplified by the digital nature of many DeFi transactions, which ultimately can involve cryptocurrencies held in digital wallets. The commission has recently brought an enforcement action against one DeFi entity which sold digital tokens that purportedly gave holders voting rights, as with shares of stock. This, the commission said, made them an investment which was subject to existing investor protection laws, violated when the entity did not file a registration statement.
Given that regulatory efforts continue to evolve – as they had with more traditional “lending club” entities more than decade ago – the onus is on investors to know their DeFi, until the DeFi tries to know their customers. The opacity of digital tokens as assets is an obstacle, but the histories of the parties involved can always be instructive. Have concerns arisen in any pre-DeFi ventures? What can be learned about the entity’s other customers? Have any brought civil actions against the entity in the past?
New frontiers always promise new opportunities, and many of those may actually materialize. Yet until regulators can establish oversight of DeFi platforms and the technology that underpins them, blockchain technology, hope and faith may not be enough. Investor due diligence is critical in rapidly evolving schemes.