A new report released by the CFTC’s Digital Assets and Blockchain Technology Subcommittee has released a comprehensive report — “Decentralized Finance” — outlining the risks inherent in the burgeoning field of Decentralized Finance (DeFi).

Spearheaded by CFTC Commissioner Christy Goldsmith Romero, the report raises critical concerns about the lack of clear responsibility and accountability within DeFi systems. Its release aligns with previous concerns raised by the Department of Treasury regarding the potential for illicit finance risks in the DeFi space.

Romero has positioned the report as a critical tool to foster dialogue between policymakers and industry leaders, aiming to shape an informed and effective regulatory approach to DeFi.

Core Findings and Implications

The report stands as a comprehensive analysis of the DeFi sector, revealing how its benefits and risks are heavily influenced by the design and operational features of specific systems. A central concern identified is the lack of clear lines of responsibility and accountability in some DeFi systems.

According to the report, these gaps pose substantial threats to consumer and investor protection, financial stability, and market integrity while increasing the sector’s vulnerability to illicit activities, such as cyber hacks and financial crimes.

The report calls for urgent government and industry collaborative action to better understand and manage these emerging challenges. It marks an essential step in addressing the complexities of DeFi and serves as a wake-up call for the industry and policymakers.

The report also recommends specific actions to strengthen anti-money laundering (AML) and counter-terrorism financing (CFT) protections within the DeFi ecosystem. This involves assessing how identity information is collected in DeFi systems, identifying compliance gaps and requirements, and evaluating options for regulating and imposing identity information discoverability and verification requirements.

Policy recommendations

According to the report, the global nature of DeFi calls for enhanced monitoring, data gathering, compliance assessment with financial regulations, and identification of regulatory gaps. It outlines several recommendations to achieve these goals.

The report suggests increasing technical capacity and understanding of the DeFi sector. This involves developing continuous data gathering, monitoring, information sharing, and forming regulatory partnerships to comprehend DeFi systems’ operational nuances better.

Given the global nature of DeFi, the report emphasizes the importance of engaging and collaborating with domestic and international standard-setters, regulatory bodies, and DeFi developers. This international cooperation is crucial for harmonizing regulatory efforts and ensuring a cohesive approach to DeFi governance globally.

A significant part of the recommendations involves identifying and assessing various risks associated with DeFi. These include risks posed by asymmetric information, conflicts of interest, operational and security vulnerabilities, liquidity mismatches, over-leverage, and other forms of market manipulation. The report also highlights the need to address the financial and technological complexities of DeFi compositions and their inherent risks.

The CFTC suggests evaluating a range of potential policy responses to mitigate the identified risks. These responses might include implementing disclosure requirements, regulatory reporting, third-party auditing, entry restrictions, regulatory supervision, governance regulation, product regulation, balance sheet regulation, activity restrictions, structural regulation, and resolution planning.