Regulating the DeFi Industry: Polygon Labs’ Proposal
Polygon Labs, the developers behind the blockchain scaling network Polygon, recently published a research paper outlining their recommendations for government regulation of the decentralized finance (DeFi) industry.
Criticism of Crypto’s Potential Misuse
Politicians, including those in the Treasury Department and U.S. Senate, have expressed concerns about crypto’s potential use for money laundering and terrorist financing, particularly when it comes to smart contracts.
The Limitations of Current Legislation
The research paper argues that existing laws and regulations designed to protect financial integrity are not suitable for decentralized, intermediary-less systems like DeFi. These laws typically apply to intermediaries defined as “financial institutions” under the Bank Secrecy Act (BSA).
Polygon Labs’ Three-Step Solution
Polygon proposes a three-step approach to address the regulatory challenges posed by DeFi. The first step involves creating a legal definition for “System Control Persons” (SCPs) who have operational authority over third-party value in blockchain-based software systems. SCPs would be subject to standard anti-money laundering (AML) requirements.
For systems without SCPs (“genuine DeFi”), a separate classification as “critical infrastructure” overseen by the OCCIP would be established. Finally, businesses interacting with genuine DeFi would not be regulated as “financial institutions” under the BSA but would still be obligated to protect national security interests.
A Different Perspective from Elizabeth Warren
Polygon’s proposal differs from Senator Elizabeth Warren’s suggestion that crypto firms should be subject to the same AML requirements as traditional banks. Warren has also claimed that North Korea is funding its nuclear arms program with crypto.
Hot Take: Balancing Policy Goals and Technological Realities
Polygon Labs’ research paper aims to bridge the gap between the policy goals of financial integrity regulations and the technological realities of DeFi. Their proposal seeks to address questions posed by regulators and policymakers in order to prevent criminals from exploiting DeFi.
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