Although various discussions continue the legal basis and supervisory mechanisms of decentralized finance, which started to be talked about after the introduction of blockchain technology in the field of finance and the widespread use of cryptocurrencies and has reached a serious volume today, it is a matter of curiosity how this phenomenon, whose risks and opportunities have not yet been fully embraced, will be regulated by the US Securities and Exchange Commission (SEC).
Features of DeFi investments
Many DeFi offerings and products resemble products and functions in traditional financial markets.
For example, people can obtain an asset or a loan after pledging collateral through decentralized applications running on the blockchain, much like traditional secured loans.
In this sense, DeFi developers are not just creating digital asset tokens, as one might think. They are also developing smart contracts that enable people to invest, leverage and trade various derivatives, and transfer assets quickly and easily across platforms and protocols.
Such DeFi projects continue to develop rapidly. However, DeFi is not just a product offering and DeFi users are not just consumers. DeFi is fundamentally about investment, and these investments involve a number of speculative risks.
Legal regulation of DeFi
In the US, DeFi falls under the jurisdiction of various agencies. These include the Department of Justice, the Financial Crimes Enforcement Network (FinCEN), the US Internal Revenue Service (IRS), the US Commodity Futures Trading Commission (CFTC) and the US Securities and Exchange Commission (SEC). In addition to these federal agencies, state agencies also have jurisdiction.
However, compared to other regulated markets, DeFi projects do not conduct adequate disclosure and compliance activities. For example, many DeFi projects fall under the jurisdiction of the SEC because they involve securities in their operations or assets. However, no DeFi participant subject to the SEC has ever registered.
At this point, it should be reminded that such investment opportunities outside the regulatory oversight are riskier for investors and other participants.
The role of the SEC
If the developers of the DeFi project are in doubt as to whether their project falls within the jurisdiction of the SEC, or if the project is not fully compliant with SEC regulations, they may consult with the SEC’s Strategic Center for Innovation and Financial Technology (FinHub) or other offices or divisions of the SEC.
According to the SEC Chairman, FinHub has so far not refused any meeting and has not hesitated to provide the necessary support and time. Indeed, more teams coming to consult on these issues will improve the SEC’s technical knowledge.
While the SEC will not be able to provide legal advice, as it does not know the project as well as the developers, it will be able to share its own views. Through this exchange of ideas, the SEC will be able to learn more about how to integrate such technologies into its existing legal regime.
The SEC Chairman has stated that to the extent that DeFi offerings, projects and platforms violate securities laws, the SEC will continue to intervene, but that working together and complying with the law would be preferable to such interventions in order to achieve DeFi’s common goals.
Starting in 2020 and continuing in 2021, the popularity of the DeFi sector is on the rise, and scams in the ecosystem are on the rise. We will briefly touch on ways to avoid losing money in the DeFi space, which is a separate article in itself:
The most common types of scams
How can you tell if a project is a scam? The first thing that users and investors should pay attention to is whether the protocol has been tested. This is because the smart contracts that make up decentralized finance protocols can be easily cyber-attacked by hackers due to human error. For this reason, it is important to make sure that the protocol to be invested in has been analyzed by independent auditors.
- Information about the team: One of the most important things to consider before deciding to invest in a project is who is developing it. The first thing to check is the “About Us” page on the project’s website. Suspicious details, fake LinkedIn profiles with no connections or background should call credibility into question.
- Advisors and known investors: The list of project advisors and investors is important. Projects with well-known consultants are often much more credible than others. The same goes for projects with well-known investors. If the project does not disclose the list of its early investors or provide any information about its advisors, it may be another cause for suspicion.
- Product vetting: When investing in DeFi projects, you should examine the product that the project promises. See if there is a future in terms of whether the product will actually work. The products that the project team has come up with so far can also give an idea.
- Smart contract: As mentioned earlier, the smart contract is critical. It’s definitely worth checking whether the team has made the project’s smart contract publicly available. This will give you an idea of the potential of the project. Independent experts can also identify potential security vulnerabilities much earlier. On the other hand, the project team may be hesitant to share its smart contract publicly for fear that another project will steal or copy it. In such a case, the prestige of the team behind the project should be taken into account. If the team is reputable and has a proven track record, it may be worth investing in projects that do not share their smart contract publicly.
- Has the smart contract been audited: This is one of the most important considerations when investing in DeFi projects. It’s worth repeating. Avoid investing in projects whose smart contract has not been checked by independent auditing companies.
- Token distribution and initial market capitalization: If the project team is holding a large portion of the circulating token supply, this should raise suspicion. If the project’s token distribution scheme is not shared publicly, it should be avoided.
If one or more of the above criteria are alarming, one should be very cautious about that project.
DeFi is one of the innovations brought by the changing world. Recognizing and even defining this new concept correctly can prevent possible damages as well as facilitate life and allow for moves that can benefit. Start to DeFi with Venice Swap.