Bankman-Fried misleads regulators by steering them away from centralized finance
Last month’s proposal by Sam Bankman-Fried, CEO of crypto exchange FTX, that regulators establish a series of standards for the cryptocurrency industry poses an existential threat to decentralized finance (DeFi) platforms and entrepreneurship. As one of a select few with the capital and influence to move the needle on the crypto regulatory debate, Bankman-Fried, aka SBF, should take a stand to protect DeFi by leading regulators where they are most urgently needed: centralized financial platforms (CeFi) and centralized exchanges (CEX).
In part of his regulatory oversight and industry standards plan that addresses DeFi, the SBF reaffirms the importance of maintaining permissionless smart contracts and validators. He goes on to suggest that DeFi front-end providers, website hosts and even related marketers need to be registered as traditional financial brokerages.
The implication of such a classification would subject DeFi agents to a series of strict regulatory guidelines and Know Your Customer procedures. Even hiring the highly specialized professionals necessary to handle relevant legal responsibilities requires enormous capital and resources.
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DeFi is itself regulated. Any regulatory measure will be redundant at best, and suffocating at worst. Nonetheless, anything resembling broker-dealer regulation will effectively crush DeFi’s entrepreneurial spirit and ultimately transfer DeFi Legos into the hands of a small group of centralized crypto powerhouses – namely Binance and SBF’s FTX exchange.
Perhaps ironically, it is the highly centralized platforms and their opaque operations that require regulation the most.
The great financial crisis: A regulator’s dream came true
It would be infantile to suggest that regulation does not serve a purpose. Here’s what the regulation does very well: It ensures that major players follow all relevant laws and injects transparency into the operations of otherwise opaque financial institutions. In short, regulation breaks down information asymmetry and prevents the big guys from colluding (and lying) to take advantage of the little guys, who can rarely see enough of the picture to make informed decisions.
The 2008 financial crisis showed citizens around the world that their financial well-being, livelihoods and life savings had been left to massive financial institutions that operate without restraints. In the wake of the crisis, regulators introduced extensive reporting and risk management requirements to prevent a relapse.
Whether representatives of the financial industry will tell you that it worked for the best in 2022 is another story. But the crisis did well to demonstrate the basic approach of top-down regulation: harnessing the power of government to keep large, opaque institutions in line and ensure customer funds and corresponding reserves are managed responsibly and with transparency.
Decentralized systems: A regulator’s worst nightmare
Alongside extensive regulation, the 2008 financial crisis provided an additional option: the Bitcoin (BTC) white paper. Citing irresponsible credit expansion and one-sided trust as primary inspirations, the anonymous author, Satoshi Nakamoto, presented the world with a trustless, immutable monetary system. In other words, they designed a system that regulates itself.
In the transparency department, there is no greater form of proof than that generated cryptographically by block producers. A cryptographic proof is, for all intents and purposes, a form of regulation hard-coded into software and maintained by a decentralized body of nodes.
Completely transparent and operating according to a set of immutable rules, decentralized systems are a regulator’s dream come true – or at least they would be if they didn’t make regulators obsolete.
By supplementing a robust consensus and decentralized node body with an Ethereum Virtual Machine and smart contract modules, DeFi is just the next iteration of decentralized money. Although it requires an element of governance, top-down regulation is simply not necessary.
Decentralized autonomous organizations have already established themselves as DeFi’s self-selected mechanisms for reserve management policies, interest rates and other key parameters. After all, who better to determine the risk appetite and reserve composition of a DeFi protocol than its own user base? Talk about skin in the game.
DeFi is where regulation is not need for. Want to know a lending pool’s total value locked? Check the blockchain. Looking for the reserve composition? Check the blockchain. Want to know the payout policies of an insurance protocol? Check the repository for open source code. Permissionless smart contracts and validators include and encompass bottom-up regulation. Bankman-Fried supports both.
The regulatory crypto needs an urgent need
Over the past five years, crypto has experienced several iterations of exponential growth – for better or for worse. Between multibillion-dollar CeFi platforms and CEXs, the space has more opaque centralized power players today than ever before.
Already, the bankruptcies of CeFi giants BlockFi, Celsius Network and Voyager have left retail customers impoverished and depressed. The CEX hack has also pushed customers to reevaluate their trust in crypto in general.
On this deal, Bankman-Fried has certainly not lost the plot. Following his thesis on DeFi, he advocates audits and regulation for US dollar-pegged stablecoins with bank reserves. Here he is on the track.
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Tether and its industry-leading USDT (USDT) stablecoin rely heavily on the core banking system to manage reserves. On this privilege, SBF and his Washington-based network may have an opportunity to alleviate a major industry pain. Tether plays a cardinal role as a liquidity provider in a nascent space, but the lack of transparency and proper audits has raised suspicions of foul play from retail traders and institutional onlookers.
Should the SBF clean up its position on DeFi and shift regulatory attention to the CeFi platforms and CEXs that badly need oversight, the crypto industry at large could move on to a golden era – one where centralized organizations and decentralized ecosystems co-exist in peace. One where trusted intermediaries and trustless protocols together serve a community of entrepreneurs, investors and enthusiasts at the bleeding edge.
Sameep Singhania is co-founder of the polygon-based QuickSwap decentralized exchange. He has more than six years of experience in software development as a professional programmer. He left the traditional software development industry in 2016 to begin exploring decentralized options in the blockchain space.
This article is for general information purposes and is not intended to be and should not be taken as legal or investment advice. The views, thoughts and opinions expressed herein are those of the author alone and do not necessarily reflect or represent the views and opinions of Cointelegraph.