2022 was billed as the year regulation will descend on the cryptocurrency (“crypto”) and decentralized finance (“DeFi”) spaces. While it seems regulation may indeed be coming, it initially appears to be buried in lengthy measures with broader and more generalized application than what may have been expected. These initial provisions could potentially—and fundamentally—alter the legal and compliance landscape for crypto and DeFi entities. However, whether intentional or not, they do not have titles or accompanying publicity that would suggest their significance to the emerging industries affected. The initial salvos are on two principal fronts: financial market regulation, and financial crime controls.
In the realm of financial market regulation, the SEC recently released for comment proposed amendments to Regulation ATS that would dramatically broaden the universe of entities subject to regulation as varieties of “exchanges.” Rather than encompassing only those entities that match buyers and sellers, the SEC proposal would reach any platform that facilitates communication between buyers and sellers regarding their trading interest. This revamped scheme would pull in additional entities that might not have supposed themselves to be regulated, but it also pulls in entities—like distributed exchanges or "Dexes," that were designed (in part) to avoid regulation under existing rules. Now with the potential rule change, these entities may need to reassess potential regulatory requirements. Commissioner Hester Peirce sounded the alarm in dissenting from these proposed amendments, warning that the revisions should be carefully read due to their presumed impact on sectors that would not have imagined they were under threat. The ability to affect the proposed amendments at this stage is limited to submitting comments that argue for desired alterations to any final regulation.
Financial crimes provisions are principally overseen by the Department of the Treasury's financial crimes enforcement network or “FinCEN,” including their application to crypto and DeFi. Though not apparent from its title, the House of Representatives' version of the America Competes Act of 2022 (the “Act”) could broadly empower Treasury to impose financial crimes restrictions with little warning. The House bill's press release says it “streamlines the process by which special measures may be introduced and modernizes the authorities granted to” FinCEN. However, it does not specify that proposed means of doing so include (i) eliminating current notice-and-comment requirements for Treasury's authority to impose these measures (including prohibiting classes of transactions by designating them as presenting money-laundering risks), and (ii) removing time limits on how long these measures can remain in place. As opposed to the expanded legal designation imposed by the Regulation ATS amendment, the Act—if successful—would present a potential risk that depended on further actions by the Treasury Secretary. But its less straightforward nature should not obscure the threat the Act poses if its expanded powers are conferred on misguided hands. Thankfully, moves are afoot to amend the House bill to re-impose some current restrictions on Treasury's ability to enact special measures, though it remains to be determined what the final language may look like, and what may emerge once the House and Senate bills are in conference committee. The Act's proposed language failed to gain approval when introduced last year as part of the National Defense Authorization Act, so its being included in any final version is not a foregone conclusion.
Regardless of the intent behind these measures and whether they are enacted in their current form, regulating crypto assets from the administrative or legislative perspective should be done transparently and explicitly, with full opportunity for public participation. The new measures, respectively, should be commented upon and challenged legislatively. Ideally, what emerges on the other end is far more palatable. But if enacted in their present forms, these provisions can be challenged via litigation, including due process challenges based on arguments that insufficient time was afforded to consider and respond to them, and/or they strip the lawmaking process of basic checks and balances. In short, there's no time like the present for the crypto and DeFi communities to make their voices heard.
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