Don’t shoe-horn DeFi into existing laws

The world of decentralized finance stands at the precipice of immense change.

Yet as the Commodity Futures Trading Commission’s recent actions against firms like Opyn, ZeroEx and Deridex underscore, regulatory clarity is paramount. With agencies such as the US Securities and Exchange Commission, the Department of the Treasury and the IRS also focusing on DeFi, the call for a defined legal framework is loud and clear.

It’s here that we might look to past regulatory and legal successes for inspiration. The early days of the internet faced a similar crossroads, where the promise of innovation was met with concerns about misuse and accountability. Section 230 of the Communications Decency Act of 1996 provided a balanced solution: It fostered a space for innovation while offering platforms a shield against certain liabilities.

Although Section 230 is still hotly debated today, it may be prudent to take a leaf from the infamous legal shield’s book for DeFi — to support innovation while ensuring consumer protection and clarity for developers and users.

The need for a tailor-made legal framework

DeFi is more than a disruptive force in the financial sector; it’s a paradigm shift. 

Enabled by blockchain and smart contracts, DeFi empowers activities like lending, borrowing and trading to happen directly between users, bypassing traditional intermediaries such as banks. A decentralized exchange acts as a facilitator rather than a middleman, speeding up transactions, reducing costs and diminishing the risk of centralized failure.

The benefits extend beyond efficiency; DeFi democratizes financial systems globally. Anyone with an internet connection can gain access to financial services, from basic savings accounts to complex derivatives, all without the need for a traditional bank account.

Now, consider Section 230 of the Communications Decency Act. This law essentially says that online platforms — think social media sites or online marketplaces — are not legally responsible for content posted by their users. It’s a provision that has allowed the internet to grow and innovate without platforms constantly fearing legal repercussions for user-generated content.

The parallel here is striking. 

Just as Section 230 provided a legal framework that allowed online platforms to flourish without undue fear of liability, DeFi could benefit from similar legislation. Specifically, new legislation could shield DeFi platforms, like DEXs, from being held legally accountable for the financial transactions they facilitate but do not initiate or control. This would help DeFi continue its trajectory of innovation through the hard work of developers and coders while adding a layer of consumer protection.

Key principles for the new DeFi-specific law

While Section 230 provides a valuable model for promoting innovation and mitigating liability, its scope and origin in a pre-crypto era make it ill-suited for the nuanced issues surrounding DeFi. It’s not about shoe-horning DeFi into existing legislation; it’s about carving out its own legal space.

Drawing from Section 230’s success in cultivating the early internet, our DeFi-specific law must offer protections against immediate punitive legal actions for platforms acting in good faith. This would give developers the confidence to push boundaries, test new services, and iterate — without the looming specter of litigation.

And given the CFTC’s recent enforcement actions, there’s an unambiguous need for a legal framework that specifies what constitutes legal and illegal activities within the DeFi ecosystem. A DeFi-specific law can offer this clarity, protecting both developers and consumers.

Read more from our opinion section: Don’t let DeFi collapse on shaky foundations

The new law must be designed to hold users accountable for their actions while requiring platforms to offer robust risk disclosures and education, echoing Section 230’s principle of user responsibility. This balance would protect well-intentioned platforms from undue liability and ensure that users understand the implications of their transactions.

Taking a cue from CFTC Commissioner Summer Mersinger’s call for public engagement, this new law should also prioritize consultation and dialogue with stakeholders. An “enforcement first” strategy risks being both uninformed and stifling. Instead, the law should adopt a graduated approach that starts with understanding and shaping the ecosystem before levying punishments.

Financial investment is the lifeblood of innovation. A clear legal landscape can lower risks for investors and attract more capital to the DeFi space, propelling it from an experimental phase into mainstream adoption.

The time is now

The recent CFTC crackdowns on DeFi platforms have made one thing abundantly clear: The need for a specialized, balanced and clear legal framework has never been more urgent. By constructing a law inspired by Section 230’s guiding principles, we can create a conducive environment for DeFi’s responsible and transformative growth.

Let’s not let the potential of DeFi be constrained by laws that aren’t built to accommodate its unique opportunities and challenges. The stakes are high, but so are the rewards: a financial system that’s more transparent, accessible and equitable. As we’ve seen in the early days of the internet, the right legal framework can be a catalyst for unprecedented innovation and societal change.

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