SEC Reportedly Could Look to Regulate DeFi Projects

Agency chairman Gary Gensler tells Wall Street Journal that certain aspects of ‘decentralized’ platforms are highly centralized

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key takeaways

  • Many DeFi projects offering token incentives appear to constitute “investment contracts” that fall in regulated space, law professional says
  • Gensler’s remarks came same day Avalanche blockchain revealed plans to launch $180 million liquidity mining incentive program

SEC Chairman Gary Gensler said Wednesday that decentralized finance, or DeFi projects that reward participants with valuable digital tokens or other incentives could count as activity to be regulated, the Wall Street Journal reported.

Gensler, who joined the federal agency in April, has been outspoken in recent months about doing more to regulate cryptocurrencies. He compared the crypto space to the “Wild West” during the Aspen Security Forum earlier this month, during which he warned against industry players working outside of regulatory frameworks.  

“The American public is buying, selling, and lending crypto on these trading, lending, and DeFi platforms, and there are significant gaps in investor protection,” he said at the time.

Gensler told the Wall Street Journal that the term DeFi is a “misnomer,” noting that platforms operating in the space can be highly centralized in certain ways.

Preston Byrne, a partner at law firm Anderson Kill, said that a product that is not clearly a security may be regulated as such if it is considered an “investment contract.” This is a term that describes contracts, transactions or schemes in which there is an investment of money in a common enterprise with an expectation of profits arising from the efforts of a promoter or third party, he explained.  

“The SEC traditionally elevates economic substance over form when making determinations as to whether it will bring regulatory enforcement action against crypto projects,” Byrne told Blockworks. “Many DeFi projects offering token incentives do appear to many legal observers to constitute investment contracts and thus fall within the regulated space.” 

Byrne added that whether the SEC would actually regulate such a project would depend on the outcome of the Howey analysis; to what extent the token project touches the US; and the enforcement priorities of the regulators.

Gensler’s comments came the same day that Avalanche announced it was set to introduce a $180 million liquidity mining incentive program that will bring DeFi protocols Aave and Curve to its public blockchain.

The new initiative will provide Avalanche’s native token, AVAX, as liquidity mining incentives for Aave and Curve users over a three-month period.

An Avalanche spokesperson did not immediately respond to Blockworks’ request for comment about Gensler’s remarks and whether the company has discussed such potential regulation with the SEC. 

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