THE DAILY ENCRYPT

October 4, 2022

Could One Change To The Definition of DeFi ‘Kill’ The Market?

The agency would like to broaden the definition of "dealer."...
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This week, the SEC released proposed rule changes. One proposal that addresses electronic Treasury bond traders could have an impact on liquidity on DeFi markets.

Even the smallest policy changes can have unexpected consequences. Consider the Exxon Valdez oil leakage in 1989. This led to states holding tanker operators responsible for any future oil spillages. Paradoxically, this increased the risk of disaster by outsourcing oil deliveries from at least one oil company to independent ships with questionable records.

The U.S. Securities and Exchange Commission has proposed a rule to deal with electronic trading U.S. Treasury bonds. One suggestion to alter the definition of “dealer” is tucked into a footnote. This could make crypto’s decentralized finance wing more effective without ever referring to DeFi.

Jake Chervinsky, Blockchain Association head for policy, explained on Twitter that the rule would expand the definition of regulated “dealers” to include those who ’employ passive markets making strategies’ that have the ‘effect of providing liquidity to others.

Snoozer, right? Isn’t this exactly how DeFi works?

DeFi is an acronym that stands for “decentralized financing” and refers to blockchain applications that allow people to bypass financial intermediaries. You can borrow and lend assets without a bank, and you can swap tokens with no broker.

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This is different than Binance or Coinbase, which take custody of assets for users. DeFi allows you to keep your assets all the time. Even though there is no one else trading on that particular trade, automated market maker (AMM), protocols allow users to trade one asset for another listed on an exchange. You might swap Axie Intinity with ApeCoin. However, APE does not want AXS.

To swap tokens on AMMs in a decentralized manner requires large amounts of liquidity. The DeFi protocol rewards people with digital assets by incentivizing them to store their tokens in vaults so that the exchange can temporarily draw upon it to facilitate trades.

This is how DeFi might be affected. Gabriel Shapiro , Delphi Digital General Counsel, tweeted that the “SEC will argue all [automated markets maker liquidity providers] were not registered dealers. This would be similar to saying that all Bitcoin miners [virtual assets service providers] – if enforced it would kill the tech.

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Hester Peirce (SEC Commissioner), who is often at odds with her colleagues when it comes to issues related to digital assets, has also concerns. However, she doesn’t mention DeFi. She asks specifically if the expanded definition might cause liquidity to dry out.

She writes that a more diverse set of liquidity providers can increase market resilience. When one type of liquidity provider is unable to step in, another might be able to fill it.” A market where all liquidity provision is concentrated in a few large dealers, regulated according to the traditional model (which the proposal seems favor) may lead to market liquidity being lower and not increasing market resilience.

Furthermore, although the motivation for the change appears to be to reduce risk from liquidity providers with too much leverage, she says we shouldn’t worry: “Markets are actually stronger when individual firms realize they can fail, and that nobody will be there to save them.”

Web3 supporters don’t want DeFi failure. They pay close attention to the fine print.

Elena Argyros

Elena Argyros

Elena is cryptocurrency writer / journalist based in Europe. She has extensive knowledge in the crypto space and is a solidity programmer by trade. Elena has built an extensive resume working with some of the most ground breaking blockchain firms. Being in Europe, Elena has amassed a large network of professionals in the space and states "The technology behind blockchain is going to impact everyone on earth in a good way, once you get to understand it".
Elena Argyros

Elena Argyros

Elena is cryptocurrency writer / journalist based in Europe. She has extensive knowledge in the crypto space and is a solidity programmer by trade. Elena has built an extensive resume working with some of the most ground breaking blockchain firms. Being in Europe, Elena has amassed a large network of professionals in the space and states "The technology behind blockchain is going to impact everyone on earth in a good way, once you get to understand it".

© 2022 The Daily Encrypt. All Rights Reserved. This article is provided for informational purposes only. It is not offered or intended to be used as legal, tax, investment, financial, or other advice.

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