Legal experts from Polygon Labs and Arktouros have put forward a groundbreaking proposal to classify truly decentralized DeFi protocols as “critical infrastructure” and place them under the oversight of federal cybersecurity agencies in the United States. The aim of this regulatory framework is to combat illicit financial activities in the DeFi space and strengthen the security and resilience of the financial services sector.
Rebecca Rettig and Katja Gilman from Polygon Labs, along with Michael Mosier from Arktouros, have outlined their vision for regulating the DeFi industry in a comprehensive 45-page document titled “A Conceptual Framework for Combating Illicit Finance Activity in Decentralized Finance.”
The proposal suggests designating truly decentralized DeFi protocols as critical infrastructure, to be overseen by the U.S. Treasury’s Office of Cybersecurity and Critical Infrastructure Protection (OCCIP). Although not an official financial regulator, the OCCIP plays a vital role in enhancing the security and resilience of critical infrastructure in the financial services sector. It coordinates efforts to minimize operational risk and shares valuable information about cybersecurity threats and vulnerabilities with finance firms, industry groups, and government partners.
The proposal advocates extending the OCCIP’s mandate to include oversight of decentralized DeFi protocols, in response to the growing concerns surrounding illicit financial activities in this space.
The paper acknowledges the distinction between truly decentralized and partially centralized DeFi protocols, recognizing that not all DeFi protocols are genuinely decentralized. According to the authors, protocols with significant points of centralization should be subject to existing financial regulations.
As part of the proposed legal framework, the authors propose the creation of a new category called “critical communications transmitters,” which would be integral to genuine DeFi systems. These entities would have specific obligations to protect U.S. national and economic security, without being classified as “financial institutions” subject to the Bank Secrecy Act. This novel approach aims to strike a balance between regulatory oversight and fostering innovation within the DeFi sector.
In addition to DeFi protocols, the framework also highlights the need for separate and independent regulation for centralized finance (CeFi) and traditional finance (TradFi). This differentiation aligns with guidance from the Treasury’s Financial Crimes Enforcement Network (FinCEN) and aims to ensure that each sector receives appropriate regulatory scrutiny by establishing clear boundaries.
This proposal marks a significant shift in policy focus towards combating illicit finance. Crypto industry lawyer Jake Chervinsky emphasizes the increasing concerns among policymakers in Washington, D.C., about illicit finance in the digital asset industry. While discussions have previously centered around securities and commodities laws, this framework represents a new priority. Chervinsky believes that this proposal could serve as a starting point for a comprehensive solution to address the challenges posed by illicit financial activities in the DeFi space.
The authors of the proposal emphasize the importance of not losing sight of the fundamental goal of empowering legitimate and beneficial activities within the DeFi sector. They highlight that this approach aligns with the Treasury’s mandate of promoting economic prosperity and ensuring the financial security of the United States. The proposal seeks to strike a balance between safeguarding against illicit finance and fostering innovation and economic growth within the DeFi ecosystem.
