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On September 10th, 2024, the House Financial Services Committee’s Subcommittee on Digital Assets and Financial Inclusion held a hearing entitled “Decoding DeFi: Breaking Down the Future of Decentralized Finance.” The hearing lasted approximately 2 hours. This was the first Congressional hearing dedicated to decentralized finance. 

Summary 

With this being the first DeFi Hearing within the US Congress, both parties, as well as industry witnesses, hit their key talking points. Legislation was not discussed heavily, aside from sparse mentions of the Financial Innovation and Technology for the 21st Century Act (FIT 21) that passed the House earlier this year. Instead, participants debated benefits, risks, regulatory purview, and appropriate legal categorization of the decentralized protocols underlying the industry. This concept of DeFi protocols being more akin to internet telecommunications infrastructure than financial infrastructure is not new within industry but has not been met with open ears by Members of Congress—until now. 

Overall Impression 

  • Democrats focused on bad actors in the space and the overall illicit finance risks of Defi—which witnesses pointed out are also a large issue in traditional finance. Discussion from Democrats included: 
    • Regular talking points for digital assets: that bad actors continue to engage in illicit activity using DeFi to conceal the origins and endpoints of crypto funds, using self-hosted wallets, chain-hopping, and anonymity-enhanced cryptocurrencies to quickly launder money, fund terrorist activities, and evade taxes.  
    • Ranking Member Lynch referenced the US Treasury Department’s risk assessment report as evidence. In a break from historic Democratic talking points regarding digital assets, however, Mr. Lynch stated there is a need for anonymity, greater efficiency, and privacy in finance—all benefits that DeFi provides. But in a return to form, Lynch then championed the centralized solutions leveraging US government systems, such as FedNow, the Federal Reserve’s real-time payment system, and MIT’s Central Bank Digital Currency Pilot Project Hamilton, as superior methods of supporting those needs. 
    • DeFi should have been addressed as part of a broader digital asset bill, such as FIT 21, instead of being pushed out to explore later. This is despite most jurisdictions worldwide, including the European Union, focusing on broader crypto legislation first, leaving DeFi legislation until after official government studies are completed. 
  • Republicans focused their attention on broader blockchain use cases, such as the concept of a decentralized web that empowers users over large tech companies. Also discussed was the ongoing lack of regulatory and legal clarity provided to DeFi protocols that must nevertheless navigate overlapping regulatory jurisdictions in areas such as KYC/AML, tax reporting, and SEC and CFTC registration. Republican discussion included: 
    • Highlighting that DeFi is an improvement on the existing financial system, filling gaps and creating efficiencies by eliminating the need for intermediaries, enabling self-custody, heightening the security of assets, settling payments faster and with lower fees, and enabling users to enjoy enhanced privacy protections. 
    • Emphasizing that DeFi would benefit from a different regulatory framework than what exists for Traditional Finance due to fundamental differences such as a lack of intermediaries. A disclosure-based regime, as opposed to a registration-based one, was discussed as a potential path forward. 
  • Industry witnesses were given a platform to explain the technology, the ecosystem, and debunk myths and misconceptions about both. Though it was contentious at times, the hearing overall demonstrated a willingness by lawmakers to better understand DeFi in earnest. Industry witnesses came prepared to help them in that regard, and with policy frameworks and recommendations in hand. 
  • Witness 1: Brian Avello – Chief Legal Officer at Universal DeFi Holding Company (UDHC) – [Testimony Link] 
  • Witness 2: Rebecca Rettig – Chief Legal and Policy Officer at Polygon Labs – [Testimony Link] 
  • Witness 3: Amanda Tuminelli – Chief Legal Officer at DeFi Education Fund – [Testimony Link]  
  • Witness 4: Peter Van Valkenburgh – Director of Research at Coin Center – [Testimony Link] 
  • Witness 5: Mark Allen Hays – Senior Policy Analyst at Americans for Financial Reform – [Testimony Link] 

 Key Points  

How DeFi Technology Works 

  • Overview: Witnesses were asked both introductory and advanced questions on the technical workings of DeFi protocols. Some Subcommittee members took this Hearing as an opportunity to educate themselves in the basics, while others saw it as a platform for industry to share their nuanced perspectives, as well as their technical and legal expertise on the technology and the ecosystem. 
  • Perspective: That Republican Members—and select Democrats—not only focused on the financial application of DeFi protocols and their efficiencies over TradFi but also on other use cases that would allow a more free, decentralized internet, demonstrates how far these lawmakers have come over a relatively short period of time since DeFi’s general introduction to the world during the Summer of 2020. This signals an understanding by these lawmakers of how significant DeFi is and the importance of crafting appropriate legislation. 

Benefits and Risks of DeFi Compared to Traditional Finance (TradFi) 

  • Overview: A running theme of this hearing was the cost-benefit analysis of the risks and rewards of DeFi, viewed both as something net new, and when compared to the existing financial system where centralized intermediaries serve as tentpoles. 
  • Perspective: The risk/benefit comparison allowed for preconceived notions about DeFi to be addressed and refuted, with witnesses providing clear examples of risk mitigation and improvements in DeFi compared to TradFi. Tuminelli flagged the work of crypto ISACs (Information Sharing and Analysis Centers) that work to advance security initiatives across the globe and assist in returning consumer funds. Rettig also pointed out the DeFi ecosystem’s partnerships with law enforcement, combined with the transparency of on-chain activity, which has helped illicit actors be found and charged orders of magnitude faster in DeFi than in traditional finance.    

Legal and Regulatory Implications and Treatment of DeFi 

  • Overview: The legal and regulatory focus was appropriately broad, covering more than the standard regulatory jurisdiction debate between SEC and CFTC oversight. Additional areas of discussion covered illicit activity, KYC/AML requirements, digital identity, custodianship, cybersecurity, and telecommunications. Importantly, the outstanding issue on the treatment of DeFi protocols as Brokers under the Bank Secrecy Act—as written in the 2021 Infrastructure Investment and Jobs Act—was raised. That definitional expansion has been at the heart of DeFi legal and policy discussions—and industry concerns—since the 2021 bill was introduced, as it would impose information gathering and reporting requirements on decentralized smart contracts acting as market makers (such as Decentralized Exchanges) and their developers, and capture wallet developers and some blockchain node validators. 
  • Perspective: The breadth of regulatory areas and outstanding questions that were covered demonstrate that lawmakers on the Subcommittee have gained a more mature, holistic understanding of DeFi technologies, protocols, and the activity taking place in the ecosystem through varied methods and use cases. This is a move forward in the right direction and is a critical step needed to introduce effective, appropriate legislation that allows the industry to continue innovating within the US under a regime that recognizes its value. 

TDC experts are available for comment, please contact: press@digitalchamber.org