DeFi Probes Should Focus on the Developers in Charge, Standards Body Says

Emily Nicolle, Bloomberg News

LONDON, ENGLAND - APRIL 25: In this photo illustration of the litecoin, ripple and ethereum cryptocurrency 'altcoins' sit arranged for a photograph beside a smartphone displaying the current price chart for ethereum on April 25, 2018 in London, England. Cryptocurrency markets began to recover this month following a massive crash during the first quarter of 2018, seeing more than $550 billion wiped from the total market capitalisation. (Photo by Jack Taylor/Getty Images) , Photographer: Jack Taylor/Getty Images

(Bloomberg) -- In the crackdown on decentralized finance, regulators should assume power is anything but dispersed.

That’s the message from the world’s top securities standards body, which recommended regulators home in on the people and organizations that directly influence or control areas like design, maintenance and finance in DeFi, which underpins the cryptocurrency industry.

Projects are operated by automated blockchain-based contracts and are usually overseen by large groups with no one person in charge.

“There is a common misconception that DeFi is truly decentralized and governed by autonomous code or smart contracts,” said Tuang Lee Lim, chair of IOSCO’s board-level fintech task force, said in a statement. “In reality, regardless of the operating model of the DeFi arrangement, ‘responsible persons’ can be identified.”

The framework proposed in a report Thursday by the International Organization of Securities Commissions follows in the footsteps of a controversial legal case in the US regarding Tornado Cash, a decentralized crypto mixer.

There, authorities charged two of the original developers of Tornado Cash with helping to launder more than $1 billion in digital assets for clients including a North Korean hacking group. Tornado Cash was designated as a sanctioned entity by the US Treasury Department last year, a move that inspired a string of lawsuits by major industry names such as crypto exchange Coinbase who challenged the goverment’s authority over the area.

Read more: Why Sanctions on This Crypto Platform’s Founders Pose an Existential DeFi Threat

Other recommendations included assessing where DeFi platforms might fall under existing financial rules, requiring platforms to identify and disclose conflicts of interest, and promoting cross-border cooperation between regulators and enforcement agencies.

While the report refrained from highlighting any specific project, a number of factors used in the US case against Tornado Cash were listed by IOSCO as ways to identify central actors in DeFi. It noted that in the case of so-called decentralized autonomous organizations, which often manage DeFi projects, less than 1% of a project’s token holders typically control 90% of the organization’s total voting power.

“Who’s raising money for the project, who’s in charge of maintaining it? Who was steering the direction of any particular project?” said Valerie Szczepanik, head of the US Securities and Exchange Commission’s strategic hub for innovation and financial technology. “Oftentimes, there are small groups of people actually controlling it.”

The report is intended to chime with an earlier framework proposed by IOSCO for cryptoasset regulation more broadly, which was published in May, with a public consultation on its recommendations now open until Oct. 19.