Can the White House protect DeFi?

Author: Alex Urbellis Source: unchainedcrypto Translation: Shan Ouba, Golden Finance

Alex Urbelis is an internationally renowned technology lawyer and cybersecurity expert, Professor of Law at King's College London, and General Counsel and Chief Information Security Officer of the Ethereum Name Service (ENS). Alex bridges the gap between legal and technical expertise and is the architect of an award-winning cyber threat intelligence platform designed to identify signs of impending cyberattacks, impersonation, and other malicious activity.

In this article, he explores why Washington's progress in the cryptocurrency space has failed to advance the cause of decentralization. He warned that if this practice isn't corrected, it may be too late. The United States is becoming the crypto capital of CeFi. Here's why change is necessary. Bo Hines didn't make much progress in decentralized crypto during his time in the White House. How can his successor, Patrick Witt, become a champion of DeFi? When Bo Hines stepped down as executive director of the President's Digital Asset Advisory Council, he boasted that he, along with White House AI and crypto czar David Sacks, had "positioned the United States as the crypto capital of the world." However, his eight-month tenure (after which he left for a high-paying position at a highly centralized crypto company) primarily resulted in significant victories for centralized crypto (CeFi). Among its greatest achievements was the July passage of the GENIUS Act, which paved the way for centralized stablecoin companies like Circle. This legislation has been mistakenly equated with support for decentralized finance (DeFi), but the opposite is true. Decentralization is being sidelined. With Patrick Witt, Hines's deputy, taking over, Witt should demonstrate a deep understanding of the power of decentralization. Otherwise, the United States risks being trapped in the structures of centralized finance (CeFi). The promise and power of cryptocurrency cannot be separated from its decentralized principles. How the US is supporting CeFi at the expense of DeFi The GENIUS Act only allows “licensed payment stablecoin issuers” to operate in the US, which significantly favors centralized companies like Circle. Broadly speaking, a “licensed entity” means one that has received federal approval from the Office of the Comptroller of the Currency (a federal banking regulator) or equivalent state regulators, has established anti-money laundering (AML) and Bank Secrecy Act (BSA) compliance programs, and undergoes regular audits. While decentralized companies could technically form a US legal entity, obtain a license, and meet all requirements, this would effectively make them centralized. These restrictions give companies like Circle, which has issued $73.55 billion in USDC, a distinct advantage. Indeed, it now appears that global leader Tether, with $171 billion in USDT, will have to catch up in the United States. The company recently hired Hines, mentioned above, as a senior advisor. He will serve as CEO of a new company, Tether USA₮, which will apply to become an issuer under the GENIUS Act. The 2022 FTX debacle showcased how CeFi can be a hotbed for bad actors. Sam Bankman-Fried and Alameda Research secretly and illegally colluded to misuse user funds. Ultimately, FTX was forced to file for bankruptcy due to insufficient liquid assets to cover withdrawals, resulting in billions of dollars in losses. It's crucial to remember that this triggered a series of liquidity crises caused by inter-company lending within CeFi, leading to bankruptcy filings for companies like Voyager, Celsius, and BlockFi. In the face of market turmoil, non-custodial DeFi protocols like Uniswap and Curve have demonstrated remarkable resilience, continuing to process transactions uninterrupted while collapsing CeFi platforms rapidly lost funds, providing essential and secure exit routes for funds. Centralized companies have faced similar issues. In 2018, Tether was accused of providing collateral for its stablecoin to its sister exchange, Bitfinex, to cover a hole in its balance sheet without informing investors or customers. The company ultimately paid an $18.5 million fine and settled the charges with the New York Attorney General. Then, in 2022, the TerraUSD stablecoin/LUNA DeFi ecosystem, once valued at $40 billion, collapsed when the elaborate financial engineering and secretive trading system backing the asset failed to maintain its peg. The project's founder, Do Kwon, pleaded guilty in August to two counts of conspiracy to defraud and wire fraud in the United States. Even Circle faced a decoupling crisis in 2023 when $3.3 billion worth of its USDC collateral became trapped at Silicon Valley Bank. Despite this history, CeFi remains a comfortable starting point for regulators because its business structures often resemble those of traditional financial firms. But this is not the foundation on which DeFi legislation should be built. How to Protect Decentralization As Vitt adjusts to his new role, protecting decentralization is more important than ever. With the GENIUS Act now a thing of the past, focus is shifting to long-awaited market structure legislation, which will determine key issues such as whether the U.S. Securities and Exchange Commission (SEC) or the Commodity Futures Trading Commission (CFTC) has regulatory oversight. At the heart of this debate is determining how a project can be considered decentralized. Most in the industry agree that the 79-year-old Howey Test—a legal framework for determining whether something is a security—is outdated in the cryptocurrency space. However, finding an appropriate replacement that allows for innovation while ensuring that true securities comply with the law is crucial. The recently drafted CLARITY Act, a piece of market structure legislation, which passed the U.S. House of Representatives, would allow projects to self-certify as decentralized. While this appears positive, it could confuse regulators and the industry about the definition of "decentralization." A better approach would be to include clear legislative language in the bill, focusing on decentralization based on protocol control. Ideally, I would also like to see the bill support community governance for projects by recognizing token-based voting and decentralized autonomous organizations (DAOs), especially when proposing major substantive changes to the protocol.

This last point is particularly important given that more and more projects are abandoning DAO governance under the new administration.

Don't Be Fooled by the Rhetoric

As we head into fall, key policymakers in Washington, D.C. are saying the right things, but decentralization remains under attack.

On July 31st, the SEC launched Project Crypto, a new initiative aimed at rewriting outdated rules, modernizing digital asset legislation, and bringing U.S. financial markets on-chain. SEC Chairman Paul Atkins called it the new "North Star" for the agency, which has historically taken a hardline stance on the crypto industry, leading many to be bullish on its future. Consistent with this, Atkins advocated for an "innovation exemption," a policy that would exempt new technologies and business models from burdensome regulatory requirements that don't neatly align with the SEC's existing rules and regulations. In Chairman Atkins' speech announcing the "crypto project," the words "innovation" or "innovators" appeared over 20 times. He even said, "The SEC will not stand idly by and watch innovation develop overseas while our capital markets stagnate." However, less than a week after Atkins announced his "crypto project," on August 6th, Roman Storm, co-founder of the privacy protocol Tornado Cash, was convicted. According to charges filed by the U.S. Department of Justice (DOJ), he was found guilty of "knowingly and willfully operating an unlicensed money transmitting business," sending a chill through the entire industry. Why is decentralization so important? The word "decentralization" is thrown around a lot these days, but it's important to remember why it's so crucial. Decentralization shifts power dynamics: it prevents a single entity or government from dictating rules, distorting markets, or confiscating funds. Decentralization is democratizing: it promotes user control, transparency, accountability, and resilience. In fact, the U.S. Constitution itself—with its checks and balances, separation of powers between branches of government, and deliberate protections for individual rights—is a persistent and remarkably successful example of decentralization. Nominal support for a cryptocurrency, such as underwriting a Bitcoin Vault Company, does not make someone a proponent of decentralization. Putting Bitcoin into a centralized company and having people buy shares rather than own the Bitcoin itself renders the chain's decentralization meaningless. A Bitcoin Strategic Reserve is no better; it simply swaps ownership of a centralized company for the custody of a central government. If the industry continues to tolerate centralized structures disguised as promises of a “decentralized future,” it risks making this fatal mistake again.