The decentralized finance (DeFi) community must address issues of "transparency" and "pseudonymity" before it can deliver on its "new and interesting potential," cautioned SEC Commissioner Crenshaw in a recent article published in the inaugural issue of The International Journal of Blockchain Law.
Noting that not one DeFi participant within the SEC's jurisdiction has yet to register with the SEC, Commissioner Crenshaw urged DeFi participants to engage with agency staff, warning that "without a common set of conduct expectations, and a functional system to enforce those principles, markets tend toward corruption, marked by fraud, self-dealing, cartel-like activity, and information asymmetries."
Commissioner Crenshaw attempted to debunk the idea that DeFi is "more egalitarian and transparent" than traditional finance (TradFi).
She stressed that "retail investors are already operating at a significant disadvantage to professional investors in DeFi" because "much of DeFi is funded by venture capital and other professional investors," and these arrangements are rarely disclosed to the public.
Commissioner Crenshaw further expressed her concerns that the resulting information asymmetry "contributes to a two tier market in which professional investors and insiders reap outsized returns while retail investors take more risks, get worse pricing, and are less likely to succeed over time."
Pseudonymity in blockchain parlance refers to the fact that visibility of transactions is limited to the public address "that sent or received assets, but not the identity of the person who controls it."
Commissioner Crenshaw shared her observation that pseudonymity "makes it much easier to conceal manipulative activity and almost impossible for an investor to distinguish an individual engaging in manipulative trading from normal organic trading activity," and further advised that DeFi "projects that solve for pseudonymity are more likely succeed."
Without a common set of conduct expectations, and a functional system to enforce those principles, markets tend toward corruption, marked by fraud, self-dealing, cartel-like activity, and information asymmetries.