The decentralized finance (DeFi) landscape is navigating a pivotal inflection point. Legal frameworks have failed to keep pace with the voracious technology-driven dynamic of our times. Meanwhile, several US states are actively trying to incorporate Decentralized Autonomous Organizations (DAOs) into their corporate structures via legislation. The lack of established guidelines only adds to the confusion for companies. This regulatory gap is further complicated by enforcement actions from agencies like the US Securities and Exchange Commission (SEC) and the Commodity Futures Trading Commission (CFTC) against DAO participants and DeFi protocols. The underlying tricky bit is determining legal liability for autonomous software. We must address the accountability of the people behind these decentralized systems.
The lack of specific guidance instead creates enormous uncertainty and peril to the further development of DeFi. It creates chilling environments that prevent innovation for fear of being sued. In the interim, loopholes are exploited by bad actors. This is where programmable regulation comes in to join the dots between what’s new and cool and what’s required by law. It provides a path for DeFi to continue developing under a structure that promotes transparency, efficiency and investor protection.
The DAO Legal Landscape
Because DAOs operate according to rules encoded in smart contracts, they pose a particularly thorny challenge to existing legal frameworks. Courts are having a hard time figuring out if autonomous software should even be liable for anything in the first place. This lack of clarity complicates questions of accountability and responsibility in a highly decentralized movement.
Other states such as Wyoming have gotten in front of the issue by enacting legislation that gives DAOs a limited, corporate-like legal status. This legislative approach provides DAOs with a prominent and straightforward clear legal structure. It enables them to plan and undertake various business initiatives with greater assurance and reduces the threat of sudden legal ambiguity. Now North Carolina’s example has inspired other states to explore similar measures. This is indicative of a growing understanding of the need to reform legal structures for decentralized entities.
These legislative efforts are significant and necessary to encourage DeFi innovation and market growth. With the right legal framework for DAOs, states can both draw in investment and drive innovation and entrepreneurship. This approach encourages the responsible development of decentralized technologies. This absence of consistency between jurisdictions creates hurdles for DAOs. Such inconsistency is no small matter and can pose profound burdens for businesses that work nationally or globally.
Regulatory Enforcement and DeFi
Specifically, the SEC and CFTC have used enforcement actions to go after individuals participating in DAOs and/or DeFi protocols. Taken together, these moves represent the high degree of regulatory pressure being brought to bear against DeFi. They illustrate the legal risks of working in this space. Often the agencies’ concerns have been rooted in ideas of investor protection, market manipulation, and/or adhering to the letter and spirit of securities laws.
As acknowledged in the recent SEC enforcement actions above, regulatory clarity for DeFi is sorely needed. While regulators are seeking to protect investors and maintain market integrity, the lack of clear rules and guidelines can create confusion and uncertainty for DeFi projects. We need to ensure sufficient regulatory oversight while recognizing that we cannot stifle innovation. Maintaining this balance is absolutely vital for DeFi to continue to develop and mature in a responsible way.
It’s the application of these existing securities laws to DeFi that makes things tricky. We know that many DeFi protocols are truly decentralized and autonomously governed. This undercuts two foundational ideas about control and fault/proximate cause that these statutes are built upon. Determining who is accountable for compliance and how to enforce regulations in a decentralized environment requires careful consideration and innovative solutions.
Programmable Regulation: A Path Forward
Programmable regulation also provides a compelling answer to the Slaughter Plan’s concerns about regulating DeFi. This strategy would mean putting regulatory expectations right into the code that makes up the smart contracts behind DeFi protocols. By automating compliance, programmable regulation increases transparency and reduces the chance for human error. Secondly, it helps put DeFi protocols on the right side of the law.
"We are at a crossroads, either reimagining the intersection between DeFi and law or allowing the gap between regulation and permissionless innovation to widen." - Raks Sondhi
Fostering the new metaskill of programmable regulation necessitates further exploration and co-creation among regulators, technologists, and legal scholars. It requires converting legal obligations into enforceable rules that can be implemented by smart contracts. This process takes an extensive expertise in working with the legal and technical side of DeFi.
"One path leads to inclusive, efficient, transparent finance governed by rules everyone can see and understand." - Raks Sondhi
The possible adoption of programmable regulation can help facilitate trust and confidence in the DeFi ecosystem. Second, DeFi protocols can be programmed to automatically comply with legal requirements. This process dramatically lowers the opportunity for fraud, manipulation, and other criminal behavior. This helps draw the most institutional investors and mainstream users to DeFi, further propelling its growth and adoption.
"The other path leads to gray markets, enforcement chaos and capital flight." - Raks Sondhi
