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U.S. futures regulator says DeFi derivatives are ‘bad idea’

June 9, 2021, 10:00 PM UTC

A U.S. derivatives regulator is putting a damper on DeFi.

Dan M. Berkovitz, a commissioner for the Commodity Futures Trading Commission (CFTC), openly criticized decentralized finance—commonly referred to as DeFi—during a conference on June 8, throwing into question its necessity, and even its legality.

“Not only do I think that unlicensed DeFi markets for derivative instruments are a bad idea, I also do not see how they are legal under the [Commodity Exchange Act],” Berkovitz said at the 2021 Asset Management Derivatives Forum.

Berkovitz’s statements come alongside a massive influx of new money and innovation into the DeFi marketplace, which is largely built on top of the Ethereum blockchain, the platform behind cryptocurrency Ether. 

DeFi applications sit on blockchain technology and use “smart contracts,” in which agreements are enforced by code rather than financial intermediaries, to power peer-to-peer lending as well as crypto trading or investing.

For Berkovitz, this poses a major concern for the U.S. regulated financial markets. He says that registration of digital currencies, blockchains, or smart contracts shouldn’t happen independently of commodity exchange rules, which require that futures contracts be traded on markets licensed and regulated by the CFTC.

“It is untenable to allow an unregulated, unlicensed derivatives market to compete, side by side, with a fully regulated and licensed derivatives market,” Berkovitz said. This could incentivize regulated entities to assume more risk to generate the higher yields necessary to compete, or seek less regulation themselves, he added.

Berkovitz is hardly the only skeptic. Crypto and blockchain technology, or at least risks posed by them, have been a point of emphasis for regulators. DeFi platforms could “raise a number of challenges for investors and the SEC staff trying to protect them,” Securities Exchange Commission chairman Gary Gensler recently said.

Many proponents believe in the underlying promise for potential innovation. The Federal Reserve Bank of St. Louis recently published research from a professor who studies blockchains and DeFi, that points to certain risks alongside the potential to “contribute to a more robust and transparent financial infrastructure.”

SEC commissioner Hester Peirce, whom some crypto fans endearingly refer to as “CryptoMom” because of her support of digital currency, said earlier this year that regulators need to provide legal clarity on the matter, while offering the “freedom to experiment” so that DeFi can compete with the centralized financial services market.

Whatever the case, DeFi enthusiasts may be able to expect more attention from the CFTC over DeFi derivatives in the future. Berkovitz called on his own agency as well as others to address the matter.

“The CFTC, together with other regulators, needs to focus more attention on this growing area of concern and address regulatory violations appropriately,” Berkovitz said.

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