The Future of Crypto Adoption is Law.
Crypto Platform Regulation — A Liability Issue (Part 1)
What if you accessed a DEX (decentralized exchange), made an exchange, but never received the crypto you purchased?
Who do you call on to compensate you? This will be one of the central issues in crypto regulation.
More broadly put:
When a transaction is performed via a decentralized peer-to-peer mechanism, who is liable when something goes wrong? Who is accountable?
This is an issue many financial regulators are soon to be faced with.
One of the positives stemming from the crypto revolution is the decrease in dependency on banks, and the traditional financial system. Though this innovation appears to have a two-sidedness: banks also hold responsibility and liability to keep your money safe. Decentralized exchanges and other DeFi protocols do not hold this responsibility since they never hold your tokens.
As of right now, many governments are attempting to regulate platforms that operate via the use of crypto assets. Notable initiatives such as the MiCA (Markets in Crypto Assets) and the Infrastructure Bill. Both these regulatory instruments attempt to target platforms under the name of ‘brokers’.
This definition works well for exchanges operating in a centralized manner such as Binance, Crypto.com, and Coinbase. Here, no smart contracts are used by the user. A user only enters a buy order: e.g. 1 BTC for 39.000 euros and Binance fulfills this buy order for the client. This action is standard for brokers.
The complexity of this issue arrives when the protocol or exchange is completely decentralized and allows users to interact with smart contracts via a GUI (general user interface). Examples of these kinds of platforms are Uniswap, Sushiswap, and DeFi protocols. For ease of reading, I will refer to these types of actors within crypto as ‘decentralized platforms’.
The concept of ‘a broker’, implies direct contact with both parties performing the transaction in the form of a middleman. The dichotomy that is observed with this ‘broker’ definition is the lack of middlemen in most smart contracts. It seems that the broker that is being addressed (in bills such as the US Infrastructure Bill) is the project behind the smart contract or the holder of the domain name.
Platforms that operate in a decentralized manner, or by allowing users to engage with smart contracts tend to fall in a gray area under this type of regulation when it comes to liability. Technically, these decentralized platforms are not operating as brokers, since the individuals using their website interact with the smart contract.
The operators of decentralized platforms are merely performing the following actions: 1) facilitating access to the URL, 2) facilitating ease of access to the smart contract (often written by the owners of the protocol/project), 3) deploying a smart contract for (non-expert) users to engage with via the GUI, 4) marketing this platform to the masses, and 5) engaging in strategic partnerships with other entities. (nr.5 being optional).
The question left here is: who is liable when something goes wrong? The platform, or you? Additionally, where does the scope of liability end?
This is something that has not been fully legislated as of yet, so here it seems appropriate to do some legal speculation.
It seems reasonable to say that being your ‘own bank’, comes with the same responsibilities as that of the bank in a traditional sense. Though this responsibility ends at the point of storing wealth. Nonetheless, when other financial vehicles are accessed (e.g. loans or earning interest — the general domain of DeFi) there is a third party involved. This third party is the company or group behind the DeFi protocol/platform since they created the smart contracts needed to operate the product they are allowing consumers to interact with.
The argument, or nuance that I am proposing here is that even though crypto transactions are per default peer-to-peer, there still is an intermediary involved with every process. And arguably, this intermediary should hold some degree of liability and a fiduciary duty to their user base. If they do not have this, it leaves many possibilities for consumer harm.
Examples of this lacking regulatory environment are mainly found in there not being any requirements for transparency in crypto (though theMiCA proposal does require certain things of crypto-asset service providers such as white papers, and actual incorporation). The anonymity of members of crypto projects, no whitepaper requirements, no incorporation requirements, all leaving much to trust, without the possibility of holding anyone accountable when issues arise.
This important issue is currently not in regulatory focus. Many legislative efforts seem to fixate on centralized crypto projects, possibly since they are the larger financial institutions in crypto at this time and have high transaction volumes(Binance, Coinbase etc.). Due to this focus, regulation still misses a significant part of the actual issues within crypto: consumer harm following from a lack of accountability on the end of the protocol owners and project teams.
What are your thoughts on this: to what degree should each party be held accountable, and are there actual intermediaries in crypto, how would you define them?
Let me know!
