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On January 8, 2024, the CFTC’s Technology Advisory Committee issued a detailed report on decentralized finance, or DeFi. The report, which was authored by the Subcommittee on Digital Assets and Blockchain Technology, notes that DeFi offers both promising opportunities and complex, significant risks to the US financial system, consumers and national security.

The report urges policymakers to balance a series of inter-related issues, including customer and investor protection; promoting market integrity; ensuring safety and soundness, financial stability and mitigating systemic risk; combating illicit finance and protecting national security; reinforcing and securing US competitiveness and leadership; and expanding access to safe and affordable financial services. To that end, the report makes a series of recommendations, each of which is discussed in great detail:

Resource assessment, data gathering and mapping. According to the report, the first priority for policymakers should be to increase their technical capacity and understanding, including by identifying what they do and do not yet know about DeFi.

Survey the existing regulatory perimeter. The report urges policymakers to use the mapping exercise as the basis for determining whether and how DeFi systems, including the wide range of activities and functions they perform, currently bring them within the perimeter of US financial and non-financial regulation.

Risk identification, assessment and prioritization. Policymakers should seek to systematically identify, define and catalogue the risks arising in connection with DeFi, including those pertaining to asymmetric information and conflicts of interest, operational and security vulnerabilities, liquidity and maturity mismatches, over-leverage, hardwired algorithmic failures and procyclicality, complexity and concentration risks in DeFi compositions, and market manipulation and illicit finance.

Identifying and evaluating the range of potential policy responses. In conjunction with the risk assessments, the report urges policymakers to evaluate the range and likely effectiveness of regulatory strategies and risk mitigations for DeFi.

Fostering greater engagement and collaboration with domestic and international standard setters, regulatory efforts and DeFi builders. According to the report, policymakers should develop a strategy for fostering greater engagement and collaboration within the domestic regulatory community, with standards and research bodies (such as the National Institute of Standards and Technology), as well as with the DeFi industry to establish not only policy objectives but also the means by which to achieve them.

Apply recommended framework to drive near-term, prioritized progress on digital identity, “know your customer” (KYC) and anti-money laundering (AML) regimes and calibration on privacy in DeFi. The report observes that pseudonymity and disintermediation provided in most DeFi systems presents serious concerns for policymakers focused on ensuring AML and countering financing of terrorism (AML/CFT) regimes are effective and provide appropriate protections and victim recourse for consumers.