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May 28, 2024

Navigating DeFi's Regulatory Complexities with Chris Brummer and Rebecca Rettig

It's not every day that you find someone who is as well versed in technology as they are in law, but Rebecca Rettig pulls it off just about every day as the head of law and policy at Polygon,” Brummer said. “Her job is to do what many of us can’t.  She delves into the tech, law, and politics of crypto to excavate legal and policy strategies for thorny issues in digital assets.

Dr. Brummer, a seasoned expert in financial technology, steered a conversation one would expect to be associated with securities law and capital markets, towards banking regulation in order to shed light on how traditional legal frameworks, like the Bank Secrecy Act, struggle to mesh with the decentralized and dynamic nature of DeFi. The insights shared during the podcast made the complexities of these issues accessible and intriguing, reflecting Brummer’s talent for making dense regulatory topics palatable and engaging for a broad audience.

For her part, Rettig provided a comprehensive overview of what she calls the financial integrity regime in the United States, emphasizing the significance of the Bank Secrecy Act and sanctions in combating illicit economic activities. Rettig provided a comprehensive overview of what she calls the financial integrity regime in the United States, emphasizing the significance of the Bank Secrecy Act and sanctions in combating illicit economic activities. She then highlighted the evolution of the BSA from its inception in 1970 as a record-keeping regime to its current role in anti-money-laundering efforts and the prevention of financial crimes.

While traditional financial intermediaries like banks and money transmitters are subject to the BSA, the decentralized nature of DeFi presents, she argued,unique challenges. Rettig explained that identifying intermediaries in permissionless systems is a crucial issue, as these systems lack identifiable actors performing traditional financial functions.

Said Rettig: “I think when you get to permissionless software or applications that are built on permissionless software that also are permissionless and run autonomously, the question is, well, what do we do there? Sanctions, people have come up with all sorts of workarounds and things like that. But I don't think it's impossible to achieve the goals of our financial integrity regime in decentralized systems, but I don't think it looks exactly the same.”

There are several operational challenges faced by regulators and policymakers in addressing illicit finance in the DeFi space. While there are technical solutions available, such as wallet monitoring and on-chain tracing, there’s a need for a nuanced approach that aligns with the goals of the financial integrity regime.

Identification of System Control Persons

One of the core concepts proposed in the paper is the identification of what Rettig calls system control persons. These individuals or entities perform functions akin to traditional financial intermediaries within DeFi ecosystems. Rettig explained to Chris Brummer, “So, is there a system control person? If yes, then the second step is, are they engaged in activity that a financial institution would be engaged in? And if so, then there is regulation?

“Now, sometimes there may be a system control person and they're not subject to the BSA, depending on what they're doing. Holding an emergency multi-sig key probably does make you a system control person, but does not make you a financial institution because you're using it only in the case of emergency. So that's the first part of the framework.”

Proposal for Critical Communications Transmitters

To mitigate illicit finance risks associated with critical infrastructure DeFi protocols, the paper also introduces the concept of critical communications transmitters. These entities, such as remote procedure call node as a service providers, play a crucial role in facilitating user-initiated communications within DeFi networks.

“We propose something, a new category called critical communications transmitters,” Rettig said on Fintech Beat. “They are not financial institutions and they will not be subject to the BSA under this proposal. But what they are really trying to do is meet the documentation, detection, and deterrence, actually prevention goals in a really serious way.”

The innovative proposals put forth in this paper and discussed by Dr. Chris Brummer and Rebecca Rettig mark a significant departure from conventional regulatory approaches. By acknowledging the nuances of DeFi and proposing tailored regulatory categories, the paper strikes a balance between regulatory oversight and technological innovation. This approach is particularly relevant as DeFi continues to gain prominence, necessitating adaptive regulatory frameworks that address emerging challenges while fostering industry growth.

Cross-Border Applications

Chris Brummer asked Rettig, “We do have plenty of international listeners, so over in the U.K., and Australia, and in Asia. Any lessons here that you think could be useful from a cross-border standpoint?”

Rettig acknowledged the global relevance of such discussions, replying, “Yeah, that's great because it's where we've really started thinking about it as well. So I think some of it just goes to going to talk about these tech solutions. Everyone's been saying tech solutions all over the world, and so regardless of what, OK, fine, there's no BSA in the EU or in Japan or wherever, but there are really serious illicit finance concerns.

“And so I think talking about why this framework actually meets goals more than using old systems or old regulations that worked for the old systems is really important to do. And to that end, we have a two-page summary, and so if people don't want to read the 45 pages and deal with a lit review footnote or anything, then there's a two-page summary that's out there as well.”

The Way Forward

The road from here is winding, but in plain sight. Nearing the end of the conversation, Rettig discussed the possibility of engaging with key stakeholders such as the treasury and private sector experts to assess feasibility and garner necessary support. She also highlighted the need for robust collaboration, mentioning the potential for the Financial Services Information Sharing and Analysis Center to play a pivotal role.

The focus shifts from mere education to practical implementation, stressing the importance of demonstrating the efficacy of new frameworks compared to traditional regulations like the BSA across different layers of technological infrastructure. This agrees with ongoing efforts to align priorities with legislative bodies, in areas like fintech and regulatory compliance.

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