Decentralized finance, or “DeFi”, is a term that encompasses all crypto activities trying to replicate functions of legacy financial systems through the use of blockchain technology and smart contracts. Although the nascent sector presents a panoply of opportunities, it also poses inherent risks for investors and the financial markets, as well as unique challenges for regulators. With major hacks and scams plaguing the fast-growing industry, the regulatory bodies are becoming increasingly concerned about the risk of crime as well as harm to investors.
As with the entire cryptocurrency industry, regulators have yet to stake out the DeFi territory and its various applications. Recent news coverage has also highlighted the emergence of Non-fungible Tokens (NFTs).
That said, the regulation of these transformative technologies is blurry. There is no such federal agency that has clear authority over a particular DApp, NFT, or even the entire industry. Who regulates the DeFi space?
This regulatory silence, however, didn’t provide relief for users or firms active with these technologies. There is a minimum compliance burden that’s likely incumbent on all parties. So, regardless of the current regulatory landscape, it is wise for associated institutions to consider compliance aspects to protect their business.
Max Dilendorf, Esq. and Micaela Baldner from Dilendorf Law Firm addressed these issues in an article entitled “ Regulatory Concerns Regarding DeFi/NFT Transactions .” The authors have tried to answer existential questions at this critical time for the digital asset industry.
What happens after one transacts on a DeFi network or buys an NFT? What process must be used to transfer decentralized earnings into a centralized financial institution? Do banks accept decentralized earnings without a detailed transaction history? If not, what are banks’ standards for filing suspicious activity reports (SARs) with the Financial Crimes Enforcement Network (FinCEN)?
Dilendorf’s legal experts recommend that entities and users in the DeFi space should begin their compliance process now by implementing basic rules for compliance with the AML measures overseen by FinCEN. The latter is the US Financial Information Unit to whom other US agencies report suspected violations. It also collects and analyzes information about financial transactions to combat money laundering, terrorist financing, and other financial crimes.
FinCEN’s authority also includes settling lawsuits and other legal issues with violators, or referring them to federal prosecutors.
Dilendorf and Baldner further explain how the compliance steps may be taken to prevent any potential lapses from developing later.
Financial institutions are required to file complete, accurate, and timely SARs in order to provide FinCEN with a method of identifying emergency trends and patterns associated with financial crimes. The purpose of the SAR is to report known or suspected violations of law or suspicious activity observed by financial institutions subject to the regulations of the Bank Secrecy Act of 1970 (BSA).
Considering the serious financial implications associated with becoming the subject of a SAR, it is worthwhile to mention that financial institutions have not been transparent about the guidelines or standards used to determine when they will consider filing a SAR. Instead, they have stated that such determinations are made on a case-by-case basis, ultimately leaving both bank account holders and the public in the dark. Crypto markets suffer from structural limitations
The NFTs are rapidly entering the mainstream without specific safeguards as they actually do not fit squarely within the parameters of traditional financial instruments. The authors, who have decades of combined experience as transactional attorneys, business consultants, commercial litigators, and entrepreneurs, examined this operational and regulatory dilemma.
For instance, take the individual who sold an expensive NFT on an unregulated marketplace and received payment from a wallet that he or she later found out was attached to an entity in a sanctioned jurisdiction such as Iran or North Korea. How can this individual protect his or her decentralized funds, or more importantly, how will a financial institution treat such individual’s funds?
From a business’ perspective, NFTs marketplaces and creators should also consider whether registration is required as a money services business or licensing as a money transmitter. Depending on facts and circumstances, anti-money laundering/Bank Secrecy Act (AML/BSA) obligations and securities laws may apply to their businesses.
Specifically, the article further reads, the BSA requires financial institutions to keep records of cash purchases of negotiable instruments, file reports of cash transactions exceeding $10,000, and to report suspicious activity that might signify money laundering, tax evasion, and other criminal activities.
To further this aim, in December of 2020, FinCEN proposed a new anti-money laundering rule aimed at reducing the anonymity allowed by certain cryptocurrency […]
source Regulatory concerns that stand behind DeFi/NFT transactions
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