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DeFi Derivatives "Are a Bad Idea": CFTC Commissioner

According to CFTC Commissioner Dan Berkovitz, the agency needs to reevaluate its regulations to address new risks in the financial derivatives markets, including DeFi.

DeFi Derivatives "Are a Bad Idea": CFTC Commissioner
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Key Takeaways

  • Speaking at Asset Management Derivatives Forum 2021, CFTC Commissioner Berkovitz expressed his concerns about DeFi.
  • According to Berkovitz, DeFi-based derivatives may be violate regulations set by the Commodity Exchange Act (CEA).
  • He added DeFi is "shadow banking" that needs to be regulated.

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Dan Berkovitz, Commissioner of the Commodity Futures Trading Commission, warned against the risks of DeFi at a keynote yesterday.

CFTC Commissioner Slams DeFi Derivatives

Dan Berkovitz, Commissioner of the Commodity Futures Trading Commission, is taking a hard stance against DeFi.

Speaking at the Asset Management Derivatives Forum 2021 Tuesday, Berkovitz aired his concerns with the decentralized finance sector. Decentralized markets, mostly found on the Ethereum blockchain, allow users to exchange cryptocurrencies, financial derivatives, NFTs, and other assets without relying on any intermediaries.

Berkovitz’s speech highlighted that DeFi-based derivatives may violate regulations set by the Commodity Exchange Act (CEA), a U.S.-based law that governs the registration of such trading products. He said: 

“DeFi markets, platforms, or websites are not registered as DCMs or SEFs [swap execution facilities]. The CEA does not contain any exception from registration for digital currencies, blockchains, or smart contracts.”

The Commissioner went ahead to refer to DeFi as a “shadow financial market” that is trying to compete with regulated markets, adding: 

“For all these reasons, we should not permit DeFi to become an unregulated shadow financial market in direct competition with regulated markets.”

In particular, Berkovitz expressed worries about unlicensed derivatives trading using DeFi protocols that he believed may be considered illegal under the Commodity Exchange Act (CEA). Such unregistered derivatives include products like decentralized options and futures, synthetics, indexes, and others. Berkovitz said that derivative instruments “are a bad idea” and that he “does not see how they are legal under the CEA.” He added that the CEA requires futures contracts to be licensed and regulated by the CFTC. 

Concerns Over Lack of Protection

Berkovitz also focused on decentralized swap derivatives. According to him, unregistered currency-based contracts that are used to swap one asset with another on the blockchain may be considered illegal. In the context of DeFi, this would apply to derivatives such as Perpetual Swaps.

Speaking of decentralized swap derivatives, Berkovitz said:

“The CEA also provides that it is unlawful for any person other than an eligible contract participant to enter into a swap unless the swap is entered into on, or subject to, the rules of a designated contract market (DCM). The CEA requires any facility that provides for the trading or processing of swaps to be registered as a DCM or a swap execution facility (SEF).”

Berkovitz seems particularly interested in consumer protection when it comes DeFi. He defended the role intermediaries play in the derivatives market and argued that removing them by introducing DeFi products would bring a lot of harm. He commented that in DeFi, “there is no intermediary to monitor markets for fraud and manipulation, prevent money laundering, safeguard deposited funds, ensure counterparty performance, or make customers whole when processes fail.”

Berkovitz’s speech indicates the CFTC may look to prohibit U.S. citizens from trade DeFi-based products such as decentralized options and futures. For a long time, the CFTC has used its power against centralized U.S. exchanges like Coinbase and others. The agency hasn’t hesitated to take strict legal action against platforms that violate its rules in the past. For example, it charged Bitmex for offering unregistered Bitcoin derivatives to US citizens. More recently, it investigated Binance over allegations that the exchange may have mistakenly allowed U.S. nationals to trade crypto derivatives.

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