We Don’t Need No Regulation

Why governments should not mess with the DeFi industry

The Securities and Exchange Commission (SEC) of the USA is currently accusing the crypto exchange Coinbase of trading securities “without a license”. They claim that tokens issued by smart contracts on a blockchain have to be considered securities and therefore anyone who offers these tokens in the USA needs an license that only the SEC can grant.

If the SEC succeeds to enforce its claims against Coinbase, this would heavily affect other crypto exchanges that are registered in the USA such as Kraken or Bittrex, and indirectly also the ones in other jurisdictions, as they might have to stop serving US customers. As a result, centralised, regulated exchanges might lose business to decentralised ones which are not regulated by government authorities.

This would actually be a good development towards more decentralisation and less regulation. We need to move away from centralised companies that can be forced by governments to comply with their rules, towards a world of decentralised, self-regulated finance.

The SEC/Coinbase case reveals the dilemma authorities face when it comes to the crypto industry. They want to apply rules that were made for the old, centralised world to the new decentralised world of trustlessness. In the old world, people had to entrust their money to banks and other financial institutions that could easily steal it, if they were not controlled by institutions trying to prevent them from doing so. That is why the financial industry is so heavily regulated.

In the new world of Decentralised Finance, you don’t need to entrust your money to anyone. It is governed by smart contracts that are confidential and transparent. The information they hold is authenticated, error-free, indelible and can only be changed under strictly defined conditions. A smart contract cannot break the rules – it is encoded law that contains its own enforcement.

However, smart contracts are software, so they can and do have bugs. That’s why they have to go through a process of auditing by companies specialised in that. These auditors try to find flaws and loopholes in a smart contract to prevent it from being hacked or otherwise exploited. No serious crypto company can afford to deploy a smart contract that hasn’t been approved by an established auditor. These private companies have skills that government authorities certainly don’t have.

It makes no sense to force crypto companies to register with a central authority and to comply with their obsolete rules. They would only waste a lot of time and energy that they could better use in improving their products and serving their customers.

Of course we need laws against fraud, theft and other crimes as well as agencies that enforce them. Unfortunately, there are some fraudsters and scammers in the crypto world. However, making crypto companies follow outdated rules does not change that. Most importantly, people have to learn how to avoid being scammed and how to protect their money against crimes.

“Not your keys, not your coins” is a good rule for that. It means in less geeky words: never entrust your coins to anyone. Only sending your money to a smart contract that has been audited by a well reputed auditing company is another. The idea to “protect customers” by forcing crypto companies to register with government institutions isn’t.

By Aaron Koenig