#229—How Sam Bankman-Fried believes DeFi should be regulated

Also, the FDIC on “payment stablecoins”

Oct 24, 2022

Welcome to Yaka Stuff, our weekly newsletter that covers news, industry perspectives, and updates from the Hard Yaka ecosystem. Check out last week’s report here.

This week:

How Sam Bankman-Fried believes DeFi should be regulated
FDIC Acting Chairman Martin J. Gruenberg on “payment stablecoins” (and more)
What we’re reading: The anti-woke bank story
Stuff happens

1. How Sam Bankman-Fried believes DeFi should be regulated

Last week, we had Charles Hoskinson’s take on regulated DeFi. (He’s a co-founder of Ethereum and the creator of Cardano.)

Here’s a quick reminder of what he said at DC Fintech Week:

You probably are going to see a term next year: Regulated DeFi. It’s this idea where you have something that's decentralized but it involves using DIDs [decentralized identifiers] and other things to do compliance so that DEXs [decentralized exchanges] don’t get captured and banned. You’re probably going to see legal wrappers for DAOs [decentralized autonomous organizations] that give some agency to some managerial group, but allow people to vote to participate without liability and so forth.
You are probably going to see all kinds of new confidentiality technologies that get invented. And what they do is allow you to have selective disclosures and in some cases, involuntary disclosures, but still preserve overall transactional privacy for the type of system.
So that age of compromise is going to force quite a bit of innovation and quite a bit of work, but actually it’ll move the industry to the next level. And that’s what’s going to get us from a trillion dollar industry to a $10 trillion industry. That’s what’s going to get us from where we’re at to where we’d like to be.

Which is a pragmatic and reasonable take. As we’ve seen with the Treasury’s heavy-handed approach to Tornado Cash, just because something is “decentralized” or “just a smart contract” doesn’t mean it can sidestep the oversight of U.S. regulators (whether or not they’re in the right).

What will inevitably be required is some sort of compliant solution that can likewise maintain the decentralized spirit and mechanics of these offerings.

FTX chief Sam Bankman-Fried takes a similar tack, apparently. Here’s The Block:

"If you host a website that makes it easy for U.S. retail to connect to and trade on a DEX, you would likely have to register it as something like a broker-dealer/FCM/etc. You would also potentially have KYC [know your customer] obligations," Bankman-Fried wrote on Wednesday. At the same time, the crypto exchange executive said it's "extremely important that on-chain code and DeFi remain free and open, and uncensored."

Sam published his full thoughts on the FTX website—covering a range of regulatory topics from tokenized equities to OFAC sanctions screening.

Here’s Blockworks on Sam’s thoughts on OFAC screening:

“Maintaining a blocklist is a good balance: prohibiting illegal transfers and freezing funds associated with financial crimes while otherwise allowing commerce,” he said.
Added: Bankman-Fried: “Everyone should respect OFAC’s sanctions lists (which, by the way, is already the law).”

Naturally, not everyone is onboard with SBF’s positioning—including Erik Voorhees. Here’s Blockworks, again:

But Erik Voorhees, ShapeShift co-founder, took up a number of concerns with the crypto billionaire. Voorhees, an early Bitcoin adopter, is one of several high-profile industry participants to speak out against some of Bankman-Fried’s proposals.
Although Voorhees agreed on the need for transparency and scam prevention, he did have opposing views on two key proposals: respecting OFAC and licensure for DeFi-related activities.
He said OFAC’s list includes entire countries and took the example of sanctioned Iran, pointing out that it’s illegal for an American to do business with an Iranian.
“You know those insanely brave Iranian women standing up against oppression in Iran right now? Those women espousing the greatest American virtue of individual liberty and doing so while literally facing torture and death?” he said, referring to the women protesting against the “morality police” in Iran over the death of 22-year-old Mahsa Amini.
“If you’re an American, it is illegal for you to interact economically with those women, because of OFAC.”
Bankman-Fried suggesting that the crypto industry should respect OFAC is “unbecoming,” he added.

Relevant:

2. FDIC Acting Chairman Martin J. Gruenberg on “payment stablecoins” (and more)

Martin Gruenberg covered a wide range of super relevant topics at a Brookings Institute event last week. (Check out his full speech here—via Chris Lewis.)

On the need for caution:

The recent Treasury Department report on crypto–assets should give us pause as it articulates the risks and implications for consumers, investors and businesses. The report states that for crypto–assets “both the existing use cases, and potential opportunities, come with risks, including conduct and market integrity risks, operational risks, and intermediation risks (i.e., traditional financial risks that have the potential to manifest in particular ways in the crypto–asset markets). Some risks are unique to the crypto–asset ecosystem, while others are versions of those experienced in traditional financial markets that may be heightened when experienced in the crypto–asset ecosystem.”2

On dealing with crypto-asset activities on a case-by-case basis:

To address that gap, in April of this year, the FDIC issued a financial institution letter,6 asking the banks the FDIC supervises to notify us if they are engaging in, or planning to engage in, crypto–asset related activities. If so, we asked banks to provide us enough details to allow us to work with them to assess the risks associated with the activities and the appropriateness of their proposed governance and risk management processes associated with the activity. The other federal banking agencies have issued similar requests to their supervised institutions.7
Once the FDIC develops a better understanding of activities planned or already active, we provide the institution with case–specific supervisory feedback.8 As the FDIC and the other Federal banking agencies develop a better collective understanding of the risks associated with these activities, we expect to provide broader industry guidance on an interagency basis.

On “payment stablecoins”:

There are three important features that could make payment stablecoins significantly safer than the stablecoins currently in the marketplace.
First, payment stablecoins would be safer if they were subject to prudential regulation. One vehicle for ensuring prudential regulation and separation from deposit taking would be the issuance of a payment stablecoin through a bank subsidiary.
Second, payment stablecoins would be safer if they were required to be backed dollar–for–dollar by high–quality, short–dated U.S. Treasury assets. Backing with such high–quality assets would help ensure that payment stablecoins could be quickly and efficiently redeemed for fiat currency on a dollar–for–dollar basis limiting the potential for risks associated with these instruments to spillover to the traditional financial system.
Third, payment stablecoins would be safer if they were transacted on permissioned ledger systems with a robust governance and compliance mechanisms. The ability to know all the parties – including nodes and validators – that are engaging in payment stablecoin activities is critical to ensuring compliance with anti–money laundering and countering the financing of terrorism regulations, and deterring sanction evasion.19 The U.S. Department of the Treasury action plan to address illicit financing risks of digital assets is a helpful step in addressing those risks.20
While these three features would make payment stablecoins safer, there remain several important policy considerations that should be taken into account when examining the benefits and risks associated with payment stablecoins.
The development of a payment stablecoin could fundamentally alter the landscape of banking. Economies of scale associated with payment stablecoins could lead to further consolidation in the banking system or disintermediation of traditional banks. And the network effects associated with payment stablecoins could alter the manner in which credit is extended within the banking system – for example by facilitating greater use of FinTech and non–bank lending – and possibly leading to forms of credit disintermediation that could harm the viability of many U.S. banks and potentially create a foundation for a new type of shadow banking.

Relevant:

3. What we’re reading: The anti-woke bank story

Spoiler: It didn’t go so hot—via Jun Hiraga. Here’s the WSJ long read:

An A-list group of financial backers including Ken Griffin and Peter Thiel gave Toby Neugebauer tens of millions of dollars to build a new kind of bank—one aimed at people who see Wall Street as too liberal.
The potential customer base was huge, Mr. Neugebauer and his business partner, former Mike Pence chief of staff Nick Ayers, told the investors. Plumbers, electricians and police officers, the pitch went, are fed up with big banks that don’t share their values.
The startup, called GloriFi, initially aimed to launch with bank accounts, credit cards, mortgages and insurance, while touting what it called pro-America values such as capitalism, family, law enforcement and the freedom to “celebrate your love of God and country.”
Within months, the investors’ money was nearly gone, and GloriFi was on the verge of bankruptcy. It missed launch dates, blaming faulty technology and failures by vendors, and laid off dozens of employees. It stumbled with products; for instance, a plan to make a credit card out of the same material used for shell casings failed when the company realized the material could interfere with security chips and potentially be too thick for payment terminals, according to people familiar with the matter.

Relevant:

Via Jun Hiraga—How a New Anti-Woke Bank Stumbled

Yaka Stuff

#229—How Sam Bankman-Fried believes DeFi should be regulated

Also, the FDIC on “payment stablecoins”

1. How Sam Bankman-Fried believes DeFi should be regulated

2. FDIC Acting Chairman Martin J. Gruenberg on “payment stablecoins” (and more)

3. What we’re reading: The anti-woke bank story

4. Stuff happens

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