Designating DeFi Protocols as Critical Infrastructure: A Proposal by Polygon Labs

Polygon Labs, in partnership with the Arktouros law firm, has recently unveiled a novel regulatory framework proposal. This initiative seeks to classify select decentralized finance (DeFi) protocols as essential infrastructure, integral to the United States’ national and economic security. The proposal aims to not only acknowledge the significant role of DeFi in today’s financial ecosystem but also to safeguard and stabilize its presence within the regulatory environment.

A New Framework for DeFi Oversight

On January 29, the team comprising Rebecca Rettig and Katja Gilman of Polygon Labs, together with Michael Mosier of Arktouros, released a comprehensive 45-page document. The focus of this document is to address and combat illicit financial activities within the DeFi sector.

Regulation by the US Treasury’s OCCIP

The document puts forth a recommendation for the US Treasury’s Office of Cybersecurity and Critical Infrastructure Protection (OCCIP) to oversee DeFi protocols that are authentically decentralized. The OCCIP is known for its critical role in bolstering the security and resilience of the financial services sector’s infrastructure, achieving this through partnerships with finance companies, industry groups, and government agencies to exchange cybersecurity threat and vulnerability information.

Addressing Legal Challenges

The proposed framework suggests a three-step approach to tackle the legal hurdles DeFi faces. Initially, it calls for the establishment of a legal definition for “System Control Persons” (SCPs), referring to those with unilateral operational authority over blockchain systems. The proposal asserts that SCPs should comply with standard anti-money laundering (AML) protocols, irrespective of the decentralized status of the system.

The Role of Critical Communications Transmitters

Furthering its innovative approach, the framework introduces the concept of “critical communications transmitters” as key players in legitimate DeFi systems, and for systems devoid of SCPs—considered “genuine DeFi”—it recommends a separate “critical infrastructure” classification. This would bring them under the purview of the OCCIP, mandating them to fulfill certain obligations to protect US national and economic interests without being labeled as financial institutions under the Bank Secrecy Act (BSA).

Contrasting with Senator Warren’s Views

This framework stands in stark contrast to the critiques of crypto by Senator Elizabeth Warren, who has previously argued for crypto businesses to adhere to the same AML guidelines as traditional banks. She has also expressed concerns regarding the utilization of cryptocurrencies in funding illicit ventures, including North Korea’s nuclear arms program.

Centralized vs. Decentralized Finance

The proposal delineates the differences between centralized finance (CeFi) or traditional finance (TradFi) and DeFi, proposing distinct control mechanisms for each, to be guided by FinCEN, the Treasury’s Financial Crimes Enforcement Network.

Industry Perspectives on the Proposal

Jake Chervinsky, a lawyer specializing in the crypto sector, remarked that while discussions about digital assets often focus on securities and commodities laws, the primary concern in Washington DC revolves around illicit finance. He regards this new framework as a potential concrete solution to these issues.

Final Thoughts

The authors of the proposal stress the importance of balancing the prevention of illicit activities with the fundamental objective of fostering positive developments. This resonates with the Treasury’s goal of promoting economic prosperity and ensuring the financial security of the U.S.

“`