Comment: The BitMEX crackdown bodes ill for the DeFi sector

The indictment by U.S. authorities against the crypto derivatives exchange BitMEX could be a gloomy omen for the decentralized finance sector. The reason is the reference to violations of the Bank Secrecy Act (BSA), according to Adam Cochran, partner at Cinneamhain Ventures.

1/25

So a lot of Crypto Twitter doesn’t understand why today’s news isn’t just bad for CeFi but is also bad for DeFi.

It has a something to do with legal nuance and a little something called the «Bank Secrecy Act» (BSA)

Here’s a run down for you 👇

— Adam Cochran (@AdamScochran) October 1, 2020

The expert notes that in criminal cases authorities often move from the letter of the law to its spirit, focusing more on achieving its objectives than on the precise wording.

He points to the joint actions of the U.S. Commodity Futures Trading Commission (CFTC) and the Department of Justice against BitMEX.

The CFTC can impose regulatory and civil penalties. In the DOJ’s remit lie criminal offenses.

4/25

Today, *JOINT* charges from the CFTC and the DoJ were handed down to BitMex.

The CFTC is a regulator, like the SEC that handles commodities. It applies regulatory and civil penalties, but it itself does not pursue criminal action. It lets the DoJ handle that.

— Adam Cochran (@AdamScochran) October 1, 2020

The CFTC’s suit against BitMEX, in which the latter is accused of operating an unregistered trading platform, invites parallels with the DeFi sector—how far the regulator’s guiding principles apply to DeFi protocols.

6/25

Just like dealing with the SEC, the ways the rules are written and applied, and the spirit of those rules in CFTC guidelines make it unclear if the regulation should apply to DeFi.

— Adam Cochran (@AdamScochran) October 1, 2020

“Perhaps the crypto community is right that the CFTC’s requirements do not apply to DeFi. It is a gray area. The Commission’s charges will lead to fines. A more serious threat is the BSA. Its job is to prevent money laundering,” the expert writes.

9/25

The DOJ handles the prosecution of the BSA which includes criminal charges.

The Bank Secrecy Act does not have the goal of protecting consumers.

The Bank Secrecy Act has the goal of stopping money laundering.

— Adam Cochran (@AdamScochran) October 1, 2020

Cochran doubts that the decentralized nature of DeFi services absolves participants from accountability. He adds that the myth has been aided by a narrow view of regulatory limits on exchanges.

As support for his view, he cites prosecutions of traders on LocalBitcoins and Paxful for alleged money laundering.

13/25

Proof of this is that the DOJ has pursued individuals on sites like https://t.co/bqnBZp4BZR and https://t.co/omKS1uzAxv with having been involved with facilitating money laundering or failing to comply with preventative measures.

— Adam Cochran (@AdamScochran) October 1, 2020

“The litmus test here is whether the person merely sold a small amount of cryptocurrency in small batches once, or engaged in systematic commercial activity. To convict the latter, not much is required,” Cochran emphasizes.

14/25

The only test here was whether the person sold crypto in small amounts once or engaged in a systematic commercial operation — and you’d be surprised how small that operation can be and still count.

— Adam Cochran (@AdamScochran) October 1, 2020

Under the BSA, the crucial point is the act of financial facilitation. Whoever you are — a person, an issuer, an exchange, a legal entity, a depository, a trustee or agent, or a combination of these — the expert explains.

“The only thing that matters is whether you helped facilitate the exchange of monetary instruments for criminals in the United States without complying with the US KYC/AML standards,” the expert notes.

16/25

Note how a company isn’t relevant.

The only thing that matters is do you make it easier for criminals in the US to exchange monetary instruments without applying the US standards of KYC/AML.

— Adam Cochran (@AdamScochran) October 1, 2020

Cochran argues that claims regulators cannot stop a smart contract are not credible. He notes leverage through the BSA on developers, frontend builders and firms hiring staff to work on the protocol.

The partner at Cinneamhain Ventures believes users are likely to refrain from interacting with the protocol, which could lead to its shutdown.

18/25

No, you can’t but DAO or no DAO you can find that developers with admin keys, users who create front-ends, companies hiring individuals to work on the protocol and others who enable or profit from the contract, to be in violation on the BSA.

— Adam Cochran (@AdamScochran) October 1, 2020

“The point is that a protocol is not outside the reach of authorities; there are always pressure points. While DeFi may sit in a grey area under some rules, it is clear that the BSA applies to them,” he sums up.

20/25

The take away here is that a protocol isn’t outside the reach of the government, there is always pressure points that can be applied.

While DeFi *MAY* be in a grey area with *SOME* regulation, it is clear that the BSA still applies.

— Adam Cochran (@AdamScochran) October 1, 2020

The expert contends that DeFi currently has no workable middle ground. There is no technology that would allow BSA compliance; and that, in his view, does not guarantee regulators won’t demand it.

22/25

The challenge is, that right now we don’t know that middle ground, we don’t have the tech solution that balances asset privacy, defi and BSA compliance — but that doesn’t mean that it doesn’t apply (or that it is necessarily a bad thing)

— Adam Cochran (@AdamScochran) October 1, 2020

“The point is that a protocol isn’t outside the reach of the government; there are always pressure points that can be applied. While DeFi may be in a grey area with some regulation, it is clear that the BSA applies to it,” the expert concludes.

25/25

DeFi needs to start planning BSA compliance or the exclusion of US users — because that day will likely come.

Disclaimer: Not a lawyer, not US-based, may be some gaps in regulatory knowledge. Not investment advice.

— Adam Cochran (@AdamScochran) October 1, 2020

One user suggested that Bitcoin users could face the same enforcement risk. In the end, anyone could face this risk regarding unknown coins.

All of BTC should be implicated under this explanation. Any entity owning, selling, or handling BTC, that didn’t self-apply KYC to incoming-unknown BTC, would fall under this.

— Nick Yeates (@nyeates) October 2, 2020

In September, SEC Commissioner Hester Peirce stated that regulators should take a less liberal approach to regulating the DeFi sector.

In the BitMEX trader list, US residents were found.

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