Front-Running Defi Regulation

Last week was big for crypto. The Coinbase IPO happened and the whole world seemed to wake up in recognition of crypto as an asset class. While this is a major step in the legitimization of the space, some even calling it crypto’s ’Netscape moment’, I want to take the opportunity to highlight the dangers of crypto going mainstream.

The United States is woefully behind in the crypto economy in every conceivable measure. For Bitcoin PoW blockchain, the U.S. represents a mere 7% of the global hash rate while China represents approx. 65%. This has lead thinkers like Peter Thiel to suggest that Bitcoin could in fact be a Chinese financial weapon against the U.S. and to unambiguously state that it specifically threatens the dollar.

Secondly, the U.S. government is frighteningly slow to even understand what crypto is or what it has produced in decentralized finance (Defi). This is clearly seen in the recent Bankless interview with SEC commission Hester Peirce when she talks about Defi barely being on the radar of her fellow commissioners and that they are just now waking up to Bitcoin.

Lastly, the U.S. is behind the curve on crypto regulation. If you spent any time in the space you will be familiar with popups at every turn telling you that U.S. customers are not able to use this exchange or Defi product due to regulatory restrictions.

“BitMEX, Bybit, FTX and Binance are four of the top coveted exchanges that ban U.S. persons from their platform, as stated in their terms and conditions… Kraken even has a separate futures trading platform, which oddly, U.S. customers are barred from using.” — Crypto Exchanges Barring US Citizens Is Heartbreaking And Frustrating

Given this deficit in understanding and an anticipated growing sense of diminished control, I fear any major market downswing could trigger sweeping regulation. Many people are predicting crypto regulation on the horizon regardless of any downturn. The World Economic Forum’s head of blockchain and digital assets, Sheila Warren, just told Bloomberg that a “dramatic” round of regulation was about to befall Bitcoin and the wider cryptocurrency space.

“We’re going to see another round of pretty dramatic attempts at regulating this space. As there’s more and more activity in these spaces there’s more and more demand signal for regulators to get engaged and involved.” — Cointelegraph

The writing on the wall seems to be exceedingly clear and it indicates that the feds are coming for Defi. Combined with the US having printed 40% of its money supply just last year potentially conducting the scariest financial experiment in history, Defi has the potential to be an enticing scapegoat to any undesirable economic consequences. The heavy-handed regulation will be presented as being for our own good and motivated to “protect” citizens.

This is what people need to fully understand and take in is that Defi is not merely an augmentation to traditional finance, it’s a repudiation of it. It’s a Wikipedia to Britannica, an Amazon to Borders, and a Netflix to Blockbuster. Governments are not going to just roll over and let themselves get blasted into obsolescence.

How does knowing any of this help you? As a blockchain developer/user, you can prioritize the following protocol characteristics to stay ahead of the idiocracy soon to flow from governments desperate to maintain control of your economic life:

  1. Availability: If the front end of your application is hosted on AWS and your domain is registered with GoDaddy then your decentralized and censorship-resistant submarine might as well have a screen door on it. To guarantee availability to end-users means employing censorship-resistant technologies like IPFS and ENS.
  2. Governance: Make no mistake about it. when the regulatory guns come out, they will be squarely targeted at At those who are building and managing these products, and if you are in a position where you can update protocols then you will be legally compelled to do so. A trustless system is not trustless if the founders have to be trusted to not update the protocol at the behest of another. This means on-chain governance.
  3. Anonymity: Even assuming that there is no attack vector at the protocol level, this does not mean that the blockchain creators are safe from attack by governments. If their identity is known, they are fully exposed to the threat of personal liability. This could mean their personal assets are confiscated or they’re held criminally liable for building and releasing the product. Just ask Arthur Hayes. I believe anonymity will be shown to be as important for founders as it has been emphasized as a feature for users.
  4. PoS Consensus: We need to move away from Proof of Work (PoW) to Proof of Stake (PoS) as soon as possible and it’s not just about scalability and speed of transactions. Physical mining represents a very real physical vulnerability because governments can dramatically lower the cost of a 51% attack simply by seizing control of the mining physical infrastructure required to drive PoW. That dramatically changes in the move to PoS because there is no physical infrastructure per se. What’s more, it also increases anonymity by removing miner IP addresses from the equation and provides greater resiliency in the face of power loss.

Building the decentralized trustless system requires a constant obsession with thinking about how users can be attacked and exploited. The same passion that exists behind decentralization will exist on the side of governments who wish to control and exploit it for power. This conflict is unprecedented for several reasons. Firstly, the servers running the code do not reside in any physical country and, secondly, all parties involved are involved voluntarily so it can’t be construed as an issue of theft or exploitation. These reasons alone will inevitably cause people to rightly question what grounds a government has to control this space but, I’m convinced, that will not deter them from claiming that right. The only way to front-run the impending clash of worldviews is with the same principles that have driven this entire movement, that being an absolute insistence on unmitigated trustlessness and decentralization.

One of the very interesting projects I see taking the above characteristics extremely seriously is DFOhub. They advocate the use of decentralized flexible organizations (DFOs) and speak of startups without founders. I personally feel that they’re extremely ahead of the curve and that time will show the great value of the thinkers and projects exploring and expanding the boundaries of this space.

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