Why the BitMEX charges could be bad news for DeFi

In the aftermath of criminal charges against BitMEX, the crypto community is debating whether the decentralized finance sector is also set to face the wrath of regulators.

On Oct 1, the U.S. Commodity Futures Trading Commission announced charges against three BitMEX executives for violating the Bank Secrecy Act (BSA) due to the exchange’s allegedly weak anti-money laundering and know-your-customer (KYC) policies.

DeFi protocols, including Decentralized Exchanges (DEXs) have made a virtue of having minimal AML and KYC procedurs. However many now wonder if DEXs are also obliged to comply with the BSA, even though most projects seek to decentralize ownership and governance throughout their communities.

While many DeFi protocols appear to believe that they can evade regulators simply by becoming fully decentralized, there are increasing doubts as to whether this is true — and in any case, DeFi protocols have come under fire recently for operating with a high degree of centralization, with 12 out of 15 top projects maintaining ‘God Mode’ admin keys.

1/25So 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

In a 25-post Twitter-thread, angel investor and blockchain consultant Adam Cochran examined the potential fall out from the BitMEX charges for DeFi protocols.

He argued that while authorities cannot directly shut down a DEX due to its decentralized nature, regulators could target the core developers who hold the admin keys and the domain providers hosting the front-end interfaces of DEXs:

“If that happened to a protocol, a large bulk of users would stop using it and not interact with the contract directly, essentially killing the protocol,” he said.

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

But Cochran believes the crypto community should actually want regulations like the BSA to apply to DeFi, adding that “there is a difference between wanting sovereignty and privacy over your funds vs enabling criminal activity.”

In response Twitter user ‘tendies.eth’ argued that DEXs are already more compliant than their centralized counterparts due to the ability to track every last transaction onchain:

“CEXs can enable money laundering through their private databases but this is not true for DeFi where every tx is public and transparent. DeFi is much more trackable than private banks and CEXs.”

Chief Investment Officer at Apollo Capital Henrik Andersson told Cointelegraph that “considering the time it took to bring this [BitMEX] case, I don’t believe DeFi cases will be brought in the short term.” He added that DeFi projects should essentially keep calm and carry on:

“DeFi projects need to continue focusing on building unstoppable financial infrastructure by free and open code.”

Dave Jevans, CipherTrace’s chief executive officer, said he doesn't believe DeFi protocols are likely to embrace regulations, but it was coming anyway.

“They’re not going to be able to escape from regulation for long,” Jevans said. “The eyes are upon them.”

CryptoWhale told his 40,000 followers that he believes regulation is coming for 8,800 projects on the market "that are operating illegally and will be shut down" including DeFi tokens, exchanges and privacy tokens.

Once regulations come, the owners of these scam projects will leave the markets in flocks to avoid prosecution. Thats billions of dollars leaving the markets, which will certainly have a large impact on the general sentiment in crypto, and force us to continue the bear market.

— Mr. Whale (@CryptoWhale) October 1, 2020

Update This article previously contained comments that were erroneously attributed to BitMEX CEO Arthur Hayes. Cointelegraph has updated the article to reflect our editorial standards.