DeFi is facing a 'full-scale attack' from regulators

By Darren Kleine, Translated by Blockworks, Golden Finance

The U.S. Treasury Department’s Financial Crimes Enforcement Network recently released a proposal for a so-called “convertible virtual currency,” or a hybrid of CVCs.

Cryptocurrency transactions can be “mixed” through certain services to hide their origin and amount in order to evade any form of surveillance. The proposal is not a bill, explained Rebecca Rettig, chief legal and policy officer at Polygon Labs, and it is a set of rules proposed by regulators. These rules are designed to curb money laundering and address the problem of confusing illicit money flows through cryptocurrency mixing mechanisms.

But the risks that could outweigh the benefits of such a proposal may outweigh the benefits. She explained on the Empire podcast (Spotify/Apple) that now the Treasury is “asking for feedback”. They will accept all opinions and weigh the pros and cons with these opinions in mind. These rules require financial institutions and institutions in the United States to implement record-keeping and reporting requirements for cryptocurrency transactions involving mixing. On the face of it, this is not outrageous.

However, the real problem, according to Rettig, is that the proposal defines “hybrid” too broadly. As it stands, it could cover “all smart contract-based applications, certainly DeFi applications, and possibly even applications that extend from DeFi.” **

‘Full crackdown’ by regulators

Jack Chervinsky, chief legal officer at venture capital firm Variant, said the crypto industry faces “macro challenges.” Regulators want to identify the parties making the transaction. They want to have a comprehensive understanding and monitoring of the financial system. A cryptocurrency mixer is a tool that people can use to protect their privacy so that the government can’t spy on their transactions.

What we’re seeing is a full-scale crackdown on us by regulators, particularly anti-money laundering regulators, trying to figure out ‘who’s trading’ and how to ‘circumvent this technology’. How do they discourage people from using these tools – keep them as low as possible and make them as difficult to use as possible to protect their privacy? One answer, he explained, is to criminalize technology, as demonstrated by the sanctions imposed on Tornado Cash.

More than 20 years since the Patriot Act went into effect, Chervinsky said the Treasury Department has been able to designate major money laundering concerns. They can designate an institution, a jurisdiction, an account type – or a type of transaction.

Chervinsky noted that the Ministry of Finance had never previously designated a type of transaction. This is a new action taken by the Ministry of Finance against cryptocurrencies. This means that these regulated financial institutions, if they don’t follow the rules, could run into trouble. CVC Hybrid is defined much more broadly than Tornado Cash or other privacy protection protocols. It basically includes anything in DeFi. The industry needs to come together" and respond to the proposal. FinCEN is “asking for examples of mixed legitimate commercial uses”. We need to discuss it very openly and submit all legitimate ways to FinCEN that demonstrate the importance of mixers for privacy.