Clashes over the benefits and dangers of DeFi erupted along partisan lines at a congressional hearing chaired by Rep. French Hill.
Republicans touted the innovative nature of DeFi, while Democrats stressed the need to protect consumers.
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Posted on September 10, 2024 at 6:28 p.m. EST.
The first congressional hearing on decentralized finance (DeFi) took place Tuesday morning, shedding light on both the promise and perils of the emerging financial technology. And as expected, partisan divisions were on full display, with Republicans touting DeFi’s innovation and economic freedom while Democrats raised concerns about consumer protections, market integrity, and the risks posed by unregulated financial systems.
DeFi generally refers to protocols running on permissionless blockchain networks to facilitate peer-to-peer digital asset transactions via smart contracts, but Tuesday’s hearing highlighted that there is no standard definition of DeFi. The committee’s memorandum for the hearing highlighted statistics showing the rapid growth of the DeFi industry. The DeFi market cap currently stands at $67 billion, while the total value locked (TVL) is $89 billion.
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Republicans vs. Democrats
Republicans have portrayed DeFi as an innovative sector with the potential to enable more efficient transactions that eliminate profit-taking middlemen, even if it carries some risks for consumers. “DeFi is a critical component of a vibrant financial sector in the United States,” said Rep. Warren Davidson (R-OH). “We have dominated markets around the world, and it would seem particularly foolish to change course now.”
Democrats, meanwhile, have stressed the importance of consumer protection, calling DeFi rife with scams in which bad actors rip off customers and evade taxes. DeFi is more complicated than traditional finance, argued Rep. Brad Sherman (D-CA). “We’re trying to create a market here for a system (DeFi) that’s much worse than the system we have for honest people… it’s much better for drug dealers, much better for human traffickers, much better for sanctions evaders, which is why Putin and Iran embraced crypto and unhosted wallets. But the real market here is tax evasion,” Sherman said.
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In calling for more regulation of DeFi, Rep. Maxine Waters (D-CA) pointedly referred to the risks incurred by the new DeFi lending company founded by the sons of former President Donald Trump. Waters noted that X accounts Trump’s daughter Tiffany and daughter-in-law Lara Trump were hacked last week to promote a fraudulent campaign.governance token” supposed to be linked to the new company. DeFi can “present an increased risk of attacks, scams, uneven information, and conflicts of interest that can harm consumers and investors…we’ve seen this play out in the new DeFi venture that Eric Trump and Donald Trump Jr. are planning to launch,” Waters said.
GOP Witness Positions and Recommendations
Republicans, the majority in Congress, were able to select four witnesses to testify before the committee, while Democrats were allowed just one. The first was Brian Avello, general counsel for an investment fund called Universal DeFi Holding Company. Avello argued for light-touch consumer protections through disclosure regimes and clearer accountability for regulators, rather than trying to enforce existing financial regulations designed for systems with intermediaries.
Rebecca Rettig, legal and policy director at Polygon Labs, also called for informed regulation that focuses on risks to consumers, weaknesses in the technology itself, and malicious actors committing scams. Her main argument was that DeFi should be redefined as critical infrastructure, suggesting that the Cybersecurity and Infrastructure Security Agency (CISA) could be a potential regulator of the sector.
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Amanda Tuminelli, legal director at the DeFi Education Fund, was more forceful in her advocacy, repeatedly arguing that DeFi is fundamentally different from traditional finance and therefore requires a tailored regulatory approach, rather than one-size-fits-all rules. Educating consumers about the risks of DeFi should be a priority, she said, arguing that the industry has already found solutions to this, such as fraud and scam alerts built into front-end software.
Peter Van Valkenburgh, research director at the Coin Center, a research and advocacy group, argued for prosecuting fraud and contract violations after the fact, rather than adhering to the kind of preemptive regulation that prevails in traditional finance. He argued for protecting technological innovation and constitutional rights such as the First Amendment. “If developing a protocol, which is a set of rules, is not publishing speech, then I don’t know what is,” he said.
The difference between Republican witnesses and those of some Democrats was highlighted by the questioning of Rep. Sean Casten (D-IL), who repeatedly asked the witnesses why DeFi protocols should allow anonymous transactions. Both Valkenburgh and Tuminelli argued that the blame for criminal activity should be placed on bad actors, rather than developers or users. Casten, however, disagreed, saying that creating a DeFi protocol that would then be used for criminal activity would be “aiding and abetting a crime.”
The Democratic Witness
Mark Allen Hays, a senior policy analyst at Americans for Financial Reform, a progressive nonprofit, advocated for applying existing financial regulations to DeFi. He stressed the importance of preserving market integrity and protecting investors by applying the same regulations used for other retail investment markets. He also raised concerns about DeFi’s resistance to regulation, citing the industry’s ideological stance that decentralization exempts it from regulatory oversight.
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“A lot of hacks are inside operations,” Hays said, arguing that many malicious actors in DeFi are actually working on the protocols themselves.
While the hearing was billed as an opportunity for Congress to learn more about how DeFi works, few questions appeared to be asked in the interest of an open discussion. The policy, however, was on full display.
