Why is the encryption industry standard proposed by SBF likely to stifle innovation?

Original: Bankless

Compilation: The Way of DeFi

Image source: Generated by Unbounded Layout AI‌.

The days of the “Wild West” of the crypto world seem to be coming to an end.

The 2021 bull market has brought cryptocurrencies to the point where regulators can’t ignore them. They are now scrambling to gain ground and gain a foothold in the industry.

It appears that crypto regulation is inevitable. That’s not necessarily a bad thing, as regulatory clarity allows builders to not worry about government action, while also helping more capital enter the space.

However, for cryptocurrencies to realize their potential, it is paramount that we strive to deploy policies that protect rather than undermine the core values ​​of the space.

Otherwise what’s the point? Why would we risk creating a world where DeFi is as unfair as TradFi?

The battle between real-world laws and metaverse principles came to a head last week when FTX CEO Sam Bankman-Fried (SBF) published an article on “Industry Standards for Digital Assets”.

There are many smart policies in it, but some of the SBF’s proposals also run counter to the value of cryptocurrencies and have the potential to hinder cryptocurrency innovation within the United States.

1. Sanctions, Whitelisting and Blacklisting

Speaking of address censorship, I agree with Sam that a blacklist is certainly preferable to a whitelist.

But having to choose between blacklisting and whitelisting is inherently wrong.

Requiring apps and protocols to review a blacklist before processing a transaction undermines their trusted neutrality and creates a dangerous precedent that makes censorship the norm.

2. KYC DeFi

When it comes to DeFi, I agree with Sam in many ways.

For example, he explicitly stated that “decentralized code is language” and that both smart contract deployment and transaction verification should remain “permissionless and free.”

However, I have some disagreements with him when it comes to his views on the front end.

Sam mentioned:

“If you built a website to facilitate and encourage the U.S. retail industry to connect to and trade on a DEX, that website would probably be classified as something like a brokerage or futures broker.”

This also means that you “may have KYC obligations”.

But implementing KYC on the front end runs counter to the idea of ​​DeFi.

While users with technical backgrounds will still be able to interact with the protocol at the contract level, this requirement would limit DeFi’s user base and prevent the use of this very valuable technology by a large group of people without access to financial services.

Additionally, this rule will significantly increase compliance costs for the protocol and third-party front ends such as Zapper or Zerion.

Not only would this push DeFi out of the U.S., it would also reduce the resiliency of the space, as the limited number of front ends would mean a larger “honeypot” for hackers and less censorship resistance.

3. Stablecoin regulation

Sam mentioned stablecoin regulation at the end of the article.

Again, Sam makes some sound points. For example, he advocates for dollar-pegged stablecoins to be backed at least 1:1 by the U.S. dollar or U.S. Treasury bills while complying with transparency reporting requirements.

This requirement makes perfect sense for a centrally issued custodial stablecoin as it reduces risk while increasing transparency, but it is unclear whether this applies to crypto-collateralized stablecoins such as DAI.

In this regard, it is worth noting that in the last paragraph, it is stated that traders should be required to undergo KYC when minting or redeeming stablecoins:

“KYC (KYC of individuals and entities that create and redeem stablecoins) should be done to traders involved in the deposit and withdrawal process. This is easy to achieve — we think there are many regulatory frameworks in place under which it is possible to Implement a stablecoin program — as long as the operating entity maintains relevant asset information and has and enforces appropriate KYC requirements.”

Although there is no mention of restrictions on the purchase of stablecoins in the secondary market, this rule is still highly exclusive and creates on-chain inequality.

For example, users who have not gone through KYC will not be able to use their ETH as collateral to create DAI, limiting their ability to unlock the full value of the asset.

This sets a dangerous precedent because it instantiates a system of “yes” and “nothings” (ie who does KYC and who doesn’t), rather than a trusted neutral system where everyone gets the same treatment.

Essentially, this means that only a few licensed individuals have access to the full power of DeFi.

an open conversation

To its credit, SBF is open to community input and has discussions around these policies. He has revised some of his positions after feedback from the community.

But if implemented, several of the recommendations in his article will erode the fundamental principles on which DeFi is built, while potentially stifling innovation and forcing builders out of the United States.

Regulation is coming.

But it is crucial that we speak our minds so that we can ensure that the right policies are implemented.

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