    [House Hearing, 118 Congress]
    [From the U.S. Government Publishing Office]

                          DECODING DEFI: BREAKING DOWN
                                 THE FUTURE OF
                             DECENTRALIZED FINANCE
    =======================================================================

                                    HEARING

                                   BEFORE THE

                        SUBCOMMITTEE ON DIGITAL ASSETS,
                             FINANCIAL TECHNOLOGY,
                                 AND INCLUSION

                                     OF THE

                        COMMITTEE ON FINANCIAL SERVICES

                         U.S. HOUSE OF REPRESENTATIVES

                        ONE HUNDRED EIGHTEENTH CONGRESS

                                 SECOND SESSION

                                   __________

                               SEPTEMBER 10, 2024

                                   __________

                               Serial No. 118-106

           Printed for the use of the Committee on Financial Services

     [GRAPHIC NOT AVAILABLE IN TIFF FORMAT]

                                www.govinfo.gov

                                    __________

                       U.S. GOVERNMENT PUBLISHING OFFICE
    57-121 PDF                  WASHINGTON : 2026
    -----------------------------------------------------------------------------------

                     HOUSE COMMITTEE ON FINANCIAL SERVICES

                   PATRICK McHENRY, North Carolina, Chairman

    FRENCH HILL, Arkansas, Vice          MAXINE WATERS, California, Ranking
        Chairman                             Member
    FRANK D. LUCAS, Oklahoma             SYLVIA R. GARCIA, Texas, Vice
    PETE SESSIONS, Texas                     Ranking Member
    BILL POSEY, Florida                  NYDIA M. VELAZQUEZ, New York
    BLAINE LUETKEMEYER, Missouri         BRAD SHERMAN, California
    BILL HUIZENGA, Michigan              GREGORY W. MEEKS, New York
    ANN WAGNER, Missouri                 DAVID SCOTT, Georgia
    ANDY BARR, Kentucky                  STEPHEN F. LYNCH, Massachusetts
    ROGER WILLIAMS, Texas                AL GREEN, Texas
    TOM EMMER, Minnesota                 EMANUEL CLEAVER, Missouri
    BARRY LOUDERMILK, Georgia            JAMES A. HIMES, Connecticut
    ALEXANDER X. MOONEY, West Virginia   BILL FOSTER, Illinois
    WARREN DAVIDSON, Ohio                JOYCE BEATTY, Ohio
    JOHN W. ROSE, Tennessee              JUAN VARGAS, California
    BRYAN STEIL, Wisconsin               JOSH GOTTHEIMER, New Jersey
    WILLIAM R. TIMMONS, IV, South        VICENTE GONZALEZ, Texas
        Carolina                         SEAN CASTEN, Illinois
    RALPH NORMAN, South Carolina         AYANNA PRESSLEY, Massachusetts
    DANIEL MEUSER, Pennsylvania          RASHIDA TLAIB, Michigan
    SCOTT FITZGERALD, Wisconsin          RITCHIE TORRES, New York
    ANDREW R. GARBARINO, New York        NIKEMA WILLIAMS, Georgia
    YOUNG KIM, California                WILEY NICKEL, North Carolina
    BYRON DONALDS, Florida               BRITTANY PETTERSEN, Colorado
    MIKE FLOOD, Nebraska
    MICHAEL LAWLER, New York
    ZACHARY NUNN, Iowa
    MONICA DE LA CRUZ, Texas
    ERIN HOUCHIN, Indiana
    ANDREW OGLES, Tennessee

                            Kim Betz, Staff Director

                                     ------

       SUBCOMMITTEE ON DIGITAL ASSETS, FINANCIAL TECHNOLOGY AND INCLUSION

                        FRENCH HILL, Arkansas, Chairman

    WARREN DAVIDSON, Ohio, Vice          STEPHEN F. LYNCH, Massachusetts,
        Chairman                             Ranking Member
    FRANK D. LUCAS, Oklahoma             JOSH GOTTHEIMER, New Jersey, Vice
    TOM EMMER, Minnesota                     Ranking Member
    JOHN W. ROSE, Tennessee              BILL FOSTER, Illinois
    BRYAN STEIL, Wisconsin               RITCHIE TORRES, New York
    WILLIAM R. TIMMONS, IV, South        BRAD SHERMAN, California
        Carolina                         AL GREEN, Texas
    BYRON DONALDS, Florida               SEAN CASTEN, Illinois
    MIKE FLOOD, Nebraska                 WILEY NICKEL, North Carolina
    ERIN HOUCHIN, Indiana
                             C  O  N  T  E  N  T  S

                                  ----------

                          Tuesday, September 10, 2024
                               OPENING STATEMENTS

                                                                       Page
    Hon. French Hill, Chairman of the Subcommittee on Digital Assets,
      Financial Technology and Inclusion, a U.S. Representative from
      Arkansas.......................................................     1
    Hon. Stephen F. Lynch, Ranking Member of the Subcommittee on
      Digital Assets, Financial Technology and Inclusion, a U.S.
      Representative from Massachusetts..............................     3

                                   WITNESSES

    Mr. Brian Avello, Chief Legal Officer, UDHC......................     4
        Prepared Statement...........................................     6
    Ms. Rebecca Rettig, Chief Legal and Policy Officer, Polygon Labs.    19
        Prepared Statement...........................................    21
    Ms. Amanda Tuminelli, Chief Legal Officer, DeFI Education Fund...    33
        Prepared Statement...........................................    35
    Mr. Peter Van Valkenburgh, Director of Research, Coin Center.....    55
        Prepared Statement...........................................    57
    Mr. Mark Allen Hays, Senior Policy Analyst, Americans for
      Financial Reform...............................................    74
        Prepared Statement...........................................    76

                                    APPENDIX
                     RESPONSES TO QUESTIONS FOR THE RECORD

    Written responses to questions for the record from Mr. Brian
      Avello
        Representative Warren Davidson...............................   117
        Representative Maxine Waters.................................   117
    Written responses to questions for the record from Ms. Rebecca
      Rettig
        Representative Warren Davidson...............................   119
        Representative Maxine Waters.................................   119
    Written responses to questions for the record from Ms. Amanda
      Tuminelli
        Representative Warren Davidson...............................   121
        Representative Maxine Waters.................................   121
    Written responses to questions for the record from Mr. Peter Van
      Valkenburgh
        Representative Warren Davidson...............................   122
        Representative Maxine Waters.................................   123
    Written responses to questions for the record from Mr. Mark Allen
      Hays
        Representative Warren Davidson...............................   125
        Representative Maxine Waters.................................   127

                                  LEGISLATION

    H.R. ------, To require the Securities and Exchange Commission,
      Commodity Futures Trading Commission, and the Secretary of the
      Treasury to jointly carry out a study on decentralized finance.   129
    H.R. ------, To require the Secretary of the Treasury to report
      on privacy-preserving technologies.............................   135

                          DECODING DEFI: BREAKING DOWN
                                 THE FUTURE OF
                             DECENTRALIZED FINANCE

                                  ----------

                          Tuesday, September 10, 2024

                 U.S. House of Representatives,
             Subcommittee on Digital Assets, Financial
                              Technology and Inclusion,
                               Committee on Financial Services,
                                                        Washington, DC.

        The subcommittee met, pursuant to notice, at 10 a.m., in
    room 2128, Rayburn House Office Building, Hon. French Hill
    [chairman of the subcommittee] presiding.
        Present: Representatives Hill, McHenry, Lucas, Davidson,
    Rose, Steil, Timmons, Flood, Lynch, Foster, Gottheimer,
    Sherman, Green, Casten, and Nickel.
        Chairman Hill. Good morning. The Subcommittee on Digital
    Assets, Financial Technology, and Inclusion will come to order.
        Without objection, the chair is authorized to declare a
    recess of the committee at any time.
        This hearing is entitled ``Decoding DeFi: Breaking Down the
    Future of Decentralized Finance.''
        Without objection, all members will have 5 legislative days
    within which to submit extraneous materials to the chair for
    inclusion in the record.
        I now recognize myself for an opening statement.

        OPENING STATEMENT OF HON. FRENCH HILL, CHAIRMAN OF THE
       SUBCOMMITTEE ON DIGITAL ASSETS, FINANCIAL TECHNOLOGY AND
             INCLUSION, A U.S. REPRESENTATIVE FROM ARKANSAS

        Welcome back, members and staff, to Capitol Hill following
    our August work period. Today we are going to discuss
    decentralized finance.
        After the Financial Innovation and Technology for the 21st
    Century Act (FIT21) legislation passed with broad bipartisan
    support, I wanted this subcommittee to explore emerging topics
    like tokenization and decentralized finanace (DeFi). As we
    consider how blockchains can be used in finances, we must
    continue expanding our knowledge of the possible costs and
    benefits as it relates to DeFi.
        Decentralized finance envisions a financial system that is
    permissionless, transparent, efficient, and built on top of
    blockchain networks. It is based on the fundamental idea that
    individuals should have the freedom to transact without the
    fear of illegal financial surveillance or abuse by governments.
        By substituting intermediaries for autonomous self-
    executing code, decentralized finance can shift the way the
    financial markets and transactions are currently structured and
    governed; a peer-to-peer future where a Canadian prime minister
    in the future cannot freeze your bank account just for going to
    a protest.
        Whether it is artificial intelligence or digital assets, we
    cannot legislate thoughtfully or do oversight of the regulatory
    agencies if we do not understand it, and DeFi is not only
    complex but cutting edge, changing, and a completely different
    way of working.
        At the end of the day, decentralized finance is not a
    person or a company. It is a technology and one that connects
    people together to reimagine how we transact with one another.
        Today's hearing is designed to take a deep dive into some
    core concepts behind DeFi. I would like members on both sides
    of the aisle to approach it with an open mind. We will hear
    from our witnesses about this technology, how it works, the
    potential benefits and risks, the legal and regulatory
    implications.
        It is important to remember that our regulatory and legal
    frameworks were designed for a financial system with
    centralized intermediaries. It does not contemplate the
    decentralized peer-to-peer ecosystem made possible with digital
    assets and blockchains.
        That is why jurisdictions like the European Union have
    chosen to explicitly carve out DeFi in their digital asset
    legislation so they can continue to better understand it.
        Rightfully, we took the same approach in drafting our FIT21
    legislation here in the House, which directed the Treasury, the
    Securities and Exchange Commission (SEC), and the Commodity
    Futures Trading Commission (CFTC) to study this issue together
    and report back to Congress on the implications and their
    recommendation.
        Contrast that with the Biden-Harris Administration, which
    uses rulemaking and enforcement actions to go after DeFi and
    threaten its existence and the future of its use in the United
    States.
        Now that this committee has moved with our historic
    bipartisan FIT21 legislation, it is important that together we
    assess DeFi and study the most effective way forward. This
    hearing is not just about smart contracts and decentralized
    protocols; it is about how decentralized peer-to-peer
    technology can preserve individual freedom and improve our
    financial services for business and consumers alike.
        Together we will take another step at our work on the
    regulatory landscape that supports transformative technology. I
    encourage everyone on the subcommittee to engage in an
    informed, open-minded dialog with our esteemed witnesses today
    to better understand how Congress can help Americans assess and
    leverage this technology in a safe and secure manner.
        I am grateful to our witnesses on our panel today and
    sharing their wealth of knowledge, and I look forward to the
    discussion.
        Now let me yield to the ranking member for some opening
    comments.

     OPENING STATEMENT OF HON. STEPHEN F. LYNCH, RANKING MEMBER OF
     THE SUBCOMMITTEE ON DIGITAL ASSETS, FINANCIAL TECHNOLOGY AND
          INCLUSION, A U.S. REPRESENTATIVE FROM MASSACHUSETTS

        Mr. Lynch. Good morning. Thank you, Mr. Chairman, for
    hosting this hearing, and I want to thank our witnesses in
    advance for their willingness to help the committee with its
    work.
        This hearing aims to explore the future of decentralized
    finance services, or DeFi. DeFi generally refers to virtual
    assets protocols and services that allow for automated peer-to-
    peer transactions by using blockchain technology.
    Unfortunately, there is no consensus definition of DeFi among
    regulators or industry, which makes this a difficult sector to
    assess.
        DeFi providers claim to offer permissionless and
    interoperable payments, allowing for efficient and anonymity.
    However, it has become increasingly evident that these features
    have made DeFi most attractive to illicit actors who seek to
    conduct illegal activity. Bad actors continue to develop the
    techniques that conceal the origins of crypto funds, such as
    chain hopping and using anonymity-enhanced cryptocurrency.
        A risk-assessment report recently issued by the Treasury
    found that cyber criminals, scammers, and ransomware actors
    take full advantage of DeFi vulnerabilities to launder illicit
    proceeds. Additionally, the lack of compliance with anti-money-
    laundering and terrorist financing laws by DeFi players make
    this space even more susceptible to illegal activity.
        To be clear, we do have consensus in the need for faster
    payments, anonymity, and privacy. These goals can be achieved
    in legal and safe ways through policy change. I continue to
    champion the Electronic Currency and Secure Hardware (ECASH)
    Act, which directs the Treasury to explore privacy-preserving
    technology that facilitates permissionless interoperable and
    instant payments.
        I am also encouraged by the Fed's progress in achieving a
    real-time payment system. I hope to see more projects that
    explore innovation, such as Project Hamilton, which was led by
    the Boston Federal Reserve System (Fed) and Massachusetts
    Institute of Technology (MIT).
        The digital assets industry had episodes of implosion and a
    continuous stream of enforcement actions and a drumbeat of
    reports of scams, money laundering, demonstrating why it will
    only survive through proper legislation.
        The crypto lobby continues its pursuit of becoming exempt
    from basic investor and consumer protections and national
    securities laws. The growing presence of the digital assets
    industry in this election cycle speaks to its growing
    desperation to remain unregulated.
        This committee should have explored digital asset topics,
    such as DeFi and tokenization, long before legislation was
    introduced. The FIT Act, which I strongly opposed, excluded
    DeFi services, and I urge this committee to refrain from moving
    forward with similar legislation that would invite the same
    consumer and investor protection risks by legitimizing this
    industry.
        The DeFi and digital assets industry has proved that it
    cannot be trusted to offer what it claims. Instead, we should
    be exploring policy changes that modernize our payments and
    banking system and encourage safe innovation.
        I want to thank the witnesses for their willingness to
    appear and help the committee with its work. I look forward to
    our exchange of ideas.
        I yield back.
        Chairman Hill. The gentleman yields back.
        Today we welcome the testimony of Brian Avello: Mr. Avello
    is the chief legal officer of Universal DeFi Holding Company
    (UDHC), an investment fund focused on DeFi's ecosystem; Rebecca
    Retting: Ms. Retting, is the chief legal and policy officer of
    Polygon Labs; Amanda Tuminelli: Ms. Tuminelli is the chief
    legal officer of the DeFi Education Fund, an advocacy and
    educational organization focused on DeFi policy; Peter Van
    Valkenburgh: Mr. Van Valkenburgh is the director of research at
    Coin Center, a research and advocacy group focused on the
    public policy issues facing digital asset technologies and;
    Mark Hays: Mark Hays is a senior policy analyst on financial
    technology (Fintech) with Americans for Financial Reform.
        Each of you will have 5 minutes for your oral remarks. Your
    whole statements will be put in the record.
        Mr. Avello, we recognize you for 5 minutes.

          STATEMENT OF BRIAN AVELLO, CHIEF LEGAL OFFICER, UDHC

        Mr. Avello. Before I begin, a brief disclaimer.
        I am here today in my personal capacity, and the views and
    opinions I express are my own and do not reflect the views or
    opinions of my employer, my colleagues, any of our portfolio
    companies, or any projects with which I serve as a nonexecutive
    director.
        Thank you for the opportunity to speak today. My name is
    Brian C. Avello, and I am the chief legal officer for the
    Universal DeFi Holding Company, a principal investment firm. I
    have been an attorney in the cryptocurrency space since 2016,
    and my experiences as outside counsel and general counsel have
    shaped my understanding of decentralized finance, or DeFi, and
    its growing significance in our financial ecosystem.
        DeFi has evolved rapidly since the early days of 2017 and
    2018. My journey here began in earnest as the general counsel
    for the Maker Ecosystem Growth Foundation, a now dissolved
    software company that worked with its industry partners to
    bearing the leading credit generation platform, Maker
    Decentralized Autonomous Organization (DAO), known as Maker, a
    decentralized stablecoin, multicollateral Dai, to market in
    November 2019. Some would say that Maker was the world's first
    DeFi project.
        I also have had the privilege of investing in various
    startups that bridged DeFi and centralized finance, or CeFi.
    These experiences have led me to believe that a thoughtful
    regulatory framework is essential for DeFi to fully integrate
    with traditional financial systems.
        DeFi, at its heart, is an open-source technology movement
    that encompasses a broad spectrum of products that operate
    outside of centralized financial institutions. They are built
    on public permissionless blockchains, Ethereum, and encompass
    various business models focusing primarily on borrowing and
    lending and decentralized exchange and now real world assets,
    or RWAs.
        Most importantly, DeFi projects are open protocols, meaning
    anyone can use them to build new and innovative products, from
    Citibank using a lending protocol to Great Lakes expand their
    client accounts to a single developer building a product
    competitive to established financial institutions.
        At present, the leading DeFi applications range from
    borrowing and lending protocols that allow users to lend their
    crypto assets in exchange for returns to decentralized
    exchanges that facilitate peer-to-peer trading through
    automated market makers.
        Moreover, RWAs have recently come to the fore. These are
    on-chain representations of off-chain assets that provide users
    access to either interest-bearing opportunities or alternative
    assets, as well as near real-time execution and settlement and
    easily verifiable accounting. They can include government
    securities, corporate credit, and tokenized funds, and allow
    accredited and institutional investors to access various
    sources of yield on-chain.
        One significant issue is the regulatory landscape
    surrounding DeFi. Many users are underinformed about the
    complexities of DeFi protocols, and the absence of traditional
    intermediaries complicates compliance.
        For instance, most, if not all, current financial
    regulations assume the existence of intermediaries like banks,
    brokers, and investment advisors, which can be difficult to
    square decentralized systems built on peer-to-peer and peer-to-
    protocol transactions.
        Addressing these challenges is hard but not impossible by
    focusing at first on enhancing consumer protections through
    mandatory disclosures. These should include clear explanations
    of the technology, detailed information on token distributions,
    and transparency regarding governance.
        Please note that I do not view simple disclosure as a cure
    all for DeFi's issues or an end around from other ideas for
    regulation. Rather, I believe it is the initial step of many
    before we arrive at DeFi sufficiently regulated and integrated
    into our financial systems.
        Indeed, a multiagency regulatory framework could ensure
    users are, one, fully informed about the protocols they access;
    and, two, protected from malicious actors or permitting
    developers and user communities to compliantly innovate and
    scale this promising technology here in the United States.
        In sum, DeFi has shown remarkable growth and potential
    since its inception, and I hope that my practical experiences
    can contribute to a better understanding of how these markets
    are developing while communicating the base idea that, however
    lawmakers arrive at regulating DeFi, a focus on disclosure and
    consumer protection is paramount.
        Thank you.

        [The prepared statement of Mr. Avello follows:]
        [GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]

        Chairman Hill. Thank you, sir.
        Ms. Rettig, you are recognized for 5 minutes. Thank you.

     STATEMENT OF REBECCA RETTIG, CHIEF LEGAL AND POLICY OFFICER,
                              POLYGON LABS

        Ms. Rettig. Good morning, Chairman Hill, Ranking Member
    Lynch, Chair McHenry, and members of the subcommittee. Thank
    you for the opportunity to testify.
        I have spent the last 7-plus years of my legal career
    representing software developers building novel blockchain-
    based technology, including DeFi applications. I brought to
    this work years of experience at a large New York law firm
    where I represented Fortune 500 companies and traditional
    financial services firms with securities and other regulatory
    matters and where I experienced the intersection of law and
    technology firsthand in one of the early peer-to-peer file-
    sharing cases.
        Currently, I am the chief legal and policy officer of
    Polygon Labs, an international software development company
    building blockchain technology.
        Today I will discuss how the unique mechanics of DeFi have
    informed the global regulatory response to this technology and
    briefly touch on a policy proposal to treat DeFi's critical
    infrastructure and maximize user and market protection.
        Decentralized finance refers to a software system that
    allows users to engage independently in financial transactions.
    It is part of the larger web3 movement that returns the
    internet to individuals, a response to consumer demand for
    peer-to-peer transparent networks, for increased competition,
    and for control over one's own data. This means no Big Tech
    company and no big finance firm sits in the middle of any DeFi
    transaction.
        The hallmark of DeFi is that users retain custody and
    control over their assets and their data at all times. DeFi
    protocols are a set of automated code-based rules that allow
    for financial transactions when users provide the instructions.
    These are similar to the software protocols, like Transmission
    Control Protocol/Internet Protocol (TCP/IP), that underlie our
    internet today.
        Code for DeFi protocols is open, can be reviewed in real
    time, and audited by anyone. There is no proprietary black box,
    as in the traditional financial world. This increases
    predictability for users, and these open systems increase
    competition to build better user experiences.
        DeFi protocols are built on public infrastructure, namely,
    blockchain networks. DeFi transactions are cryptographically
    settled on these networks via automated consensus of thousands
    of computers, which creates a transparent record of transaction
    data. Like the internet itself, this infrastructure can be
    accessed and utilized by anyone with an internet connection.
        The term ``infrastructure'' usually evokes the idea of
    roads and bridges. Today, it is also the technological system
    that underpin many industries, from aviation to farming to
    financial services. In the United States, that infrastructure
    is overseen by CISA, the Cybersecurity and Information Security
    Agency, as critical infrastructure in collaboration with
    various other agencies, including the Treasury Department and
    law enforcement. DeFi can, likewise, fall under their purview.
        Today, DeFi allows users to exchange one crypto asset for
    another, provide crypto asset liquidity for borrowing, or
    engage in novel trading strategies. Yet DeFi remains nascent.
    The first DeFi protocol is approximately 7 years old, and
    today, DeFi holds around $78.9 billion of crypto asset value.
    This is only 3.9 percent of total crypto value and .07 percent
    of global Gross Domestic Product (GDP).
        Because DeFi systems are neutral technology, regulators
    have recognized that we cannot perfectly map traditional
    financial laws onto intermediary-less systems. The
    International Monetary Fund (IMF) and the financial stability
    board recognize that, quote, in the case of DeFi, the lack of
    intermediaries means that the traditional approach to
    regulation cannot be applied.
        The U.K.'s (Her Majesty) HM Treasury agreed, stating that
    regulation of DeFi, if any, would occur after any centralized
    crypto regulation.
        The same is true for EU, Japanese, Singaporean, and UAE
    regulators, all of whom have implemented centralized crypto
    regulation but not DeFi regulation to date. In fact, it used
    markets and crypto asset regulation, specifically exempt
    services performed in a fully decentralized manner without
    intermediaries, and requires a study of DeFi.
        Other regulators around the globe have devoted time and
    resources to analyzing novel DeFi use cases, including the Bank
    of International Settlements, various central banks, and the
    Singapore Monetary Authority, who have all experimented
    themselves with DeFi technology.
        DeFi addresses many of the core policy considerations of
    traditional financial services in a different way through
    automation, transparency, and user control over assets and
    data, and many of the risks in DeFi can be addressed by
    treating it as critical infrastructure.
        This is the topic of a recent paper I coauthored examining
    how CISA, in collaboration with OCCIP, Treasury's Office of
    Cybersecurity and Critical Infrastructure Protection, can work
    to mitigate cyber and system management risk to bring about
    policies that protect both users and markets, a mission
    fundamental to the long-term growth of DeFi.
        I am appreciative of the subcommittee's efforts to
    understand this technology, and I look forward to your
    questions.

        [The prepared statement of Ms. Rettig follows:]
       [GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]

        Chairman Hill. Thank you for your testimony.
        Ms. Tuminelli, you are recognized for 5 minutes to give
    your oral remarks.

       STATEMENT OF AMANDA TUMINELLI, CHIEF LEGAL OFFICER, DEFI
                             EDUCATION FUND

        Ms. Tuminelli. Thank you to the subcommittee for holding
    this hearing.
        My name is Amanda Tuminelli, and I am the chief legal
    officer at the DeFi Education Fund, a nonprofit, nonpartisan
    group that educates lawmakers and the public about
    decentralized finance and advocates for sound DeFi policy.
        We believe that DeFi is the path to a more equitable and
    more efficient financial system, one in which people have
    access to finance regardless of where in the world they live
    and regardless of the merits of their application.
        I will leave you with two points today. First, DeFi is
    different from and an improvement upon traditional finance
    because it does not rely on intermediaries. Second, the
    existing approach of demanding that DeFi look like, function
    like, or be treated like traditional finance has not and will
    not work.
        So what is DeFi, and how is it different? As others have
    said today, DeFi enables peer-to-peer transactions in which
    user self-custody their assets, just like with cash. Using
    DeFi, a person can trade assets, make and take loans, or earn
    interest.
        It is an improvement on the current system in a number of
    ways. For example, traditional finance (TradFi) relies on
    intermediaries that often serve as gatekeepers to finance.
    Traditional financial institutions like big banks can and do
    deny access to the system for discriminatory reasons or no
    reasons, but DeFi has open access. Anyone with an internet
    connection has access to a DeFi protocol, and that is the
    epitome of financial inclusion.
        TradFi is expensive to access and slow to use. Even the
    simple act of sending money usually requires paying fees to
    third-parties and waiting days for a transaction to be approved
    or processed, but using DeFi, I can send money or execute far
    more complicated transactions anywhere in the world, 24/7, with
    nearly instant settlement.
        As one last example, DeFi is better because it is self-
    custodial. As this committee knows, when TradFi services fail,
    customers lose access to their assets but, in DeFi, there is no
    fear of losing access to your money in a bank crisis because
    assets in your self-hosted wallet are always available to you.
        So that brings me to my second point. The existing approach
    of trying to apply rules for TradFi to DeFi will not work. The
    traditional financial system requires intermediaries to
    function. Brokers affect stock trades and clearinghouses settle
    transactions, and that means that we need to trust
    intermediaries to do their jobs reliably and honestly and the
    existing rules evolve to prevent the abuse of our trust.
        DeFi does not use intermediaries. If I want to swap two
    digital assets using a DeFi protocol, there is no broker, and
    there is no clearinghouse. DeFi's existence, the very reason
    that this technology was developed was to eliminate the need to
    rely on intermediaries and empower people to transacting
    directly with their peers.
        Existing law assumes that there is some identifiable entity
    that can take possession of my funds, collect information about
    my transaction, and even block a trade, but that entity does
    not exist in DeFi.
        The untenable position between the law as it stands and the
    reality of DeFi technology has led to an increasing amount of
    regulatory uncertainty. Seasoned lawyers with decades of
    regulatory experience cannot give their clients advice with
    certainty about whether their projects comply with the law.
        That is why judges in multiple district courts across this
    country have called on Congress to make new rules regarding
    digital assets, and this Chamber has supported bipartisan
    efforts and signaled that the status quo is not working for
    DeFi and digital assets.
        The existing approach of trying and failing to apply
    existing rules to this technology has led to so much hostility
    to innovation that American jobs and businesses have been
    heading overseas but the vast majority of DeFi developers are
    smart, creative people with a vision of building a better
    financial system, and they want to do that legally. So the U.S.
    can be at the forefront of that and create a clear path to
    building here, or we can let other countries pass us on the
    path toward our digital financial future.
        If you care about national security and you care about
    economic development, then you want this industry here on U.S.
    soil.
        We appreciate the efforts of Members of Congress, such as
    those on this committee, who have engaged with us on the
    reality of the technology and engaged with us on a path
    forward.
        Thank you.

        [The prepared statement of Ms. Tuminelli follows:]
        [GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]

        Chairman Hill. Thank you very much.
        Mr. Van Valkenburgh, you are recognized for 5 minutes.

    STATEMENT OF PETER VAN VALKENBURGH, DIRECTOR OF RESEARCH, COIN
                                 CENTER

        Mr. Van Valkenburgh. Chairman Hill, Ranking Member Lynch,
    Chair McHenry, members of the subcommittee, thank you for this
    opportunity to testify at today's hearing.
        In the 1940s, there were 350,000 telephone switchboard
    operators in the United States. Privacy-conscious Americans
    worried that operators might still be listening to their calls
    after connection, and their fears were not unfounded.
        In the 1928 Supreme Court decision Olmstead v. U.S.,
    wiretapping was deemed not to violate the Fourth Amendment.
    This allowed police to listen in to calls and conversations
    without any proof of reasonable suspicion our judicial
    oversight and to use that evidence against those Americans in
    court.
        By the end of the 20th century, two significant changes had
    occurred. In 1967, the court overturned Olmstead in the
    landmark decision Katz v. U.S., and by the 1980s, computers and
    automation had largely replaced human telephone operators. By
    the end of the 20th century, those changes had occurred.
        Today, there are around 600,000 licensed stock brokers in
    the U.S., fewer brokers per person than telephone operators in
    the 1940s. Like the operators of the past, financial middlemen
    can and do learn the intimate details of our lives, but in the
    1976 decision Miller vs. U.S., the Supreme Court ruled that
    Americans have no reasonable expectation of privacy in the
    financial records they keep with third parties.
        Fortunately, now in the 21st century, two things are
    changing once again. First, many financial transactions no
    longer require a human intermediary, a concept known as DeFi.
    Second, the Court is poised to overrule Miller and vindicate
    privacy rights just as it did with Olmstead.
        There is a pattern here that is hopefully clear. Initially,
    we have privacy in our day-to-day affairs, but we have to do
    things in person, a cash transaction, or a face-to-face
    conversation. Then technologies emerged that scale human action
    across vast distances, but we lose our privacy in the process:
    a telephone call, a bank wire.
        Finally, technologies improve, restoring privacy without
    sacrificing scale, and the law catches up to protect citizens'
    expectations of privacy. We get encrypted messaging. We get
    Bitcoin transactions.
        In the past, American dynamism and constitutional law drove
    these changes, but it is not inevitable that America will
    always lead this revolution. If we do not allow Americans to
    use and develop peer-to-peer financial systems, those tools
    will be used and developed overseas.
        Insisting on re-intermediating and surveilling peer-to-peer
    financial transactions would make the U.S. as noncompetitive as
    a country still relying on human switchboard operators for
    telephone calls.
        Nonetheless, the Internal Revenue Service (IRS) is drafting
    rules that would force unhosted wallet software developers to
    go into the business of monitoring the users of their software:
    re-intermediation. The Department of Justice is prosecuting
    mere software publishers as unlicensed money transmitters. The
    Office of Foreign Asset Control, OFAC, has banned Americans
    from using certain DeFi software tools even for entirely
    domestic and legitimate purposes.
        The Securities Exchange Commission is using enforcement
    actions to fit cryptocurrency activities into traditional
    regulatory frameworks that require intermediaries.
        These agencies pursue these regressive strategies without
    clear congressional direction. The IRS is contradicting the
    plain language of the Infrastructure Act. The Southern District
    of New York is offering unjustified interpretations of the Bank
    Secrecy Act. The SEC is stretching its jurisdiction through
    overzealous enforcement and an unconstitutional rulemaking.
        Congress has a pivotal role to play in preserving American
    dynamism. Some Members have already began to push back. The
    Blockchain Regulatory Certainty Act, the Keep Your Coins Act,
    and FIT21 would clarify the legal landscape and leave room for
    innovation.
        My organization, Coin Center, is also dedicated to
    preserving American dynamism. We are here to educate Members of
    Congress and the executive branch about these technologies,
    advocate for reasonable regulation, and preserve constitutional
    rights as we are doing through two challenges to regulatory
    overreach that we have brought in the courts.
        I appreciate the committee's time today, and I look forward
    to addressing any of your questions.

        [The prepared statement of Mr. Van Valkenburgh follows:]
        [GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]

        Chairman Hill. Thank you, sir.
        Mr. Hays, you are now recognized for 5 minutes for your
    oral remarks.

    STATEMENT OF MARK ALLEN HAYS, SENIOR POLICY ANALYST, AMERICANS
                          FOR FINANCIAL REFORM

        Mr. Hays. Thank you, subcommittee chair, Ranking Member
    Lynch, and members of the committee. Thank you for the
    opportunity to testify here today.
        I am Mark Hays, a senior policy analyst with Americans for
    Financial Reform, which is a coalition of over 200 consumer,
    community, labor, civil rights, and other organizations that
    advocate for a financial sector that serves workers,
    communities, and the real economy, and provides a foundation
    for advancing racial and economic justice.
        The cryptocurrency and decentralized finance, or DeFi
    industries taut themselves as alternatives to traditional
    finance. They use technology to side step intermediaries and
    offer new ways to build wealth and finance.
        Unfortunately, the crypto industry is highly volatile,
    scam-ladened, and frequently predatory, which exposes investors
    to substantial financial losses. In fact, yesterday, the
    Federal Bureau of Investigation (FBI) reported that there were
    5.6 billion in losses in 2023 alone reported associated with
    crypto, which was 10 percent of the cases reported but 50
    percent of the reported losses.
        This is largely because the industry often does not comply
    with or is not subject to the same sorts of investor or market
    protections found in conventional markets. Many have lost their
    life savings due to industry practices, and people from
    communities of color and low-income neighborhoods have
    particularly been targeted and harmed.
        Crypto and DeFi must be subject to the same kinds of
    investor protections and market regulations as other retail
    investment markets, such as those overseen by the Securities
    and Exchange Commission and State securities regulatories.
    These rules promote market transparency, price discovery, and
    market stability, as well as protect investors from fraud and
    market manipulation.
        Some of these risks stem from the aggressive promotion of
    new crypto products, DeFi or CeFi. This often includes
    celebrity endorsers sometimes compensated to boost investor
    interest in assets with little real-world tangible value.
    Boosters have included marquis figures like Larry David, Gisele
    Bundchen, and Steph Curry, among many others.
        The most recent example of this type of promotion is the
    launch of the crypto venture World Liberty Financial, which has
    insinuated the involvement of public figures, such as the Trump
    family. Yet this does not work out well for consumers. A
    Harvard and Indiana University study on such promotional
    activity found that crypto ventures promoted by influence or
    tweets slid by 18 percent within 3 months.
        The DeFi industry's contention that its technology
    democratizes finance and makes regulatory standards found in
    other markets less needed or unnecessary altogether does not
    hold water. In fact, there is considerable centralization and
    consolidation of the ownership, control, infrastructure and
    economic relationships found in DeFi.
        As I describe in my written submission, decentralized
    finance is not all that decentralized. A limited set of
    powerful players control crucial elements of the DeFi industry.
    For example, one industry study showed that just 1 percent of
    DeFi platform users control 90 percent of governance tokens on
    10 major DAOs, or decentralized autonomous organizations.
        Far from automatically creating safety, the technology used
    has enabled or allowed multiple scams and hacks, amounting to,
    by one industry estimate, 1.5 billion worth of losses in 2023
    alone, which is, based on the cases used, more than one scam
    per day on average.
        In reality, DeFi is composed of de facto crypto-based
    intermediaries that play similar roles and pose similar risks
    as traditional financial markets do but who are not covered by
    or abide by the protections and rules that exist in those
    markets. The DeFi industry is replete with these risks and
    harms, widespread hacks and cyberattacks, extractive and
    exploitive financial products and services, market
    manipulation, illicit finance, and more.
        These problems warrant a proactive regulatory approach to
    protect investors, crypto markets, and the financial system,
    but Congress' efforts to advance crypto-related legislation,
    such as with FIT21, which passed the House this year, have
    mostly proposed creating new, lax, custom-made crypto and DeFi
    regulations or exempting the DeFi industry from existing
    regulatory oversight altogether.
        Instead, Congress should work with regulators to use their
    existing regulatory authorities to protect investors,
    consumers, and communities from the risks and harms that DeFi
    presents and to hold crypto and DeFi actors accountable for
    complying with existing rules and regulations.
        Studying this history may be useful, but it should not
    preclude action to protect consumers today.
        I look forward to your questions, and thank you for your
    time and consideration.

        [The prepared statement of Mr. Hays follows:]
        [GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]

        Chairman Hill. Thank you, Mr. Hays.
        We will now turn to member questions, and I recognize
    myself for 5 minutes.
        I spoke earlier about how our regulatory and legal
    frameworks were designed for a financial system with
    centralized entities. Because of this, it can be challenging to
    apply the approach of same risk, same regulation to DeFi due to
    its permissionless peer-to-peer nature. I think our witnesses
    all have done an excellent job talking about that concern or
    opportunity and the cost and benefits, but nothing is without
    risk. Current rules and regulations were established to address
    specific risks, and they are not the same between traditional
    finance and DeFi.
        Ms. Tuminelli, what are the potential risks regulators
    should be focused on when they think about DeFi?
        Ms. Tuminelli. Thank you for that question.
        As you suggested, the inherent risks in the traditional
    financial system are related to intermediaries. They are often
    opaque. We do not know what is going on, and they are often
    discriminatory or subject to human bias or subjective error.
        In DeFi, the risks are more related to the actual
    technology, so like vulnerabilities in code, or consumer
    protection and education, making sure that people understand
    what a DeFi protocol does, how it is self-hosted while it
    works.
        Of course, illicit finance is a risk in every system. It is
    just that the way we deal with illicit finance in DeFi has to
    be different than the way we address that risk.
        Chairman Hill. Right. You recognize that we have to solve
    for that equation, which is how we do the authentication and
    protect against bad actors in DeFi.
        Do we have the ability--when you think about it, are we not
    very vulnerable from a cyber point of view? I am not a big
    Cybersecurity and Infrastructure Security Agency (CISA) fan. I
    know they have that responsibility, but I think there are a lot
    of vulnerabilities inside our cyber system in our country, no
    greater risk than the U.S., which is why I do not support big--
    more U.S. data bases being created. They are just bigger
    targets.
        How do you--what is the best way to do that for consumer
    protection from being hacked, their wallet, their protocol? I
    do agree that is one of most inherent risks compared to an
    intermediated risk of a capital failure or an error made by not
    doing the CrowdStrike patch in your system. We know those risks
    but talk about how you avoid that hack issue if you are in a
    decentralized finance environment.
        Ms. Tuminelli. I think, as you flagged, there is a big
    difference between a cybersecurity risk and a risk on the
    actual blockchain layer with the technology itself.
        With cybersecurity risks, those are often unlocalized to
    one person or a small group of identifiable people, and we know
    what to do with cybersecurity risks. For years we have been
    navigating----
        Chairman Hill. We are not very good at it, though, are we?
        Ms. Tuminelli. Well, the industry has created actually a
    number of crypto Information Sharing and Analysis Centers
    (ISACs) that specialize in this exactly. They jump in if there
    is an ongoing exploit or hack and try to assist in returning
    victim funds.
        To get to your other point on consumer education and
    protection, the industry has also come up with solutions for
    that, and a number of front ends have actually built into the
    front end software fraud alerts, scam alerts so that a person
    can be protected on the front end.
        Chairman Hill. Good.
        Let me stick with our discussion but switch over to the
    commission now, and they proposed a new rule that broadly
    expands the definition of an exchange. I would like your views
    and Mr. Van Valkenburgh's, too, on this to capture not just
    decentralized digital asset platforms but also DeFi.
        Pretty broad. I was telling Mr. Lynch things are not very
    well-defined here, and so it seems to be a pretty massive
    overreach, over-definition by the commission.
        How should DeFi think about this exchange function? Like,
    one of the key functions of an exchange in an intermediate
    system is market making in a bond or a stock to aid in that
    matching for pricing purposes. I get both of your points, but I
    would like both of your comments on this.
        The Gensler approach, what is wrong with it and what a
    better approach is? You have 25 seconds, I will give you 25
    seconds. Go.
        Ms. Tuminelli. I would say that the very first problem is
    that the SEC has still never defined what a crypto asset
    security is, which is a precursor to this entire discussion.
        With the exchange rulemaking, they have swept extremely
    broadly to catch developers and protocols that have no ability
    to comply with the rule as they have proposed.
        Chairman Hill. Very helpful.
        Mr. Van Valkenburgh.
        Mr. Van Valkenburgh. The only thing I would add to that
    excellent answer is the SEC swept so broadly in its Exchange
    Act rulemaking that it has run right into the First Amendment
    of the Constitution, and it is not the first time. They got
    slapped down in SEC vs. Lowe for being overzealous in their
    enforcement of the Investment Advisor Act and regulating mere
    publishers of newsletters.
        In the Exchange Act, they want to regulate people who,
    quote, make available a communications protocol. If making
    available a protocol, which is a set of rules, is not
    publishing speech, then I do not know what is.
        Chairman Hill. Thank you, sir. My time has expired.
        I turn to the ranking member for his 5 minutes of
    questions.
        Mr. Lynch. Thank you, Mr. Chairman.
        Mr. Hays, recently the multiservice crypto platform DeFi
    estimated that almost $2 billion in crypto assets on DeFi
    platforms were lost back in 2023 due to hacks, theft, or
    exploits based on they had 448 documented cases, more than a
    hack per day and only about 10 percent of these losses were
    recovered from investors, according to the report.
        The nearly $2 billion in DeFi attack losses in 2023 was
    dwarfed by the 47 billion that was lost in 2022. If you look at
    the traditional finance system, the Bank Secrecy Act, our money
    laundering protocols all resulted because we had crises in the
    industry, and we needed to take steps.
        I mean, you can even look at the collapse of the banking
    industry during the Depression. We lost--over 1,000 banks went
    down. We had to come in with regulations to say, okay, we are
    going to have deposit insurance. We created the Federal Deposit
    Insurance Corporation (FDIC).
        What about this argument that we do not need any
    intermediaries and all this theft and fraud continues to occur?
    What would bad actors benefit from if, per se, we do not employ
    Know Your Customer or anti-money-laundering protocols connected
    to DeFi?
        Mr. Hays. Thank you for the question, Congressman.
        I think you are right to be concerned. That is a large
    volume of loss that is affecting consumers who are already
    engaging in these practices whether or not we truly understand
    what DeFi is or whether decentralization has been achieved.
        I think the problem goes deeper, and I want to stress there
    is a focus on the role in which cybersecurity and the
    technology of these platforms facilitate some of these
    problems. Arguably, there is almost always a human component
    behind it, and the problems that arise have parallels in our
    current financial system and the economics of finance, which we
    already have addressed or at least are addressing with the
    regulatory structures today.
        For example, many hacks are inside jobs. They are set up by
    the actual people involved. Rug pulls are ubiquitous, and rug
    pulls involve insiders that are dictating how code is written
    and promoting tokens or products that draw in investors with
    little knowledge of those products.
        More disclosure, more information, such as the things found
    in securities regulation, would help those investors have a
    better understanding of who is behind the products, how they
    are operating them, what they are offering, what their
    background is but that does not exist in this space today.
    White papers are not standardized. People have to read code. It
    is a real problem.
        Oracle attacks are manipulation of real-world price data.
    That is something that goes through DeFi interfaces, but
    someone designs that interface and determines how the Oracle
    goes in there.
        With money laundering, I think the problem is there is a
    conundrum: If you allow DeFi to operate without the same
    consistent Know Your Customer (KYC) controls, money launderers
    look for gaps in the broader financial system. They are looking
    for weaknesses. They are looking for lowest common denominator
    spots so that they can exploit.
        This committee knows full well that some of the anti-money-
    laundering measures that were passed in the early 2000s, or
    different financial professionals, were just recently, after 20
    years, implemented by Treasury because of massive resistance in
    the industry. That was a massive gap in that framework.
        So, if we allow that gap to continue in DeFi, we are
    essentially laying, setting a table for money launderers to
    continue to exploit those gaps in ways that harm lots of
    people. So there are ways to look at how we can tweak those
    things, but the bottom line is if those rules are not
    consistent, you are going to damage the entire approach to
    combating illicit finance, and that is going to harm a lot of
    people.
        Mr. Lynch. There is much said about the decentralization in
    DeFi. Is that actually the case? I mean, we have studies here
    that say there is a narrow group of people that actually
    control this and it is not--it does not have the full benefits
    of decentralization. Is that what you have found?
        Mr. Hays. The research we have seen suggests that, and much
    of that is industry research or outside observers. I think it
    raises a question, if decentralization cannot be defined and
    cannot be realized, then it cannot provide the benefits it
    offers.
        So I think, before we rush into allowing these actors to
    sort of have full access to the financial system, particularly
    if it becomes interconnected with the broader financial system,
    which is starting to happen, I think we should take a
    precautionary approach and that includes regulators reining in
    some of this activity before it can cause more amplified harm.
        Mr. Lynch. Thank you.
        Mr. Chairman, I yield back.
        Chairman Hill. The gentleman yields back.
        The gentleman from Oklahoma, Mr. Lucas, is recognized for 5
    minutes.
        Mr. Lucas. Thank you, Mr. Chairman, for holding this
    hearing, and thank you to our witnesses for testifying today.
        First, I think it would helpful to step back and appreciate
    where decentralized finance fits into the larger conversation
    around digital assets, blockchain technology, it does not
    matter, the future of the internet.
        Ms. Rettig, starting broadly with Web3, could you discuss
    how blockchain technology enables decentralized digital
    ownership and could you highlight some of the use cases beyond
    DeFi?
        Ms. Rettig. Thank you very much for your question,
    Congressman.
        As I noted in my oral testimony, DeFi protocols are
    deployed onto permissionless blockchain networks. On a network
    like Ethereum, there are hundreds and thousands of computers
    that must come into consensus to settle these DeFi
    transactions. At the base layer, they are highly decentralized.
    At the DeFi application layer, they may be decentralized in a
    number of ways but protocols that operate without
    intermediaries autonomously through software are--do meet the
    level of decentralization.
        Your second part of your question, on nonfinancial use
    cases, there are a number. About over a year ago, Polygon Labs
    launched an open-source data base of blockchain-based use cases
    called the value prop. Today, there are over 500 applications
    and 43 use cases, and the nonfinancial use cases outweigh the
    financial use cases.
        Two that are most notable are the California DMV has
    digitized 42 million car titles to smooth the title transfer
    process. GeoNet is an application that pulls satellite data in
    order for farmers to have better predictability about their
    crops and be able to enhance predictability.
        Mr. Lucas. Mr. Valkenburgh, could you also share your
    perspective about the impact of decentralizing the internet?
        Mr. Van Valkenburgh. I would be happy to. Thank you,
    Congressman.
        So there is a paradigm shift involved with DeFi, and we
    keep coming back to it, which is the removal of intermediaries.
    The cybersecurity threats that we have discussed in the context
    of the larger internet are a part of that paradigm shift.
    Hackers today target centralized servers. Centralized serves
    have wealths of information and data about the users of those
    services.
        This does not need to be the way the internet is built.
    Indeed, the original internet was built with individual servers
    run by individual internet users in mind. You would have your
    own blog. You would speak your own voice, and you would have
    censorship resistance, autonomy, and privacy, the core values
    of the American revolution.
        We have seen a change as large companies built services,
    Facebook, Google on top of the internet, and created moats
    around their user data. DeFi, along with the nonfinancial uses
    that Ms. Rettig highlighted, is an alternative to that, a
    return really to the original view of the internet, which is
    that it should be an open playground for people to build what
    their hearts say they should build and do it themselves and own
    their own data in the process.
        Mr. Lucas. In the remaining time I have, I would like to
    focus on an issue that I put a lot of energy in on the Science,
    Space, and Technology Committee, and that is the future of
    quantum computing. Quantum computing has an enormous untapped
    potential to solve the world's most complex problems but also
    has the ability to wreak havoc in the wrong hands.
        Cryptography, of course, is the backbone of blockchain
    networks, which is, in the near future, must withstand a post-
    quantum world.
        Ms. Tuminelli, would you--how much attention has been given
    to post quantum cryptography in the context of DeFi protocols
    as we slide into quantum computing?
        Ms. Tuminelli. Thank you for the question.
        As you suggested, cryptography is the backbone of
    blockchain technology, which means that it is also the backbone
    of DeFi technology. I think, exactly as your question said, it
    is key and central to the future of DeFi.
        Mr. Lucas. With the potential for quantum computing that
    exists, I believe, from the hearings we do on the Science
    Committee, the effects on these encryptions are going to be
    dramatic. How do we keep up? Anyone else wish to touch on that
    for a moment?
        Mr. Van Valkenburgh. The one thing I would add about
    quantum computing is it could make a lot of our current crypto
    systems obsolete in a dangerous way.
        Now, the interesting things about DeFi here are that we
    would see in real time the need to update our systems because
    hacks would become immediately apparent. Large centralized
    banks, financial services providers, and internet corporations
    may get hacked and may fail to rapidly disclose those
    vulnerabilities.
        So there is something beautiful in the fact that these
    systems are open and that we immediately see when a
    vulnerability exists, and we can start to patch it. The value
    in these systems means there is effectively a very good bug
    bounty to draw people to fix these problems.
        Mr. Lucas. Thank you.
        I yield back, Mr. Chair.
        Chairman Hill. The gentleman yields back.
        The gentleman from Illinois, Mr. Foster--Dr. Foster, I
    should say, is recognized for 5 minutes.
        Mr. Foster. Thank you.
        I would like to actually follow up on the chair's
    discussion about the need to identify bad actors. How is this
    actually implemented in DeFi right now? First, how do you
    identify them in a system where the underlying protocol is that
    of a permissionless, anonymous, self-hosted custody of assets?
    How do you identify and how do you effectively ban bad actors,
    or is there no such concept as bad actors in DeFi?
        I will just go down the line, and if you could describe how
    it is implemented, if at all.
        Mr. Avello. Sure. Happy to do that. Thank you for the
    question, Congressman.
        Our fund, actually, has invested in a company that is
    building what is called zero knowledge proof protocols.
        Mr. Foster. Yes, that is not--what is there right now? I
    understand. We have had hearings on homomorphic encryption. It
    is not ready for prime time. With the technology that exists
    today, how do you do it?
        Mr. Avello. Well, this particular company has launched a
    product. It is actually being used in the marketplace now. It
    is--they have not gotten market share at this point, but they
    are growing significantly.
        Mr. Foster. There is also fundamental problems with the
    zero knowledge, which you still need a third party to control
    the privacy budget on these things. I have looked at the
    mathematics behind there. I have programmed blockchain.
        By the way, Ms. Tuminelli, I appreciate your efforts to
    educate Congress on this, which is a challenge. If you ever
    would like to learn how to program blockchain, I would be happy
    to teach you.
        If we can go next and say, how do you implement, how do you
    implement identification and banning of bad actors in an
    anonymous self-hosted situation?
        Ms. Rettig. Thank you so much for your question,
    Congressman.
        I think there are two primary--three primary ways that it
    happens today. First, there is an organization called the
    Security Alliance, which is an organic group that monitors and
    works in public-private partnership with law enforcement to
    watch for hacks and engage in other types of activities.
        Mr. Foster. When you have identified a bad actor and a bad
    actor reappears with an anonymous self-hosted wallet, how do
    you identify the fact that you are a bad actor?
        Ms. Rettig. Law enforcement and blockchain analytics tools
    are actually able to trace a lot of this very transparently.
        Mr. Foster. A lot is not enough. You need to be able to
    trace all of it, and that is I do not believe technically
    possible.
        Ms. Rettig. Our current system under the Bank Secrecy Act
    (BSA) is not 100 percent, but I think we should be aiming for
    that in the DeFi ecosystem, and there are a number of ways to
    handle that. I have actually made one such proposal in a paper
    that I coauthored and published in January where we identify a
    new category called critical communications transmitters that
    will take on enhanced risk-mitigation measures for financial
    integrity.
        Mr. Foster. Okay. Now, when you have identified a bad
    actor, how does DeFi come together to say, ``This is a bad
    actor; we are going to ban you?'' How do you even trace that
    person when people are operating multiple identities
    anonymously?
        Ms. Rettig. Sure. The critical communications transmitters
    will bring immediate reports to the Financial Crimes
    Enforcement Network (FinCEN). They will not look identical to
    Suspicious Activity Reports (SARs), but they will have the type
    of information that will allow FinCEN and other law enforcement
    to be able to trace both the immediate wallet you are talking
    about and anything that emanates out from that as well.
        Mr. Foster. How do you trace all users of anonymous
    wallets? If one person is operating 12 anonymous wallets, how
    is that dealt with in this system?
        Ms. Rettig. I can say that, through public-private
    partnerships and working with the FBI and the Department of
    Justice (DOJ). on a number of these matters, they are actually
    able to trace wallets very quickly and much more quickly than
    the decades that it has taken to trace illicit funds in the
    traditional financial world.
        Mr. Foster. Does that not apply to the most deliberately
    anonymous financial products that have been made, which are
    made, by design, very hard? This rapidly gets into classified
    stuff, and so, if you cannot talk about that, that is all
    right.
        Ms. Rettig. I cannot talk to you deeply about it, but I
    will say that funds from some of the worst actors are frozen
    today and unable to be moved given the immediate identification
    that has happened both with industry and law enforcement
    working together on these issues.
        Mr. Foster. When you freeze someone's funds, do you freeze
    their activities in every one of the anonymous wallets that
    they control?
        Ms. Rettig. You certainly freeze the illicit activities,
    the illicit funds that you have identified.
        Mr. Foster. That you have identified. Okay. So there is no
    way to ban a bad actor. They just pop up in some other guise
    with some other set of self-hosted wallet?
        Ms. Rettig. That may be but----
        Mr. Foster. Okay. Thank you.
        There are also questions of governance here. Mr. Hays,
    there is a fundamental guarantee that people who are investing
    in anything in the regulated markets in the U.S. at least that,
    when you invest into something, there is not a cabal of people
    secretly controlling what you have just invested in that are
    going to rip you off.
        It seems to me that also cannot really be a guarantee in a
    situation where people have anonymous self-hosted wallets that
    control the voting. How do you view this as a problem, and are
    there any ways to fix it?
        Mr. Hays. Well, briefly, I think it is a problem. You see
    concentration of ownership of governance tokens across
    platforms, particularly with venture capital funds, who
    arguably are dictating how these programs are run and that is
    for their benefit, not necessarily other retail investors.
        Mr. Foster. Thank you.
        My time is up. I yield back.
        Chairman Hill. Mr. Rose of Tennessee, you are recognized
    for 5 minutes.
        Mr. Rose. Thank you, Chairman Hill and Ranking Member
    Lynch, for holding this hearing today.
        Thank you to our witnesses for your time and being present
    today.
        I am proud to say that my home State of Tennessee is a
    leader in blockchain investment thanks to the forward-thinking
    approach we have taken to regulation. Limited--one such example
    is our recent passage of legislation that allows limited
    liability companies to register as decentralized autonomous
    organizations, or DAOs. At the time of the passage, Tennessee
    was only the second State in the country to have such
    legislation signed into law.
        Mr. Avello, could you explain what DAOs are and why they
    have become so popular?
        Mr. Avello. Happy to. Thank you for the question,
    Congressman.
        In DAOs, if you ask 30 different people, you might get 30
    different answers, but the way that I like to think about it
    kind of starts from this primitive that there are individuals
    who are using blockchain technology or leveraging blockchain
    technology to create a governance system without a centralized
    management team.
        What the same come aspects that kind of exist in all of
    these different organizations are a lack of a centralized
    management team. There are collective decisionmaking across the
    groups that are organizing natively on the internet. Typically,
    there is a governance token involved. That is not in every
    single case, but there is typically your governance token
    rights.
        As far as why they are becoming popular, I think it is
    very--when there is excitement within a group of people that
    are interested in a different project--that can be DeFi; that
    can be investment clubs; that can be social groups. There is a
    whole host of activities that people engage in through DAOs,
    but I think the ease with which they are able to organize
    initially makes them popular.
        As far as long term, they can be, depending on the services
    that are being offered by the DAO. They take on a variety
    different forms: limited liability companies, different
    foundations overseas, sometimes operating--there are sometimes
    groups that operate without entities.
        So the flexibility that is offered through the DAOs and of
    organizations I think has given rise to its popularity.
        Mr. Rose. Thank you.
        Ms. Tuminelli, last year, the Internal Revenue Service
    proposed a rule requiring broker reporting of sales and
    exchanges of digital assets. This rulemaking seemed to be
    contingent on the assumption that broker businesses are in the
    position to know a person's potential tax obligation.
        Is the IRS proposal workable?
        Ms. Tuminelli. Thank you for the question.
        In short, no, it is not. The proposed definition of broker
    is extremely broad. As you said, it puts anybody in a position
    to know in the place where they have to report.
        For example, right now I am sure members of your office
    have started fantasy football. At the end of the season, the
    commissioner of your fantasy football league is in a position
    to know the winnings or loss of any person who participated.
    That person would be a broker under the IRS' new rule.
        Mr. Rose. What is the status of the rulemaking?
        Ms. Tuminelli. Right now, the IRS finalized the part of the
    rule that applies to others outside of DeFi, and we applaud
    them for that. They did take the right tack in trying to learn
    more about DeFi before they finalized the rulemaking as it
    applies to DeFi.
        Mr. Rose. Ms. Tuminelli, I think that my colleagues on the
    other side of the aisle and the Biden-Harris Administration
    scapegoat the digital asset industry as a mechanism to avoid
    tax liability. How can the DeFi industry support tax
    compliance?
        Ms. Tuminelli. Sure.
        Obviously, the tax liability for an individual is on the
    individual themselves, but as an industry, of course there are
    software and technology solutions that make it easier for a
    person to assess their tax liability and pay that tax
    liability. Ultimately, it is their responsibility as an
    individual to pay their taxes.
        Mr. Rose. Thank you.
        Under President Trump, the Financial Crimes and Enforcement
    Network released guidance in 2019 that has been one of the few
    regulatory actions that has provided legal clarity for DeFi
    developers and businesses. However, I was unsurprised to learn
    that the Biden-Harris Administration's Department of Justice
    has poured cold water on that guidance and taken a more
    aggressive enforcement path.
        Ms. Tuminelli, could you explain what the impact or what
    impact that has had on the DeFi industry?
        Ms. Tuminelli. Sure. As you said, in 2019, FinCEN finalized
    guidance that was very helpful to the industry and explained
    what a money services business was in the context of providing
    and publishing software, and the industry followed that
    guidance for years. Just this year, the Department of Justice
    took the position that guidance is merely a suggestion and that
    they do not need to comply with it or listen to it, and it is
    really unfortunate that two entities in the same government are
    disagreeing on what the law is, and the consequences is a
    person's liberty.
        Mr. Rose. Thank you, and my time has expired. I yield back.
        Chairman Hill. The gentleman yields back.
        We are honored to hear from the ranking member of the full
    committee, Ms. Waters, for 5 minutes.
        Ms. Waters. Thank you very much.
        While decentralized finance, or DeFi, aims to create
    greater efficiencies and transparency, it can also pose
    heightened risks of hacks, scams, unequal information, and
    conflicts of interest that can harm consumers and investors. We
    have seen this play out in the new DeFi venture that Eric Trump
    and Donald Trump, Jr., plan to launch, called World Liberty
    Financial.
        Because of the prominence of those behind the project, bad
    actors took advantage of the opportunity to scam potential
    users. Lara Trump and Tiffany Trump's X accounts were hacked,
    and scammers used them to announce links to a coin falsely
    claiming to represent World Liberty Financial. According to the
    analysis, at least 200,000 people viewed the post, and
    approximately 2,000 people purchased $1.8 million worth of the
    fake token. Lawmakers have a responsibility here, and I think
    the lawmakers have a responsibility to consider strong
    protections to prevent such scams from moving forward.
        Mr. Hays, I would like to ask you a question. Opaque DeFi
    platforms with unclear governance and control mechanisms may
    create hurdles for regulators to establish responsibility and
    accountability for regulatory compliance. In launching actions
    against DeFi entities, regulators, like the Securities and
    Exchange Commission and the Commodity Futures Trading
    Commission, have had to navigate complex legal issues. We have
    seen these issues play out in litigation involving
    decentralized autonomous organizations and virtual currency
    mixers.
        In your view, how can regulators deal with mass
    noncompliance by entities that claim they are decentralized to
    avoid regulatory compliance? What more needs to be done to
    ensure robust consumer and investor protections in this
    industry?
        Mr. Hays. Thank you, Congresswoman. The issues you have
    laid out here are pretty profound, and I think the simplest way
    to answer your question is that regulators should continue to
    do what they are doing. For example, the Securities and
    Exchange Commission's rulemaking, looking at the definition of
    exchange, we have heard some discussion about that today. I
    think there are a couple points to keep in mind.
        The original law that drafted that Securities Exchange Act
    was meant to be expansive to cover a lot of different
    scenarios. Far from sort of an antiquated idea, it really was
    meant to be evergreen. Congress in the past has considered
    narrowing that definition but decided against it. So this
    rulemaking ironically provides a certain degree of clarity that
    looks at the functional nature of how exchanges operate.
        What their--the proposed rulemaking has said or the rule
    has really explored, look, if you are matching a buyer and a
    seller to facilitate a trade, that is an exchange. You can be a
    regulated exchange under that act. You can be an ATS. You can
    be a DCM under the CFTC if you are not dealing with securities.
    There are a couple different pathways. In fact, I know they are
    continuing to work on that rulemaking to further clarify what
    kind of information applies to that.
        So the SEC is already embarking upon that effort, and we
    should continue to support their efforts. I think the CFTC has
    done similar work with the Ooki DAO case, where they have
    identified how there are times and places where DAOs meet the
    facts and circumstances similar to what you might find with an
    unincorporated association, so, in fact, persons are
    responsible. I think legislation that undermines that and makes
    it harder for regulators to do that is misguided.
        Ms. Waters. Thank you very much. I yield back.
        Chairman Hill. The gentlewoman yields back.
        The gentleman from Wisconsin is recognized for 5 minutes.
        Mr. Steil. Thank you very much, Mr. Chairman. Thanks for
    holding today's hearing.
        We were just talking about risk. I want to just dive in
    because I think there is some real strong counter points that
    we need to make sure are on the record, right. With every new
    technology, there are benefits, there are risks. How do you
    manage the benefits? How do you scale down the risks?
        If I can, I want to come to you, Ms. Rebecca Rettig. DeFi
    shows promise. There is also some risks that needs to be
    addressed. DeFi's hacks cost more than $3.6 billion in 2022,
    and the number has likely gone up since. Can you talk about
    what DeFi protocols in the broader community have done to
    address these risks, and what else may need to be done to
    target existing vulnerabilities, because I think it is really
    important to talk. Sure, there is risk out here, but how are we
    working to downsize that risk?
        Ms. Rettig. Thank you very much for your question,
    Congressman. I think we can all agree that any of the hacks or
    scams or any of the risks should be mitigated as thoroughly as
    possible. I would say that the three primary risks in DeFi are
    cyber risk, system management risk, as well as usage risk.
    There are current efforts to combat many of those. As I
    mentioned previously, the Security Alliance looks at all of
    those types of risks, both what is happening from the illicit
    finance perspective but also training developers how to build
    safer ecosystems in general, as well as how to put in place
    appropriate system management controls to ensure that there are
    not these centralized places of data or other areas of
    vulnerabilities.
        So that is one of the primary places that it happens, but
    there is also significant public/private partnership with law
    enforcement going on in the industry to ensure that a lot of
    these risks are addressed.
        Mr. Steil. That is helpful.
        Let me jump over to you, if I can, Mr. Brian Avello. In
    your written testimony, you noted that many DeFi participants
    are having trouble navigating the jargon and code associated
    with DeFi projects. On top of that, you argued that many
    projects failed to prevent fulsome information. What can market
    participants do to ensure counterparty communications and
    disclosure are better understood?
        Mr. Avello. Sure. I think--and thank you for the question,
    Congressman. I think you will see a lot of the most notable
    projects in DeFi have developed kind of almost as custom
    disclosing massive amounts of information, not only on
    tokenomics with regard to each project but also at a very
    granular level discussing and explaining in plain English how
    these different technologies work, specifically different smart
    contract functions if one or more persons is interacting with a
    contract, exactly what you will be engaging in by interacting
    with those protocols.
        Mr. Steil. What should regulators be looking at in
    considering with respect to rules required around disclosures
    or other communications?
        Mr. Avello. I think there has to be a lot of interaction
    with the industry, probably the most notable or largest
    projects that have a presence and are actually coming here to
    engage in Washington would be a good starting point. Then, you
    look at kind of--I think I highlighted in my written testimony
    what I as a user and an investor in this space would expect to
    see, and I think, frankly, it is about--it is a matter of
    making the information as simple and as clear as possible for
    the users who are using it so that you do away as best as
    possible with the lack of confusion.
        Mr. Steil. Thank you very much.
        I am going to come back to you, if I can, Ms. Rebecca
    Rettig. Shifting gears here because I think it is worthwhile
    talking about use cases, and I know Polygon Labs maintains a
    data base of DeFi use cases. Commissioner Peirce wrote the
    following Stagnation, centralization, expatriation, and
    extinction are the words of this release, Today's Commission
    treats its basic approach to exchange regulation as something
    that must not--indeed cannot--be altered to allow room for new
    technologies or for new ways of doing business.
        Strong words from a sitting SEC commissioner.
        I think what Commissioner Peirce is actually touching on is
    a point that we have made many times in this committee that
    laws and regulations need to evolve to accommodate innovation
    safely. So we are talking about the risk upfront. We know that
    there is use cases out there. Can you just comment on some of
    the use cases that you are seeing that American families and
    workers would benefit from this?
        Ms. Rettig. Thank you very much for your question,
    Congressman, and the use case aspect is something that really
    brought me to Web3. I talked about some of the nonfinancial use
    cases, and--but others that abound in the DeFi context, as we
    are talking about today, is faster payments, which allow for
    humanitarian aid transfer from the United States to those on
    the front lines. In Venezuela, there are health workers there
    who have needed it. There has been also payments in the
    humanitarian aid context for the efforts for Ukraine, both from
    people in the United States as well as outside this country, as
    well. Some of the other types of efficiencies that we have seen
    have been for the exchanging of assets and the like.
        Mr. Steil. Thank you very much.
        Thank you, all, for your testimony.
        Mr. Chairman, I yield back.
        Chairman Hill. The gentleman yields back.
        The gentleman, Mr. Casten, is recognized for 5 minutes.
        Mr. Casten. Thank you, Mr. Chair.
        Thanks to you all for being here.
        So I am--I remember when I got out of college, I was living
    in Boston, I was in my 20s, mostly just reading the Federalist
    Papers. Yes. I remember there was this great pizza restaurant
    over on Commonwealth Avenue by Boston University (BU) that,
    rather famously, was--the pizza was fantastic, to be clear--
    they were found to have basically retained virtually every law
    firm in Boston, and they would hire young lawyers to go make
    deposits at banks that were often just below the levels that
    would trigger anti-money laundering (AML) requirements, but if
    they were above, the FBI office was full of pictures of young,
    aspiring lawyers, whose firms had all been completely
    conflicted out of ever working against the owners of said pizza
    restaurant.
        Nobody would have ever argued that the beneficial use case
    for this particular pizza restaurant meant that we should never
    regulate pizza restaurants under AML protocols. I get concerned
    in this DeFi conversation that we are framing that as its
    beneficial use. It is really good. It is maybe as good as the
    pizza that was at this pizza joint, and therefore we should not
    have anti-money laundering rules. Like, that does not make any
    sense to me.
        Mr. Hays, you had mentioned the Ooki DAO case where they--
    my understanding is that Ooki DAO was actually advertising that
    they were--that you could get around AML laws, and CFTC has
    come after them, had alleged that they were actually created
    with the explicit goal of operating an illegal trap form.
        So, I guess, Mr. Van Valkenburgh and Ms. Tuminelli, I am
    just curious, yes or no--because I do not want to misunderstand
    your testimony--is it your argument that, if a DeFi protocol is
    found to be violating anti-money laundering rules, should there
    be any legal accountability to the creators, the operators, the
    people maintaining that services? Yes or no, should those
    people have any legal liability?
        Mr. Van Valkenburgh. Those who are not decentralized, those
    who are custodial have AML laws that apply, and they should----
        Mr. Casten. If it is a DeFi protocol----
        Mr. Van Valkenburgh.--should be enforcing it.
        Mr. Casten. If it is a DeFi protocol, are you saying that
    there should--you are saying it is decentralized?
        Mr. Van Valkenburgh. An immutable smart contract that I
    transact with?
        Mr. Casten. I am just asking, yes or no, should they have--
    --
        Mr. Van Valkenburgh. As an American transacting with an
    immutable smart contract, I am transacting with my own funds; I
    should not be subject to the Bank Secrecy Act.
        Mr. Casten. Okay. So you think no.
        Ms. Tuminelli, do you think, yes or no, should there be any
    liability that is there?
        Ms. Tuminelli. I think bad actors should be held liable for
    the bad conduct that they engage in, not the developers, not
    the people who created the software. It is the bad actors who
    actually committed the crime. We should go after them.
        Mr. Casten. There should be no liability for the people who
    created the tool. So, in my--back to my pizza example, the
    people made the pizza joint. They used these laws. There should
    be no liability for them because they are just pizza producers?
        Ms. Tuminelli. If I make a neutral tool that somebody uses
    to commit crime, I should not be held responsible for that
    person's conduct.
        Mr. Casten. Okay. Mr. Hays--that is bizarre. I mean, that
    is aiding and abetting commission of a felony.
        Mr. Hays, who do you think should be held liable in those
    cases? Is it the DAO members? Is it the creators? Is it the--
    where should that liability lie?
        Mr. Hays. I think it is a good question. It is complex, but
    I think you could apply existing laws to find some answers. I
    think it also depends on the facts and circumstances of those
    cases, but I think what you are raising raises a conundrum.
    Developers and admins intervene in the platforms that
    facilitate these transactions on a fairly regular basis, either
    directly or indirectly through the functions of the DAO. They
    change--update the code. They issue assets. They help determine
    how the validation process works.
        There are many times when interventions happen by
    individuals with knowledge. Those include people outside of the
    developer team and inside the developer team. It is tricky,
    because why are they intervening in those moments when not only
    are those about the infrastructure operation of the platform
    but actually what the platform does, which is to facilitate
    transactions and move assets? Why, then, should they not be
    held accountable if the transactions that they help facilitate
    end up facilitating illicit finance? I would argue that you
    have to find a way to hold developers accountable to some
    degree, and the question is, where do you draw that line?
        Mr. Casten. Okay. I want to get back, because I think we
    talk about this technology as being unique and not recognizing
    that we have, to your point, we have these tools. If I buy a
    security on Nasdaq, I have to disclose, and Nasdaq has clearing
    offices, and they verify the identity.
        Ms. Rettig, coming to you, following in your exchange with
    Mr. Foster, in the case of a Nasdaq transaction, there is a
    clear custody title that is clear there is no way to
    participate in that as an anonymous actor. Is there any reason
    why we could not insist on those rules for DeFi protocols? If
    you want to be anonymous, if you want to think you conduct
    rules, fine, you cannot play in this sandbox.
        Ms. Rettig. I think it goes to what--to actually what Mr.
    Van Valkenburgh talked about in his oral testimony, which would
    be importing intermediaries into disintermediated systems,
    which will put the U.S. at a large-scale disadvantage from a
    long-term perspective.
        Mr. Casten. Well, look, I am out of time, but there is no
    disadvantage to the U.S. economy of not protecting the
    interests of child traffickers, money launderers, and the North
    Korean nuclear system.
        Ms. Rettig. The one point on your pizza example is that the
    pizza restaurant had individuals who were acting with center,
    and that is very different than what is going on here.
        Chairman Hill. The gentleman's time has expired.
        Mr. Casten. I yield back.
        Chairman Hill. The gentleman from Nebraska, Mr. Flood, is
    recognized for 5 minutes.
        Mr. Flood. Thank you, Mr. Chairman, and thank you for
    holding this hearing today.
        I would like to maybe just explain my thinking on this
    topic. I know there has been some discussion of the way DeFi
    could change finance, but in my view the largest implications
    of DeFi are unrelated to the financial applications. Smart
    contracts could change things that have nothing to do with
    speculating on assets or currency. It is the technology we are
    talking about, not trading our wallets, that could really
    change the world.
        This leads me to what is called Web3.0. I am fascinated by
    how a decentralized web could change the applications that we
    use every day. If we have a decentralized web, it would
    disempower the Big Tech intermediaries that wield so much
    influence today. I would like to demonstrate what I mean by an
    example.
        If you are a creator of videos, right now you are probably
    using YouTube to get your videos out there. Now, if you are
    putting your videos on YouTube, then your income stream is
    beholden to the rules that YouTube has regarding how much ad
    revenue they share with their creators. Everything flows
    through a centralized intermediary between the creator and the
    revenue generated from the audience.
        What a decentralized web would do is cut out that
    intermediary. The creator, as I understand it, would own what
    they create, and they would keep the lion's share of that value
    that their creation brings. That would have to be beholden to
    the terms of a corporate third party hosting their work. They
    would not have to be beholden. The infrastructure of the
    platform itself would guarantee they are compensated directly
    for the value they bring.
        Ms. Rettig, I know Polygon Labs is involved with some
    Web3.0 projects. Could you talk a little bit about those
    projects and your thoughts more broadly on a decentralized web?
        Ms. Rettig. Sure. Thank you very much for the question,
    Congressman. Polygon Labs builds the networks on which all of
    these Web3 applications are built, and those types of
    applications abound, including both in the financial context
    and otherwise. One of the use cases we did not talk about but
    you touched upon is the idea of creation and the ability to
    hold your own IP, not just your own assets or your own data,
    although that is critically important. On those types of
    creator platforms, including social media, it really returns
    ownership back to individuals, and that is one of the great
    benefits of a decentralized web.
        Mr. Flood. Just continuing with you for a second here, do
    you have any sense of how far along we are to a potential
    decentralized web, and at what point do you envision we would
    see decentralized web solutions more broadly offered for
    consumers, like consumers of social media and other
    applications?
        Ms. Rettig. Sure. I would say that the internet has been
    around for 40 or 50 years and that we are probably not even 25
    percent of the way into that for Web3, but very far along and
    moving at an exponentially rapid pace.
        Mr. Flood. Ms. Rettig, do you have any thoughts--I guess, I
    have to back up. My background is in media, and I have thought
    a lot about how a decentralized web could change traditional
    print media, broadcast media, and how we consume the news more
    broadly. Right now, newspapers are going out of business across
    the Nation, and as a result, fewer journalists are watching the
    school board and all these political subdivisions. Do you have
    any thoughts on this topic?
        Ms. Rettig. Thanks very much for your question. I do think
    that a decentralized web or Web3 application is changing the
    way that we consume information. It is coming a lot more
    organically from individuals who are witnessing the news in a
    way and able to bring it on to the web in an immutable context
    and also to crowd source information in a way that traditional
    media may not be able to right now.
        Mr. Flood. I appreciate that. It can be challenging, I
    think, to forecast what the great next innovations are going to
    be. I am excited about what this is. I see a world of
    opportunity for America. I see us as the one country that can
    harness this like we did the internet. With the right
    protections for consumers and safety and internet sex
    trafficking and all those things, we should lead the world in
    blockchain. Now, candidly, I do not know if the blockchain is
    the technology that is going to bring this to bear, but plenty
    of smart people do think blockchain is our next
    transformational technology.
        One of the things that the chairman and I really agree on
    is that there is so much innovation opportunity for America if
    we harness this technology in the right way, protect our
    citizens, protect the vulnerable. I just hope that as Congress
    continues down this path we do not suffocate innovation in a
    way that lets another country or series of countries have an
    advantage over what should be an American opportunity.
        With that, Mr. Chairman, I yield back.
        Chairman Hill. The gentleman yields back.
        The gentleman from North Carolina, Mr. Nickel, is
    recognized for 5 minutes.
        Mr. Nickel. Thank you, Chairman Hill, for holding this
    hearing.
        Thanks to our witnesses.
        Decentralized finance, or DeFi, has transformative
    potential. It can make our financial system more accessible,
    transparent, efficient, and innovative. DeFi can create a more
    inclusive financial system, as traditional finance just might
    not be for everyone. Of course, as with any new technology,
    there are risks. I hope we can learn more about how to mitigate
    those risks during today's hearing.
        It is important that DeFi remains a bipartisan issue. I
    would urge my colleagues to find common ground in supporting
    both innovation and consumer protection in DeFi. Bipartisan
    work is absolutely crucial to creating a balanced and durable
    legislation that will protect consumers and keep digital
    innovation in the United States. Frankly, I just do not think
    it is an either/or. I think we can do all of these things. We
    can protect consumers. We can encourage digital innovation. We
    can embrace this amazing new, transformative technology that
    can improve the lives for so many Americans. We have to keep
    those jobs here in the United States.
        Ms. Rettig, first question for you, can you talk about some
    of the risks with DeFi and how legislators on this committee
    should be thinking about how to address them?
        Ms. Rettig. Thanks very much for your question,
    Congressman, and for your leadership in this emerging space. I
    will hit on the illicit finance side of the risks, because I
    know that is the greatest concern and I think a place, to your
    point, where bipartisan and industry can all agree that we want
    that to stop. Not a penny should go to bad actors.
        I proposed a framework along with my coauthors in a paper
    that came out in January that looked at how to combat illicit
    finance in DeFi with a three-part framework. The first was to
    expand on the definition of ``independent control'' found in
    the 2019 FinCEN guidance to be able to actually identify
    intermediaries that exist who may actually have regulatory
    obligations. So it will close the gap that the DeFi Treasury
    Illicit Finance Risk Assessment put forward in DeFi.
        The second part is what I alluded to in my testimony, which
    is to treat pure technology protocols as critical
    infrastructure, just like we do with electronic clearing
    systems and financial messaging systems.
        The third part is to create a new category of entities that
    will have additional risk mitigation obligations in the
    financial integrity space to be able to meet the goals under
    the BSA of document, detection, and deterrence of bad actors.
        Mr. Nickel. Thanks so much. Same question to you again. How
    are other jurisdictions approaching the regulation of DeFi, and
    is the U.S. falling behind countries like China?
        Ms. Rettig. Thank you very much for your question.
    Unfortunately, we are falling far behind and putting--setting
    China aside, we are falling behind the rest of the world. Just
    from an anecdotal perspective, regulators across the world have
    actually been engaging with industry for, I would say, the last
    5 or 6 years to talk about what to do in a collaborative way,
    the EU in particular, the U.K. as well, and numerous countries
    in Asia, Japan, Singapore, and the like.
        Every single country to date has--even if they have
    implemented centralized crypto regulation, they have said we
    either need to study or explore or do further analysis of DeFi.
    I will say the one notable proposal is from France's prudential
    regulators, which seek to think about regulating DeFi much like
    cyber infrastructure and imposing certain types of
    cybersecurity standards and audits of these DeFi protocols. So
    it is very different everywhere across the world than how we
    are handling it in the U.S., other than in some of the proposed
    legislation we have seen, all of which suggest studying DeFi,
    which is the right way forward.
        Mr. Nickel. Thanks so much. We did a bipartisan CODEL
    (Congressional Delegation). We traveled around the world to
    meet with these other markets. They are open for business. They
    are trying to take jobs here from the U.S., and it certainly
    dawned on me the importance of making sure we continue to keep
    up with the rest of the world, because this is a place where we
    continue to fall behind, unless we act here in Congress, and we
    have the ability to do that. I am eternally optimistic that we
    can get it done.
        Mr. Avello, next question to you. We constantly hear that
    both innovators and capital are leaving the U.S. due to a lack
    of regulatory clarity. What human capital and financing trends
    are you seeing in the U.S.--as the U.S. falls behind in Web3
    and DeFi?
        Mr. Avello. I can say from wearing my investor hat and from
    a personal perspective, I have seen a number of incredibly
    qualified teams, the exact types of people I think that you
    have mentioned that you would want to see here, building
    multi--hundreds of millions of multibillion dollar companies
    and protocols, unfortunately having to move abroad necessarily
    to set up operations for their companies and basically
    offshoring most of their activity.
        I can tell you from working with or seeing pitches from
    teams like this, that there is an incredible interest about
    staying here in the United States and running--potentially
    launching and operating their protocols in a compliant fashion.
    I think the regulatory unknowns are just too challenging on a
    personal level, and unfortunately have had to move abroad in
    order to effectuate their businesses.
        Mr. Nickel. Thanks so much. I am out of time. I yield back.
        Chairman Hill. The gentleman yields back.
        The distinguished gentleman from Ohio, the vice chairman of
    our Digital Assets Subcommittee, Mr. Davidson, is recognized
    for 5 minutes.
        Mr. Davidson. Thank you, Chairman. I thank our colleagues
    and the panel for your testimony today.
        DeFi is an essential component for a vibrant financial
    sector in the United States, so we have dominated markets
    around the world, and it would seem particularly foolish to
    change course now. That is what we are at the risk of. I mean,
    as I listen to some of my colleagues, I was--really appreciate
    Mr. Nickel for highlighting that this is an issue that largely
    unites Republicans, and it does divide Democrats. Most of the
    panel, we have seen from Democrats today, though, has been
    insane.
        I mean, we have basically--if they were applying their same
    logic, I guess, think how many crimes Google becomes an
    accomplice for because people do searches or use the Maps
    function to navigate to the place they are going to commit
    crimes. Thankfully--I mean, they are targeting speech in other
    ways. Thankfully, I have not seen them make that ridiculous
    level of an argument yet.
        Mr. Van Valkenburgh, you are highlighting the code of
    speech, and one of the things that is at the core here is
    another thing: privacy. The idea of--you would think, when I
    hear Mr. Foster talk about the government granting permission
    for you to do something that the government is the granter of
    our rights. Thankfully, in America our Founders recognize that
    rights come from our creator, that among them are life,
    liberty, and the pursuit of happiness. The First Amendment is a
    limitation on the government's ability to infringe on your
    right to speech, and the Fourth Amendment is a limitation on
    the government's ability to infringe on your right to privacy.
        DeFi, I think how in the world can you have decentralized
    finance without the decentralized part? They want a central hub
    that is the granter of permission, the filterer of speech, the
    filterer of privacy, the granter of permission. Now, you could
    expect that in a police state. You could expect that in an
    authoritarian country controlled by the Chinese Communist Party
    or something like that, but why in the world would we see our
    colleagues here in Congress where we are sworn an oath to
    support and defend our Constitution would you see people
    advocating for that?
        Mr. Van Valkenburgh, could you pick up--I know you wanted
    to say a bit about this speech angle and perhaps more.
        Mr. Van Valkenburgh. What Member Foster suggested where the
    problem with anonymity is that we do not have 100 percent
    identification and control over financial transactions in the
    economy, I do not think we will have 100 percent identity and
    control over DeFi transactions, and I think we will have robust
    anonymity, and that is an American constitutional right. So you
    have a constitutional right to anonymous transactions that
    support organizations and causes that defend against
    discrimination and violations of our constitutional rights. We
    fought about this during the civil rights movement in the
    1970s.
        As Thurgood Marshall said with respect to the Bank Secrecy
    Act, the law that actually requires financial surveillance of
    custodial intermediaries, though not noncustodial
    intermediaries, Marshall dissented from the constitutionality
    of even that level of surveillance. He said, ``The fact that
    some may use negotiable instruments for illegal purposes cannot
    justify the government's running rough shot over the First
    Amendment rights of the hundreds of lawful yet controversial
    organizations like the American Civil Liberties Union (ACLU).
    Congress may well be correct in concluding that law enforcement
    would be facilitated by the dragnet requirements of the Bank
    Secrecy Act, but those who wrote our Constitution recognized
    more important values.''
        Mr. Davidson. Thank you for that, and great insight. I hope
    we can go after that in third-party doctrine again in some
    other venues.
        As it relates to DeFi, Ms. Rettig, you have done a great
    job of highlighting how privacy is an inherent part of the
    reason people would choose to conduct transactions. It has to
    be protected for it to function. The other part is, for
    somebody to surveil your transaction, most of these companies
    are charging a fee-for-service. Look, I mean, I appreciate what
    Visa and MasterCard and American Express--I have one of each of
    those, or perhaps more--they do. They check and make sure it
    really is me, and I am buying from somebody else and if it was
    not me, they would provide a hedge, and for that I know--I am
    kind of comforted that there is an intermediary.
        Now, I will admit I am a little creeped out when the
    government wants to mandate that they surveil me and hand over
    my transaction data without a warrant or subpoena. That is a
    lot more government than I want but for other transactions, I
    still carry cash, and I like that there is no intermediary. I
    know that, once I gave the cash to somebody, my ability to
    reclaim that is more limited. It does not mean I have no
    recourse. How do you make DeFi function if you do not have
    privacy?
        Ms. Rettig. I think--thank you very much for your question,
    Congressman. I think DeFi, as Mr. Van Valkenburgh said, will
    have at least pseudonymity, right, a privacy over who you are
    and certain types of information in that regard. I think, to
    your point on Visa and MasterCard, we agree that not only the
    people who can access those are not the only people who should
    be able to access the economy, right. Goldman Sachs and those--
    and their clients are not the only people who can participate
    in the American economy, and so DeFi and the larger Web3
    movement is meant to expand and democratize that even more
    greatly.
        Mr. Davidson. Thank you for that, and may God bless you all
    with great success in spite of some of my colleagues' efforts
    to undermine it. I yield back.
        Chairman Hill. The gentleman yields back.
        The gentleman from California, Mr. Sherman, is recognized
    for 5 minutes.
        Mr. Sherman. What we have here is an effort to liberate
    billionaires from income taxation. Every time a billionaire
    successfully cheats on his taxes a member of the Freedom Caucus
    earns his wings. Billionaires cannot keep anonymous with $100
    bills because their pockets are not that big, and the decision
    our country has made not to print the $500 bill or $1,000 bill
    means that the use of cash becomes less in terms of the amount
    of cash in a single bill declines by 3 or 4 percentage points,
    2 or 3 percentage points over the last 5 or 10 decades.
        Now, we are trying to create a market here for a system
    that is much worse than the system we have for honest people.
    If you have crypto, you can go to Coinbase or a similar broker,
    put it up, and get a loan at margin rates that are similar to
    what you do if you have stocks or bonds that you are borrowing
    against. This system is going to be more expensive, but it is
    much better for drug dealers, much better for human
    traffickers, much better for sanctions evaders, which is why
    Putin and Iran have embraced crypto and unhosted wallets.
        The real market here is tax evasion. Trump's IRS
    Commissioner testified we have $1 trillion a year of
    uncollected taxes. That is $3 trillion of unreported income
    every year. That is $30 trillion of unreported assets every
    decade. So the question is, why would somebody use a less
    efficient system? The answer is, if you are a patriotic
    anarchist and you agree that we should have a powerful America
    but only wage earners should pay the income tax and it should
    be voluntary for those in business and investment, then you
    design a system in which Know Your Customer is optional and in
    which those who wish to cheat, whether it be because they are
    cheating our sanctions laws or our income tax laws, they have
    an efficient system to do so.
        Now, the other aspect of this DeFi is whether it is a
    security. We applied the Howey test. Mr. Hays, if you have a
    system where you put your money up and you have somebody else
    manage it and loan it out for you and then you get a return
    based on the results, in effect, if you have the Howey case
    but, instead of oranges, you have crypto, is that a security?
        Mr. Hays. Thank you, Congressman. The Howey test is
    designed for--to answer the question you have just raised, and
    it is designed to be tested broadly to apply to lots of
    different facts and circumstances. I would argue it is an
    applicable test to the situation, and there are many instances
    where crypto securities, whether issued on CeFi platforms or
    DeFi platforms, meet that test.
        To be clear, a platform does not have to be issuing or
    facilitating the transfer of those assets. They do not all have
    to be securities. There just have to be a number of them that
    meet the test for an exchange to meet the term, conditions and
    obligations of a securities exchange. I think there are many
    instances where the Howey test is an appropriate tool and
    provides a useful answer in this regard.
        Mr. Sherman. I would just reiterate that those who talk
    about privacy for billionaire tax evaders are waging a war
    against economic democracy in this country but also creating a
    corrosive system in which at the country clubs and wherever
    billionaires meet, it will be thought to be stupid to pay
    income taxes when there is a whole system of finance that
    allows you to hide your assets while buying your yacht.
        What worries me is not just those who are the tip of the
    spear, who will be the first to evade our income taxes and our
    laws against sanctions evasion and our laws against drug
    dealing, but a--and I have seen this happen in a number of
    other countries. I have studied tax enforcement in a number of
    other countries. Once it becomes a feeling among a subculture
    or an economic class that only the suckers are paying their
    taxes, we create a system in which no billionaire will feel
    right paying their taxes. After all, nobody else in the country
    club does it. Wages will be taxed. You get a W-2 form, and the
    question is whether anybody else. You can make a lot of money
    by making sure billionaires do not have to pay their taxes. I
    yield back.
        Chairman Hill. The gentleman yields back.
        The gentleman from South Carolina, Mr. Timmons, is
    recognized for 5 minutes.
        Mr. Timmons. Thank you, Mr. Chairman.
        Thank you to all our witnesses for being here today.
        Decentralized finance is an incredible advancement in
    financial technology. At its core, DeFi leverages blockchain
    technology and smart contracts to create an open, transparent,
    and accessible financial ecosystem. This means that anyone
    anywhere in the world can access services like lending,
    borrowing, and trading without relying on centralized
    authorities. However, along with the many promising use cases
    come many questions about the government's role in this
    burgeoning space. As a Congress, we have yet to fully
    acknowledge, understand, and address this technology causing
    our country to fall short of our innovative values.
        Mr. Van Valkenburgh, given the unique nature of DeFi
    protocols, it is clear that incorporating DeFi into the U.S.
    regulatory perimeter is a complex endeavor. While we have
    already touched on some, are there other challenges the U.S.
    oversight mechanisms and regulatory structures face as these
    emerging financial systems increasingly come into orbit?
        Mr. Van Valkenburgh. Thank you for the question,
    Congressman. Why do we not stay on the subject of tax, because
    Member Sherman brought it up? So tax evasion is a crime which
    should be aggressively policed. Those who do not pay their
    taxes should suffer consequences in this country. I do not,
    however, think that tax evasion and its existence warrants a
    100 percent surveilled and controlled financial system. So a
    difficult area in the cryptocurrency space has been getting
    clear tax guidance from the IRS on how Americans can pay their
    taxes when they earn capital gains or perhaps their wages on
    these networks.
        Mr. Timmons. I did not hear his question or his argument. I
    mean, it is an open ledger. It is publicly accessible. How
    would you evade something that the world can see? How can you
    avoid taxes on an open ledger?
        Mr. Van Valkenburgh. It is, in fact, more difficult to
    evade taxes when you are using open blockchain networks than
    using the legacy financial system, which is happy to open shell
    accounts for you all over the world. I would also add that the
    IRS has been very, very late in offering clear guidance, and
    they are the big part of the problem here. They should have
    offered guidance on brokers, who need to file third-party tax
    documentation and reports, long ago using existing
    congressional authority.
        Coinbase is a custodial broker, if you will, of
    cryptocurrency for tax purposes and should be doing third-party
    tax reporting to ensure that Americans are paying their taxes
    and the IRS is getting their revenue. There was no need to
    change the laws to tell Coinbase that they are a broker. The
    IRS simply had not made that rule change. Eventually, Congress,
    rightly, decided to direct the IRS to change those rules with
    the Infrastructure Act. In that process, they explicitly said,
    ``IRS, you need to give third-party tax reporters in the crypto
    space the guidance they need so that Americans will pay their
    taxes.''
        Even after Congress directed the IRS, the IRS went on a
    multi-year rulemaking spree where they ultimately tried to even
    apply these rules to noncustodial intermediaries apart from
    Coinbase in an effort that will not work----
        Mr. Timmons. We are running out of time.
        Mr. Van Valkenburgh [continuing].--and will trample our
    constitutional rights.
        Mr. Timmons. We can agree that the government is not
    helping this process.
        One more question. While Treasury and the SEC have made a
    regulation by enforcement, the dominant theme of the Biden
    Administration's approach to DeFi, we have seen some foreign
    jurisdictions, such as the EU, take a different approach to
    this space.
        Ms. Rettig, I am curious if there are frameworks in place
    in other jurisdictions that United States can draw from as it
    contemplates how to approach establishing protections around
    DeFi, and what did these foreign regulatory approaches get
    right and what can we learn from them?
        Ms. Rettig. Thank you so much for your question,
    Congressman. I think the foreign jurisdictions have moved
    forward with centralized crypto regulation and given clear
    guidance to centralized actors in this space. Governments all
    over the world have uniformly taken the approach to study DeFi
    more. There are also regulators who have actually experimented
    with DeFi themselves and conducted transactions, and there are
    some regulators who themselves have looked at DeFi protocols as
    cyber or technology that should be reviewed from a cyber
    perspective in order to accomplish policy goals in that way.
        Mr. Timmons. Thank you for that. I think we can all agree
    that this is the future of technology. There is going to be
    disruption associated with it, but we need to lead the way and
    not have the enormous amounts of resources invested in what is
    indeed the future go offshore. When the U.S. economy is no
    longer the best place to start a business, we will lose long
    term, and so I would just say that is something we need to
    focus on, and there is balance in this approach, but we need to
    be intentional about it and not fall behind.
        With that, Mr. Chairman, I yield back.
        Chairman Hill. The gentleman from South Carolina yields
    back.
        I want to thank our panel for your excellent testimony
    today and for participating in our hearing.
        Without objection, all members will have 5 legislative days
    within which to submit additional written questions for the
    witnesses to the chair, which will be forwarded to each of you
    for your response. I ask each of you to please respond as
    promptly as you are able.

        [The information referred to can be found in the appendix.]

        This hearing is adjourned.

        [Whereupon, at 11:41 a.m., the subcommittee was adjourned.]

                                A P P E N D I X

                               September 10, 2024
    [GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]

                                     [all]