[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
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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:]
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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:]
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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:]
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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
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