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Regulatory oversight in decentralized finance (DeFi) has garnered significant attention recently. It has become a focal point for protocols and firms such as Polygon as they strive to navigate the evolving regulatory landscape and establish a solid foundation in the sector. 

In a recent research paper authored by Poylgon’s Chief Legal Officer (CLO) Rebecca Rettig, in collaboration with Michael Mosier from Arktouros, a proposal has been presented to classify “genuinely decentralized” DeFi protocols as critical infrastructure. 

The paper begins by clarifying the definition of DeFi and highlighting the unique sources of illicit finance risks in this sector. Unlike traditional finance, DeFi faces risks such as cyber risks, system management risks, and usage risks. By differentiating these risks, the legal authors lay the groundwork for a comprehensive approach to combat illicit finance in DeFi.

The proposed framework comprises three key components. First, it defines “independent control” to identify smart-contract-based financial protocols with centralized intermediaries that may falsely label themselves “DeFi.” This definition aims to distinguish so-called “genuine DeFi protocols” from others.

Secondly, the authors propose classifying these DeFi protocols as “critical infrastructure” and subjecting them to oversight and security coordination by the Office of Cybersecurity and Critical Infrastructure Protection (OCCIP), a branch of the US Treasury Department. 

While OCCIP does not have regulatory authority over financial institutions, its alleged expertise in managing critical infrastructure can contribute to the “safe operation” of DeFi systems, according to Rebecca Rettig, who represents Polygon. 

Lastly, the paper suggests introducing new laws requiring specific businesses, referred to as “critical communications transmitters” (CCTs), to adopt additional illicit finance risk management practices. 

These businesses, which facilitate the transmission of communications related to DeFi transactions, would not be considered financial institutions under the Bank Secrecy Act (BSA) but would play a role in meeting financial integrity objectives. 

Addressing Illicit Finance Risks The proposal aims to enhance the security and resilience of DeFi systems by classifying them as critical infrastructure and involving OCCIP in oversight. 

According to Polygon’s CLO, the coordination provided by OCCIP can strengthen existing cybersecurity frameworks and information-sharing initiatives within the DeFi sector. 

Additionally, introducing CCTs as a new category acknowledges the importance of managing illicit finance risks at “specific touchpoints” in the DeFi transaction flow.

Overall, Polygon Labs’ and Arktouros’ proposal presents a comprehensive framework for addressing illicit finance risks in the DeFi sector. 

By classifying these DeFi protocols as critical infrastructure and leveraging OCCIP’s coordination, the proposal seeks to strike a balance between regulatory oversight and the permissionless nature of DeFi. 

MATIC’s price uptrend over the past 7 days on the daily chart. Source: MATICUSDT on TradingView.com Currently, the native token of Polygon, MATIC, is trading at $0.7979. Over the past 24 hours, the price has remained relatively stable, showing sideways movement. However, MATIC has experienced a significant surge of over 9% in the past seven days.

Featured image from Shutterstock, chart from TradingView.com

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