Polygon Labs proposes defi protocols as critical infrastructure in new regulatory framework

Polygon Labs, in collaboration with Arktouros law firm, has put forward a new regulatory framework that proposes designating certain decentralized finance (defi) protocols as critical infrastructure crucial to the national and economic security of the US.

The suggestion was published on Jan. 29 by Rebecca Rettig and Katja Gilman of Polygon Labs, alongside Arktouros co-founder Michael Mosier. Their 45-page document focuses on combating illicit finance activities in the DeFi space.

The proposal recommends that genuinely decentralized DeFi protocols should be overseen by the US Treasury’s Office of Cybersecurity and Critical Infrastructure Protection (OCCIP).

The OCCIP, while not a traditional financial regulator, plays a pivotal role in enhancing the security and resilience of the financial services sector’s critical infrastructure, in collaboration with finance firms, industry groups, and government partners to share information about cybersecurity threats and vulnerabilities.

Polygon’s framework outlines a three-step solution to the legal challenges facing defi. The first step involves creating a legal definition for “System Control Persons” or “SCPs.” These are individuals or entities that can unilaterally exercise operational authority over blockchain-based systems.

According to the proposal, SCPs should adhere to standard anti-money laundering (AML) requirements, regardless of whether the system is labeled as decentralized.

Another significant proposal by the team is the creation of a new category of “critical communications transmitters.” These entities would play a crucial role in genuine DeFi systems.

For systems without SCPs, which are considered “genuine defi”, the framework suggests a separate classification as “critical infrastructure”. This would place them under the supervision of the OCCIP. These entities would be responsible for fulfilling specific obligations to safeguard US national and economic security without being classified as financial institutions under the Bank Secrecy Act (BSA).

This proposal contrasts with the views of crypto-critical senator Elizabeth Warren, who last month suggested that crypto firms should meet the same AML requirements as traditional banks. Warren has also raised concerns about the use of cryptocurrencies in funding illicit activities, including North Korea’s nuclear arms program.

The proposed framework also distinguishes between centralized finance (CeFi) or traditional finance (TradFi) and defi, with each having independent control mechanisms based on guidance from FinCEN, the Treasury’s Financial Crimes Enforcement Network.

Jake Chervinsky, a lawyer in the crypto industry, commented that while securities and commodities laws often dominate policy discussions about digital assets, in Washington DC, the focus is more on illicit finance. He views this new framework as a potential real solution to these concerns.

The authors emphasize the importance of balancing the prevention of illicit activities with the fundamental goal of promoting positive actions. This aligns with the Treasury’s mandate of promoting economic prosperity and ensuring the financial security of the U.S.