June 30, 2022

Volume XII, Number 181

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State Investor Advisory Addresses DeFi Risks

Decentralized finance, DeFi, has quickly grown in popularity and is beginning to gain the attention of regulators attempting to stay ahead of one of the latest investor crazes. Blockchain-based financial technology such as DeFi largely operate outside of the traditional finance ecosystem occupied by  governmental agencies, intermediaries, central banks, brokerages, exchanges, and  banks by utilizing cryptocurrencies. DeFi providers are offering lending, banking, and investing options that are decentralized and not dependent on financial markets or regulations. As a result, DeFi providers often operate illegally or lack the protections that govern traditional financial service providers.

Similar to peer-to-peer systems that allow users to lend fiat money (e.g., U.S. dollars), DeFi platforms allow individual lenders to offer cryptocurrency loans in a permissionless manner, without an intermediary, such as a bank or broker. DeFi lending relies on smart contracts to pool investors’ money and the smart contract issues the tokens to the borrower. The collateral for these DeFi loans are the cryptocurrency itself, which is often worth more than the loan.

State bank regulators have begun to release guidance to consumers that addresses risks related to DeFi, including investments through exchanges in cryptocurrencies, noting that DeFi platform users typically have little recourse should a transaction go wrong, and the parties involved in the transaction could be located anywhere in the world .

Putting It Into Practice:  While the advisory attempts to put a positive spin on DeFi, it cautions investors before they entering into relationships with potentially unlicensed people in an unregulated marketplace, who are operating illegally.  While it is  true that many well-known and not-so well-known companies are engaged in DeFi or running decentralized exchanges or marketplaces, some appear largely to be doing so without heeding any consumer protections laws or regulations, including licensing requirements where applicable.  As a result, these DeFi platforms, at a minimum, likely are facilitating the violation of basic lending and investing laws, as the advisory notes.

Copyright © 2022, Sheppard Mullin Richter & Hampton LLP.National Law Review, Volume XII, Number 108
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About this Author

Moorari Shah Bankruptcy Lawyer Sheppard Mullin Law Firm
Partner

Moorari Shah is a partner in the Finance and Bankruptcy Practice Group in the firm's Los Angeles and San Francisco offices. 

Areas of Practice

Moorari combines deep in-house and law firm experience to deliver practical, business-minded legal advice. He represents banks, fintechs, mortgage companies, auto lenders, and other nonbank institutions in transactional, licensing, regulatory compliance, and government enforcement matters covering mergers and acquisitions, consumer and commercial lending, equipment finance and leasing, and supervisory examinations,...

213-617-4171
A.J. S. Dhaliwal Bankruptcy Attorney Sheppard Mullin Washington DC
Associate

A.J. is an associate in the Finance and Bankruptcy Practice Group in the firm's Washington, D.C. office. 

A.J. has over a decade of experience helping banks, non-bank financial institutions, and other companies providing financial products and services in a wide range of matters including government enforcement actions, civil litigation, regulatory examinations, and internal investigations.

With a diversified regulatory, compliance, and enforcement background, A.J. counsels financial institutions in matters involving...

202-747-2323
Associate

Gabriel is an Associate on the Telecom team and the Co-Lead Associate on the Blockchain and Digital Assets team in the firm’s Washington, D.C. office. He is a Blockchain Law Professional as Certified by the Blockchain Council.

At Sheppard Mullin, Gabriel assists the Telecom team in all aspects of communications law and regulation including, satellites, spectrum, 5G implementation, media companies, and new technologies. He assists the Blockchain and Digital Assets team in legal issues relating to the use of blockchain technology, social media, internet, video games, online gambling,...

202-747-2194
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