The rapid proliferation of decentralized finance is transforming investment protocols, lending, and non-fungible tokens. It’s raised some unique challenges, which experts argue can only be solved by fresh perspectives. As regulators scurry to apply 100-year-old rules to a technology that’s only a few years old, some critical questions need to be answered.
Enter Georgetown professor Chris Brummer. In 2022, he authored a paper titled “Disclosure, Dapps, and DeFi” focusing on the rapidly emerging field of decentralized finance. It adds to the conversation on DeFi by introducing a framework that provides innovators with new crypto building blocks for the DeFi ecosystem. But more importantly, it proposes a set of questions that need to be answered as we construct a functional DeFi ecosystem.
The paper provides a framework for people navigating the complex landscape of DeFi. Brummer also introduces readers to different tools within the crypto ecosystem that will not only help generate discourse, but also improve technological literacy.
Brummer explained that his paper “observes that DeFi presents novel policy questions for disclosure because much of the material information required to participate in an informed way is already available to technologically sophisticated actors on blockchains.”
Challenges and Capabilities of Blockchain
What’s genuinely transformative about Chris Brummer’s work is that it forces readers to think about crypto and blockchain as a new infrastructure that, despite its challenges, presents users with powerful capabilities — capabilities that can be used to solve some of the biggest concerns being flagged by regulators such as transparency and verifiable information.
“This white paper offers a framework transposable to securities law, but given the information already accessible to technologically savvy actors, emphasizes the need for shorter, crisper disclosures typically associated with consumer protection law,” Brummer wrote.
A radical but practical idea that Brummer advocates through his work is that we need to rethink problems and not confine ourselves to the older financial regulatory framework. For Brummer, the answer lies within the technology itself because the old system might not be able to solve these new issues.
Instead of presenting simplistic answers, Brummer raises pertinent questions that regulators and coders need to have in the back of their minds when designing the DeFi ecosystem. “You have to ask yourself on a very fundamental level, what do you want the regulatory system to even look like?” asks Brummer.
Dealing With Transparency and Disclosures
Given that DeFi is a completely new frontier, regulators must revisit core concepts of regulatory systems and adopt a ground-up approach. While the task may seem daunting, blockchain isn’t the first technological revolution. The emergence of the internet presented its own set of challenges, which ushered in a massive evolution of the regulatory apparatus. Regulators adapted then and will be able to do it now.
A recurring regulatory concern is ensuring transparency through effective disclosures — something that might seem impossible for a technology that has decentralization of data at its core. Brummer argues that looking at blockchain from the lens of dated concepts is bound to create problems. Instead, regulators need to shift their focus toward looking at the relationships between the different actors in a particular space.
Some questions that can guide this line of inquiry include how people get their information, the systems people use to get their information, and whether the information being shared with investors and consumers is optimized for easy access.
Gamification of Disclosures
In this context, Chris Brummer proposes a unique model for improving disclosure — gamification. He suggests that companies could improve disclosure by uploading their disclosures on their websites. After a visitor has read those disclosures, they can be quizzed with some follow-up questions. Successfully answering those questions would provide a unique nontransferable token to the visitor. The token will be evidence that the person has both received and understood the disclosure. The gamification of disclosures would not only assuage transparency concerns but also play a significant role in improving technological literacy.
Suggested Brummer: “For especially risky ventures, protocols could even be programmed to only accept customers who possess disclosure tokens in their wallet, leveraging NFTs in ways akin to [anti-money-laundering/know your customer] white-listing tools used for the verification of identities for combatting terrorism and illicit finance.”
Advantages of an Open-Source System
When we look at the traditional system, there’s a substantial level of bureaucratic oversight that’s needed for it to function, whereas unique solutions such as these make it easier to tackle the internet’s openness. And while this isn’t to say that some regulatory oversight wouldn’t be needed, the agility of such a system would definitely make regulation easier.
For instance, on-chain corporations — enterprises in which transactions happen on the blockchain and are dependent on that blockchain — offer shareholders and regulators radical transparency because every decision, vote, and financial move is easily accessible. On the other hand, gaining access to information about companies through the traditional method requires a team of experts, from auditors to accountants to lawyers. Volumes of books and records are published, which are condensed into reports, which then need to be approved by regulatory bodies like the Securities and Exchange Commission. What blockchain offers is the elimination of all of these complex layers. This will help lower costs, which will prove highly beneficial for startups.
Additionally, this could lay the foundation for advanced reputation systems. The internet already utilizes reputation systems. Everyone can rate virtually everything: Diners can rate restaurants, ride-share passengers can rate their drivers and the drivers their passengers, and hosts can rate their guests and the guests their hosts. Such open-source reputation systems could make it easy for consumers to select financial services and similarly, it will be easier for regulators to monitor compliance.
Advice for Policymakers
Regulators approach crypto and blockchain with a degree of hesitation — and Chris Brummer understands that there will always be some risk aversion whenever new technologies emerge. After all, whenever something goes wrong, the regulators are the first to be criticized.
However, Brummer posited, “Innovating compliance itself would still likely require or greatly benefit from regulatory engagement or, at a minimum, symbolic government support or encouragement. Regulators could bolster disclosure by modernizing and periodically reviewing and clarifying disclosure expectations in light of technology developments; supporting technology sprints aimed at innovating new compliance approaches; and even providing standards and oversight for emerging infrastructure providers like third-party auditors of smart contract code and dApps in order to ensure the accuracy of information provided to retail investors and end users.”
Luckily, regulators have started to warm up to blockchain technology. Brummer, who is active in policy circles in Washington and has often testified at congressional hearings on issues relating to financial regulation and digital assets, has been approached by people with varying degrees of seniority. This is an encouraging development as it’s evidence of interest from the Hill. His paper has garnered a positive response and has seemingly succeeded in achieving its objective of igniting discourse.
To learn more about the proposed framework, you can listen to this episode of Chris Brummer’s podcast, “Fintech Beat,” where he discusses this and more with Jeremy Allaire, the CEO of Circle.
