As published in The International Journal of Blockchain Law, Vol. 1, Nov. 2021.

The term “crypto” is now used broadly to refer to a variety of different things, from tokens to non-fungible tokens to decentralised finance (DeFi). Different readers will have different levels of understanding of DeFi. For those who are not already familiar with it, there are many different definitions. Generally, DeFi is an attempt to create financial system equivalents using blockchain-based smart contracts that are composable, interoperable, and open source. A lot of DeFi activity happens on the Ethereum blockchain, but any blockchain that supports certain types of scripting or coding can be used to develop DeFi applications and platforms.

DeFi presents a panoply of opportunities. Pose a question. What are some of the risks and challenges for regulators, investors, and the financial markets associated with cryptocurrency? While the potential for profits in the crypto market is attractive and often overwhelming, there is also significant confusion about important aspects of this emerging market. People are wondering on social media who regulates the DeFi market in the U.S. and why regulators are involved at all. What are the answers to these crucial questions? Why are they important to lawyers and non-lawyers? This article is about the current state of regulation around the decentralized finance industry, specifically mentioning the role of the United States Securities and Exchange Commission. The article argue that the community should address two important hurdles.

I. Many Investments Share Important Attributes

[4] There are many offerings in the DeFi market that are similar to products and services in traditional finance. [5] For example, there are decentralized applications that allow users to borrow assets by posting collateral, just like traditional collateralized loans. Both types of products offer returns, some directly, and some indirectly by enabling the use of borrowed assets for other DeFi investing opportunities. In addition, there are web-based tools that help users identify, or invest in, the highest-yielding DeFi instruments and venues.[6] Other applications let users earn fees in exchange for supplying liquidity or market making.[7] There are also tokens coded to track the prices of securities trading on registered U.S. national securities exchanges, and then can be traded and used in a variety of other DeFi applications. Even though the technology may be foreign, the digital products and activities have familiar counterparts within the SEC’s area of responsibility.

This should come as no surprise, as finance is included in the name. It should not be surprising that investing is often the core activity of DeFi. This is a movement to create a new digital asset ecosystem. The goal is to create a new digital asset ecosystem, not just to develop new digital asset tokens. This text is discussing how developers have created smart contracts that allow individuals to invest and take different types of positions with their investments. And there are projects that have the potential to make transactions faster, cheaper, and more customizable.

The projects are developing rapidly with new and exciting possibilities. Given that blockchains that support the scripting needed for sophisticated smart contracts are relatively new, the development of DeFi is particularly impressive. The offerings from this company are not just products and the people using them are not just consumers. DeFi, again, is fundamentally about investing. This article is discussing the risks of investing in cryptocurrency, which can be either speculative (based on hoped-for price appreciation) or active (based on a return on investment).

II. Unregulated Markets Suffer From Structural Limitations

Those who raise money from investors or provide regulated services to them typically have legal responsibilities. Many DeFi promoters attempt to disclaim their legal obligations by disclosing that DeFi is risky and that investments may result in losses, without providing the details that investors need to assess risk likelihood and severity. Others could accurately be characterized as advocating a “buyer beware” approach; by participating, investors assume the risk of any and all losses. This means that many people who are currently involved in DeFi advise new investors to be careful. Many experts and academics also agree that there are significant risks.

DeFi has created new ways to handle transactions, but it hasn’t changed everything about economics or human nature. Certain truths apply with as much force in DeFi as they do in traditional finance:

• Unless required, there will be projects that do not invest in compliance or adequate internal controls;
• when the potential financial rewards are great enough, some individuals will victimize others, and the likelihood of this occurring tends to increase as the likelihood of getting caught and severity of potential sanctions decrease; and
• absent mandatory disclosure requirements,[10] information asymmetries will likely advantage rich investors and insiders at the expense of the smallest investors and those with the least access to information.

DeFi participants’ current approach of “buyer beware” is not a good foundation to build new financial markets. If there are no expectations for how people should behave in a market, and no way to enforce those expectations, the market will be corrupt, with people engaging in fraud, self-dealing, and cartel-like activity, and there will be a lack of information symmetry. Over time that reduces investor confidence and investor participation.[11]

In contrast, markets that are well regulated tend to do well, and I believe that our capital markets in the United States are excellent examples of this. Our markets are reliable and adhere to standards of disclosure and conduct, making them the destination of choice for investors and entities looking to raise capital. Our securities laws serve an important purpose by regulating the market and protecting investors. The actions they take help to improve the issues mentioned before, as well as others, making our markets function more effectively. So far, regulatory frameworks that would provide protection in other markets have not been widely adopted in the new world of decentralized finance.

III. Who Regulates DeFi?

In the United States, multiple federal authorities likely have jurisdiction over aspects of DeFi, including the Department of Justice, the Financial Criminal Enforcement Network, the Internal Revenue Service, the Commodity Futures Trading Commission, and the SEC.[12] State authorities likely have jurisdiction over aspects as well.[13] In spite of the number of authorities having some jurisdictional interest, DeFi investors generally will not get the same level of compliance and robust disclosure that are the norm in other regulated markets in the U.S. For example, a variety of DeFi participants, activities, and assets fall within the SEC’s jurisdiction as they involve securities and securities-related conduct.[14] But no DeFi participants within the SEC’s jurisdiction have registered with us, though we continue to encourage participants in DeFi to engage with the staff. If investment opportunities are offered without any regulatory oversight, investors and other market participants must understand that these markets are riskier than traditional markets, where everyone generally follows the same set of rules.

IV. The Role of the SEC

My role as an SEC Commissioner is to help make sure that all market activity, both new and old, is carried out fairly, and that all investors have an equal opportunity. I would expect that those involved in the DeFi market would want to achieve this same goal.

The SEC has the power to create rules, give special permission, or take enforcement action. If DeFi development teams are unsure if their project falls under the SEC’s jurisdiction, they should reach out to the Strategic Hub for Innovation and Financial Technology (FinHub) or other Offices and Divisions. These groups of experts are well-versed in digital asset issues and are happy to have meetings to discuss these projects. If a project won’t work well with our current methods, the team responsible for it should talk to us before they try to sell it. They’ll have better luck if they come up with some solutions first. Although our staff cannot provide legal advice, they are open to hearing ideas and giving feedback. Developers know their projects better than anyone else, so their input is valuable. It is important for us to get specific ideas about how new technologies can be integrated into our regulatory regime to ensure that protections for the market and investors are maintained, while also allowing for innovation.

Projects that do not comply with our regulations will be subject to our enforcement procedures. The SEC recently settled an enforcement action with a DeFi platform and its individual promoters. The SEC says that the company raised $30 million through an unregistered offering and misled investors while spending their money on themselves. If other companies are doing something similar, the SEC says they will take action. I prefer to choose a different path, and I do not think that enforcement is necessary. Broad non-compliance with DeFi goals is not an efficient way to achieve shared goals. More companies complying with regulations will lead to the SEC needing to pursue investigations and litigation less often.

V. Structural Hurdles

Although the SEC’s role is not to prevent all investment losses, I don’t want to stop investors from having chances to get good deals. I demand that investors have access to critical information so they can make informed decisions about whether to invest and at what price. I also want to make sure that markets are fair and not manipulated. Given this, the two specific structural problems that the DeFi community needs to address seem to be _______.

Common cryptocurrency scams and how to avoid them

Cryptocurrency investment scams

There are many types of crypto scams. Some of the most common include:

Fake websites

Some scammers create fake cryptocurrency trading platforms or fake versions of popular crypto wallets to trick people who are not careful. These websites usually have similar domain names to the sites they are trying to imitate, but the domain names are usually slightly different. These sites are designed to look like legitimate sites, making it hard to tell them apart. Fake crypto sites often operate in one of two ways:

• As phishing pages: All the details you enter, such as your crypto wallet’s password and recovery phrase and other financial information, end up in the scammers’ hands.
• As straightforward theft: Initially, the site may allow you to withdraw a small amount of money. As your investments seem to perform well, you might invest more money in the site. However, when you subsequently want to withdraw your money, the site either shuts down or declines the request.

Phishing scams

Scammers will often target information relating to online wallets in order to get hold of crypto currency. Private keys are required to access crypto wallets, making them an appealing target for scammers. Other phishing attempts usually involve creating a fake website that looks real in order to get people to enter their personal information. This method of working is similar to that. To trick people into giving them private information, they send an email with a link to a website that looks real. Once the hackers have acquired this information, they will use it to try and steal any cryptocurrency that is in those wallets.

Pump and dump schemes

This involves a particular coin or token being advertised by fraudsters through an email blast or social media such as Twitter, Facebook, or Telegram. Not wanting to miss out on potential profits, traders rush to buy the coins, driving up the price. After successfully inflating the price, the scammers sell their holdings, which causes a crash as the asset’s value sharply declines. This can happen within minutes.

Fake apps

A common scam cryptocurrency investors fall for is downloading fake apps from Google Play or the Apple App Store. The fake apps are quickly found and removed, but they are still impacting many bottom lines. Thousands of people have downloaded fake cryptocurrency apps.

Fake celebrity endorsements

Scammers will sometimes pretend to be celebrities or well-known figures in order to get people’s attention and scam them out of their money. This typically involves selling non-existent cryptocurrencies to novice investors. Fraudulent investment schemes will often use celebrity endorsements to give the appearance of legitimacy. For example, a scammer might create a website that looks like it was made by a well-known company, and use images of celebrities to suggest that they endorse the product.

Giveaway scams

In a giveaway scam, a scammer promises to match or multiply the cryptocurrency that is sent to them. A sense of urgency can be created by clever messaging from what looks like a valid social media account. People who are promised a “once-in-a-lifetime” opportunity may be more likely to transfer funds quickly in the hope of getting an immediate return.

Blackmail and extortion scams

Another method scammers use is blackmail. The scammers send out emails claiming to have a record of the adult websites visited by the user and threatening to expose them unless they share private keys or send cryptocurrency to the scammer.

Cloud mining scams

Companies that allow you to rent out their mining hardware in exchange for a fixed fee and a share of the revenue you make. This allows people to mine for cryptocurrency without having to invest in expensive mining hardware. However, many cloud mining companies are scams or not effective, which means you could lose money or make less money than expected.

Fraudulent initial coin offerings (ICOs)

An ICO is a way for start-up crypto companies to raise money from future users. In other words, in order to get the new cryptocurrency coins, customers have to first send an active cryptocurrency, like bitcoin, to the company. Some ICOs have been created by criminals in order to deceive investors. They have gone to great lengths to make their ICO look legitimate, such as renting fake offices and creating high-end marketing materials.

How to spot cryptocurrency scams

So, how to spot a crypto scam? Warning signs to look out for include:

No financial investment can promise or guarantee future returns because investments can always go down as well as up. Offers that promise you will make money are red flags.

If a cryptocurrency doesn’t have a whitepaper, it’s likely because the team behind the project is inexperienced and not worth investing in. The purpose of the whitepaper is to explain the design of the cryptocurrency and how it operates. Be cautious if the whitepaper doesn’t make sense, or worse, if it doesn’t exist.

Excessive marketing: All businesses promote themselves. Fraudsters in the cryptocurrency industry attract potential investors by investing heavily in marketing, advertising, and paying influencers to promote their projects. The goal of this is to quickly raise money by reaching as many people as possible. Be wary of marketing that seems over-the-top or unsubstantiated, and investigate further before investing in crypto.

The people behind this investment business are not easy to find. This usually refers to easily accessible biographies of the people running the investment, as well as staying active on social media. Beware of cryptocurrency if you cannot find out who is running it.

You should be wary of any investment opportunity that promises free money, whether in cash or cryptocurrency.

How to protect yourself from cryptocurrency scams

Many crypto frauds are sophisticated and convincing. Here are some steps you can take to protect yourself:

To invest in cryptocurrency, you need to protect your wallet by keeping your private keys safe. Don’t give your keys to anyone who asks in order to participate in an investment opportunity, as it is likely a scam. Keep your wallet keys private.

only send a small amount of money the first time you use a crypto wallet app to ensure that it is legitimate. If you notice any suspicious behavior while updating your wallet app, cancel the update and uninstall the app immediately.

You should only invest in things that you understand. If you’re not sure how a cryptocurrency works, do more research before you decide whether to invest in it.

Don’t be rushed by scammers who try to get you to invest immediately with bonuses or discounts. It is important to do your own research before investing money. This way, you can take your time to make sure you are making a wise investment decision.

Beware of ads on social media- scammers will often use platforms like Facebook and Twitter to advertise their fraudulent schemes. They may use unauthorized images of celebrities or high-profile businesspeople to make themselves seem more legitimate. They may also promise giveaways or free cash. When you see opportunities to invest in cryptocurrencies being promoted on social media, be skeptical and do your research.

If someone calls you randomly to try and sell you a crypto investment, it is more than likely a scam. Do not give your personal information to someone who contacts you, and do not send them money.

You should only download apps from the official Google Play Store or Apple App Store, as these platforms are much safer than others. Although there may be some fake apps on these platforms, it is still much safer to download apps from here than from other places.

Before investing in any cryptocurrency, it is important to do your research to make sure it is not a scam. The most popular cryptocurrencies, such as Bitcoin and Ethereum, are not scams. If you’re thinking about investing in a cryptocurrency that you’re not familiar with, make sure to do your research first. Read the whitepaper, find out who is running the company and how it operates, and look for reviews and testimonials to get a better idea of whether or not it’s a good investment. Make sure to find a fake cryptocurrency list that is up-to-date and credible in order to avoid scams.

If a company guarantees high returns or promises to make you rich quickly, it is likely a scam. Be suspicious of things that seem too good to be true.

only invest what you can afford to lose. Cryptocurrency is a volatile and speculative investment, so it is important to understand the risks before investing.