️‍Balancing Freedom and Compliance: Should DEXs Be Regulated?

[Music] thank you very much uh thank you for joining us for the balancing freedom and compliance should dexes be regulated I won't take a long time on the introductions you've all been sitting here for some fantastic speeches about why Dex shouldn't be regulated so uh I guess we'll have to jump straight into it now first up I'm going to turn to to Charles was the CEO of the world's leading decks for Perpetual Futures and um previously headed the Hong Kong department fintech so you've got both policy SL and a um Pol well policy side and also from from industry now so could you give a a brief introduction of to um what what are the difficulties in regulating a decentralized exchange absolutely so I think when when I look at decentralized exchanges and defi in general there is really five things coming to to mind uh the first thing is decentralization decentralization if you want to put into layman uh terms and and try to map it over what what Regulators think about decentralization is essentially an upgrade of the way we transact uh in traditional Finance two different entities are are are transacting with one another and when you look at decentralization and what defi brings is essentially a new paradigm shift where users are uh transacting with protocols and protoc are not really entities and we can touch on this later on so the first benefit of the way of of decentralization is really core to the to the industry and it has it's very important to be understood by the practitioners as the early adopters but also The Regulators so it creates a very big Paradigm Shift where you cannot really regulate anymore entities but you have to regulate a flow uh which is happening on public blockchains which brings transparency which brings security also there is no custody of the asset which is lost by the users anymore so there are benefits transparency and security but also the flow is totally different so this big challenge for Regulators it's who who exactly to regulate now in this new kind of uh in this new kind of of setup um and I believe conversation should be progressing towards not only controlling these entities because the flow is kind of broken now there is protocols which which are part of these transactions with users should they be individuals or regulated entities but thinking how we can eventually monitor the risk and moving away from a control type of regulations to risk monitoring because we don't have the opportunity to regulate the full flow of entities but now there is a big part which is technology and Technology cannot really be regulated operators over technology can but technology cannot be regulated so I think we will see in the coming in the coming years different parts of the world are moving at different pace where Regulators will essentially leverage a technology itself where they can get an instant view of the marketplace via this public blockchains knowing exactly who is doing what uh and thinking how the technology can essentially support the monitoring of the flows rather than regulating the the entities themselves and maybe the last point also why it's important to think deeply about regulations of dexes in general uh it's putting the dexes in the context of the new infrastructure for for finance um it's very strategic for any International Financial Center to be totally aware and embrace the upgrade of the financial ra which is happening before our eyes and and really en ambling this these new technologies of of Defi and and decentralization and this and those public uh public blockchain ledgers to really upgrade their financial uh their financial industry overall it's not only fintech anymore it should be fintech plus uh plus infrastructure and Defi and dexes are strategic infrastructures which any any jurisdictions cannot let on the side too for too long because I would say the train has started to go and and we see the numbers we see the engagement here for example at adgm U Finance week how many people are talking about digital asset and how this this kind of migration or expansion towards uh the the blockchain and defi is expanding yeah no it's well I think we're all excited to see where the train will end up or at least where it's going to take us along the journey so y on turning to you um so you're the policy lead at Unis swap one of the largest uh d the um dexes in the world and uh previously you the European commission I think we've heard on the last panel about how defi was kept out of mik and I understand you were part of the team um involved in that so what do you see as the benefits and risks and regulation of dexes yeah thank you so I think building on what uh when sh said I think what we see as the benefit uh when we talk about uh fully decentralized protocols or true defi I think it's the open Innovation that it actually brings if you have these public blockchains that are technically immutable and there's no one in control that allows people to build new types of financial services and Technology on top of that so the uniswap protocol is used by a lot of uniswap labs as competitors as well because it just drives liquidity so it it's accessible to everyone like charl says if you're technically capable you don't need to use any kind of tool by a commercial entity you can simply connect yourself you can provide liquidity yourself if you are a traditional Market maker that wants to go into the crypto space you can build tools and you can start providing liquidity without any obstacles at all um and I think what we see as well is we see then additional layers being built on top so you have all these applications that simply use the same infrastructure so Unis swop sits on different chains but primarily it started on ethereum and then it's just another application it's another layer that people can all use to have the same standards the same protocols and I think to your point on why is it difficult that that's exactly why it's it's almost impossible to regulate it I mean you could you could come up with standards you could say there was a specific way that you needed to build new versions of protocols but since they are immutable and they will run forever and ever and ever there is still Unis swap V1 Unis swap V2 now it's on Unis swap V3 but as long as ethereum is turned on as long as the internet is turned on they just keep running so where you have to look from a regulatory perspective is really figuring out but what are the actual risk since this has knock on wood never been hacked the actual risks sits on the outer layers we need to figure out do people the comparison with centralized ex do people know when we go to retailers do they know what they're doing or should we put an obligation on some of these new tools that help them transact directly with each other to assist them in understanding the economic uh actions that they're about to enter into right so I think it's it's about explaining or educating Regulators how you must protect or you must have the base layer remain credibly neutral that has to be jurisdiction agnostic in my view um because you couldn't incorporate all the different rules of all the different jurisdictions into the protocol and it could be outdated very quickly and then you're again at the mercy of liquidity actually going to a new version if you implemented new changes so I think that's why you have to you have to try to figure out together industry and the public sector what is the appropriate regulatory hook and again I think it's important when we say now we say all decentralized exchanges but it is like the normal flow if you are new to crypto and you don't for some reason have them already you would always pass through a payment service provider or a regulated exchange where we would do your kyc you would buy crypto you would then go into a non-custodial wallet and then perhaps when you are a bit more educated yourself you would start transacting peer-to-peer because most users still come on to centralized exchanges mainly for the ease of use it's simply it looks more similar to something they're used to dabbling in to build on this very quickly I think it's our responsibility at defi practitioners to stay engage with regulators and I will go beyond educating I will go beyond claiming that defi is better for all kind of reasons we we just talked but essentially demonstrating because this is obvious when people take the time or have the chance to get a professional to explain to them how is the agenda of regulators which is protecting investors and keeping healthy marketplaces how this agenda of regulators very legant uh overlap with the capabilities and the intasc um I will say design of defi defi does not take custody of any asset defi is and decentralized exchanges are transparent by Nature when they're properly designed so I think it's really our our role and our responsibility to engage and demonstrate not only claiming no I fully agree with the engagement point and turning then to K who's head of legal at backpack and uh formerly GC at one of the world's largest uh centralized exchanges you no doubt have had plenty of regulatory interactions in the past um how in your view has regulation impacted sexist centralized exchanges and and what are the implications for that regulatory uh discussion for dex's going forward appreciate it so um uh I think we're all actually talking about the same thing but I'm going to slice it a little different way so I think the distinction between centralized exchanges and decentralized exchanges it's actually a Continuum rather than a black and white line I think there's you know features of certain you know uh uh dexes that are actually more centralized you have a more centralized front end you have a more centralized multi you have a more you know centralized uh cross-chain Bridge um you have a more centralized upgradeability upgradeability key or you know some sort of admin you know super super Keys um uh and um uh so there you know in my view it's it's a whole Continuum between you know centralized to decentralized exchanges and so it doesn't quite make sense to talk about the two as if they're Polar Opposites it's more it's really more of a Continuum in fact we've even seen centralized exchange adopting you know more onchain components as well um so in terms of the lessons that I think that um could be learned from you know centralized exchanges um I think there's a principle that a lot of regulators sort of uh look to which is um uh same risk same regulation um uh if you know if you look at a a D5 protocol obviously if it's fully you know immutable and and and and you know there's no custody um then you know it's it's hard to actually even find a legal actor that you can regulate um but if you if you look at a you know uh decentralized um uh smart contract or a protocol and there's a risk of rugging there's a risk of custody loss there's a risk of you know something that happened with you know FTX for instance lack of segregation between the spot assets and the derivative assets um between the margin and the non-m margin assets I think those become areas of focus um that Regulators should look to um because you know if they present if if they present the same um risk I think the same sort of um uh uh principles should apply um one other thing I think is is is liquidity um and I think this is one area that um uh uh for me it's quite interesting because if you look at all the liquid liquidity that's happening in you know in Industry traditional Finance you know it's it's not that uh uh uh uh Market uh sort of different but there's a lot of liquidity that is moving in between centralized and decentralized exchanges and so as we think about how we regulate uh uh centralized and decentralized exchanges I think Regulators should be very keenly aware that you know if they actually turn up the knob on one side of the spectrum it's going to drive liquidity to other sides of the just just you know to to somewhere else and so if you make it very hard for centralized exchanges to service customers to actually try to comply with the laws then a lot of the liquidity is just going to go into the decentralized exchange where Regulators even though they want to you know for instance take a more conservative approach and regulate the centralized exchanges more is ultimately just going to cause the opposite effect because all the liquidity all the users just going to go to decentralized exchanges um same thing if you try to you know apply um uh outdated tools outdated principles of Regulation um to uh uh these Central exchanges um uh and make it very hard for people to to even code or write computer software um and I think that's going to have um unintended consequences as well that's a good example of Market influence as well so turning then to Emma um top 20 influential women in crypto and the head of um um emia for gbbc what's the industry's take on on this um I think they'd agree with a lot of what's already been said actually um and look there's a reason that defi was left out of MAA it is very comp complicated to regulate what we are very focused on at the moment is bringing industry together bringing Regulators together it is all about that education that John mentioned I think and truly really understanding it which is is difficult to at the moment I think we're heading um in a Direction I mean obviously we're talking about um decentralized exchanges but when you're talking about the wider industry we're still not there with regulation fully yet you know so what will come 2025 um I think a lot will happen in 2025 particularly with the change in US government and we will see an uptick in regulation and those regulatory Frameworks um talking about you know can we regulate dexes I don't think we can yet um maybe we can in the future but at the moment I think it's a little too difficult well it's interesting to see because we see Bermuda this week quite unhelpfully issued their first license for aex with gravity seeing how that's going to work in function whether it's going to be operational who knows I agree with John's point about you know from a universal standpoint how does that work there's no uniformity in approach there but I me then going going going back to you in regards to um what what do you view as the the main risks then or what's the industry telling you the risk we've heard a little bit before about AML concerns kyc concerns but but really is that what you're hearing I mean the main risk with Dex for me are like any type of trading it's losing money um and you know a lot of the time I think that is can be user error um so the big risk with dexes is that you have to have a very good understanding of what you're doing and many people on those platforms will but there will be some every single day that absolutely don't and so that's the main risk you know how do you educate those people to what they're really doing what they're really trading um um you know very simple things like losing your private Keys um how you know and there do people fully understand the risks that they take when they step onto these platforms that they are not covered there is no insurance um there isn't customer service phone line that you can call up so for me and unsurprisingly coming from me a lot of it is about education and how we increase that right um John then to you very briefly uh obviously you were involved in the discussions we touched on at the European Commission you've been part of uniswap now remarkable growth with uniswap do you think if we could find a way for regulation to be introduced that it could be done done so without stifling that growth that Innovation that um Dex is naturally are draing um I think it could ultimately land in a spot where it would be as beneficial at as it might be uh like restrictive in the sense of something we would have to get used to I think think to K's point I think one of the one of the issues I have when I speak to regulators and having been one myself I know it's not something you want to hear but if you want to actually find a future where you do some type of defi regulation you're going to have to compromise more than you're used to because to your point exactly it's it is a I mean there will be technically decentralized protocols there will be protocols that are that have sufficiently distributed governance that they're also decentralized but they might for some specific function they need to be able to upgrade those smart contracts some will be simpler and you will never ever change them but then when you go to that very commercialized interface wallet layer the question is what what are the comparisons to CI where are the risks the same where could you uh easily Implement some consumer protection rules and I think to to Emma point I think one of the things that we are using or we're seeing now as a a competitive Advantage is to be the interface where you did not get scammed so there is a lot of self-regulation already taking place there are companies that I mean we try to do a lot of different things we try to create a new protocol we try to create a chain we try to create a wallet so we're spread pretty thin but there are also companies that just do the wallet stuff right and there is a lot of competition there to give you an example I think on any given given day on the Unis swap protocol in terms of volume our proprietary interfaces like where we actually make any money can be around seven or 8% of the overall volume so the rest is either market makers going directly or it's competitors who are simply building better applications to allow users to go to the protocol I think there is the French put out a paper more than a year ago where they kind of went from the perspective of acknowledging that these do exist there is a new type of tool that users will use to connect and trade and it's not the same as a centralized exchange and then the question is then what what could be feasibly applied to them right and I think the best that I've seen is that it comes down to disclosures there could also be uh an idea where the the mainstream interfaces that provide the user with the tools to use the blockchain they have to assess the protocol they send you users too so they have to make sure that they're not sending them to something where all their tokens will be siphoned away or where they have to do both a security test but also an economic test of the smart contract so these are just like things that the French already imagined could be one of the things that you could do so regulating The Operators and not the technology so yeah so looking at the access points or the tools and then having them kind of impose the restrictions in the sense that if you knew your us it would not be safe on one Dex but on another you would probably start sending only to the ones where you know what's going on to your point about transparency as well yeah so that's the tools on the protocol then um Char turning to you then behind the protocol use of dows and dlts heavily involved in that space what is the role of Regulation when it comes to Dows we know that there's a great framework now in the ad G but what's your views on that so D maybe for people which are not familiar with the term da stands for decentralized autonomous organization they are some kind of new limited companies they kind of new legal status for this digital organic uh or digital organism I will say and the big challenge with d is we need to find for them like a legal status are they a limited company are they an association after you get some more clarity and many Regulators are working on this here in in Abu Dhabi as as well as some others after you get a legal legal state for Dow you get a little bit more uh the next topic coming on is actually what do you do with the token holders are the token holders uh shareholders are they participant of a new kind and therefore you need to Define what what kind of participant they are some token holders might be just holding the token some token holders might be participating uh in the governance of the Dao and and essentially steering the directions of the protocol itself so do they do they have a different role and different responsibilities some token holders might might decide to contribute to the to the the network Itself by being stakers for example so that these are hard questions and I think many Regulators now are into the taxonomy stage where they try to map these new roles and this new this new kind of organization it's a big challenge when when you get like the legal status of a dow settle as well as an good understanding of what are the stakeholders of those Dows then comes taxation uh a topic very close to the heart of of many governments obviously and which is which is necessary and good so how do you tax these token holders which are coming from multiple jurisdictions and and it depends mostly where is this Dow kind of anord is it a DA under Abu Dhabi regulations or kiman or some others and when you've got all this work done legal status uh token ERS kind of definitions uh taxations come also like uh kind of Investigations to make sure you don't overlap too much with Securities laws which exist for a good reason for a number of years and you you're really on the On The Fringe of it right where actually a token holders is not a shareholder per se but you want to make sure you're not overlapping or getting over over this headline so Dow are very very experimental they're very new but they they also new type of Corporations Global corporations in a way so it's I think it's very important to have those questions settled I think there is a lot of uh research being done here in Abu Dhabi there is an open uh open consultation I think was which was released last week so I really encourage everyone to be engaged with the regulators and not only claiming but educating because there is a lot of good uh good intention and there is a global competition between all these those jurisdictions to to make the best of the the digital asset economy no indeed indeed um K just to you for for one minute John touched on a an important point he said you know there's a lot of self-regulation currently that's what we heard when the centralized exchanges were coming through the the regulatory Year from we've seen the SEC the cftc enforcing through well regulating through enforcement what Lessons Learned From the centralized exchange you think that the Regulators need to know at this stage in one minute please so uh maybe I'll answer a slightly different question so when I came here I looked up the definition of regulate just on on online Maran Webster and the the definition is to bring under the control or Dominion of um and to me regulation is fundamentally about human behavior um it's about fundamentally what we can do um uh uh to make people do the right thing and so for instance you know doesn't make sense to regulate a piece of stone a piece of you know a mountain or a river um and I think I think I think one thing that um we keep come I I keep coming back to is other than sort of um the more public laws um that been out there um the SEC cftc there's actually been a body of case law um in analogous space um P2P file sharing it's been actually around for for over 20 30 years and there's actually a body of laws on how to actually think about regulating um behaviors in the space different players in the space um uh instead of the software instead of the decentralized P2P um immutable you know uh uh software contracts um for instance there's a very famous case 2007 um US Supreme Court um uh uh uh groer whereby a fully decentralized P2P file sharing soft software the developers of that software was found liable because uh they had specifically marketed that piece of software for illegal purposes and that makes sense if you just go back to First principles like I can manufacture a knife if I sell it to um a chef but if I you know try to sell it to someone knowing that he's going to kill someone that's wrong so anyways take out more that that that's fantastic I think time's up now but one last question sh should dexes be regulated as of December 2024 say it again should dexes be regulated as of today yes or no operators should be regulated not the technology can no no John no no Emma I'm in between okay thank you all very much for your time this afternoon much appreciate thank you everyone [Applause] [Music]