Decentralized Finance 3.0 - The Great Reckoning is Nigh
A critical look into Decentralized Finance 3.0 and how Aggregated Finance is preparing for impending crypto regulations.
Make no mistake folks, there’s a storm coming. And honestly? It can’t get here fast enough. As Decentralized Finance (DeFi) projects are launching at a rapid rate, so has the drift away from structures designed to protect all involved parties of the projects.
Over the last 2 years, the number of crypto projects claiming to be “truly decentralized” has reached an astonishing count. On one hand, DeFi has connected crypto to a new world of financial products – products that either didn’t exist previously – or were only accessible through “traditional finance” vehicles. On the other hand, DeFi has spawned a bird’s nest of challenges, questions, and risks. Project developers touting Twitter pseudonyms and NFT profile pics are suddenly vanishing, oftentimes with their project’s coffers in tow. Telegram is brimming with tales of deception and deceit in the DeFi space. But while everyone’s attention is oftentimes focused on the most recent DeFi ‘rug pull’, there remains a far more pressing topic to discuss.
DeFi 3.0, (also known as Farming-as-a-Service or FaaS) remains the coolest kid on the block in the neighborhood of Decentralized Finance. FaaS/DeFi 3.0 typically refers to crypto projects that aggregate or “pool” community funds. The funds are held in a Treasury wallet and are collected via token transaction taxes charged/collected whenever the project’s token is bought, sold, or transferred from one wallet address to another. The Treasury funds are invested in various crypto assets by the Project’s keepers – on behalf of the community/token holders. Profits made from these investments are typically dispersed amongst the token holders.
Sound familiar? In case it isn’t overwhelmingly obvious, we’re witnessing the birth of the Community Hedge Fund. But we're not witnessing it alone.
Quite a few regulatory bodies in United States (for example)likely have some jurisdiction over the DeFi space, according to an SEC Statement issued in November 2021. SEC Commissioner Caroline A. Crenshaw lists a host of US agencies that probably have grounds to weigh in on the DeFi discussion, including, “the Department of Justice, the Financial Criminal Enforcement Network, the Internal Revenue Service, the Commodity Futures Trading Commission, and the SEC”.
The SEC statement lists a plethora of concerns regarding DeFi, but the following excerpts from the SEC statement stand out as the most relevant concerns in DeFi 3.0/FaaS:
- “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…”
- “Without a common set of conduct expectations, and a functional system to enforce those principles, markets tend toward corruption, marked by fraud, self-dealing, cartel-like activity, and information asymmetries. Over time that reduces investor confidence and investor participation.”
The SEC is more than capable of dealing out heavy penalties to any organization it feels violates its policies – as it did to BlockFi on February 14th, 2022. BlockFi was fined $100 million for a multitude of reasons, including failing to register its BlockFi Interest Account (BIA) offering under the Securities Act of 1933, violating the Investment Company Act of 1940, and making misrepresentations and omissions regarding the level of risk in its loan portfolio.
BlockFi’s troubles, as nuanced as they are, suggest regulating bodies such as the SEC are particularly focused on DeFi products that are controlled (and therefore easily manipulated) by centralized entities:
“Some commentators might see this outcome as a blow to the emerging decentralized finance (DeFi) ecosystem, but it is unclear whether this can be generalized to completely decentralized platforms in the DeFi space. Although BlockFi is sometimes referred to as a DeFi platform, it arguably engages in centralized financial management, which was at the crux of the SEC’s argument…”
Projects utilizing centralized financial management systems,coupled with pseudonymity, raise even more red flags:
“Without an efficient method for determining the actual identity of traders, or owners of smart contracts, it is very difficult to know if asset prices and trading volumes reflect organic interest or are the product of manipulative trading by, for example, one person using bots to operate multiple wallets, or a group of people trading collusively…"
The number of potential risks extend far beyond Crenshaw and Fornaris’ truncated lists. In the wild west that is DeFi 3.0, massive Treasuries with balances totaling double-digit millions worth of assets rest in the hands of individuals with zero accountability or proven credibility. The average investor has no recourse if a developer goes AWOL with no communication to their respective communities or worse yet, makes off with the Treasury. The risk profile extends to also include the unintentional circumstances. A project’s Leader could simply burn out, become ill, or in extreme cases, pass away suddenly. Even without malicious intent, DeFi projects not operating with a decentralized solution in place are perpetually leaving themselves exposed to unnecessary and dangerous risk.
The Decentralized Autonomous Organization (DAO) offers an elegant and comprehensive solution to the aforementioned dilemmas. When executed correctly, a DAO can solve the inherent concerns of both Security AND Decentralization in one fell swoop.
A DAO is, by definition, an entity with no central leader. Instead of decisions being made by a CEO or Board of Directors, decisions are made by voting – with token holders serving as the deciding powers, the participants/community and are usually organized around a specific set of rules enforced by a blockchain.
So how can a DAO be implemented in DeFi 3.0 to protect investors, satisfy regulators, and achieve the coveted status of being ‘truly decentralized’?
Aggregated Finance ($AGFI) set out with the clear mission and vision of checking off all three of these incredibly critical boxes.
The AGFI DAO
Slated to launch on March 28th, 2022– the AGFI DAO utilizes three interoperable management groups to effectively manage a DAO:
- Voters/Token Holders
- Proposal Managers
- Custodian or "Guardian"
These three groups form a secure, decentralized organism – capable of withstanding significant forces, both externally as well as internally.
Voters/Token Holders have two primary functions in the AGFI DAO:
A) Draft and submit Proposals – which are changes that they feel if made, would benefit the DAO
B) Vote on Proposals – utilize their tokens via the DAO Management Platform to vote on Proposals
Proposal Managers have one primary role in the AGFI DAO with a few different functions:
A) Vet/Qualify Proposals submitted to the DAO and determine if they are valid (Proposal Managers are the first line of defense against nonsensical and/or malicious Proposal submissions).
B) Scrutinize Proposals to ensure they contain the required Proposal Criteria
C) Proposal Managers must reach a 75% quorum on any given Proposal prior to it being sent to the DAO Management Platform and voted on
D) There must be at least 5 Proposal Managers at all times
E) The Proposal Manager role is acquired by being voted in by the DAO
The Custodian or Guardian role has its own functions as well:
A) For all votes requiring an executable change in the smart contract, or a transferring of funds, the Guardian executes those changes after the passing of a vote.
B) The Custodian/Guardian is the last line of defense against DAO attacks – and may demonstrate discretion if by executing an action, the DAO may be placed in harm’s way or exposed to other, unforeseeable risks.
AGFI positions itself with its DAO to be a truly unique FaaS project within the space – one that can protect investors (and itself) from peril. To serve as the first DAO Custodian, Congruent Labs will undertake the role for the community, who will foster a culture of transparency, one that regulators are likely to look favorably on when assessing the landscape of DeFi in the coming months:
“While some in DeFi believe in absolute financial privacy, I expect that projects that solve for pseudonymity are more likely to succeed, because investors can then be comfortable that asset prices reflect actual interest from real investors, not prices pumped by hidden manipulators. Projects that address this problem are also more likely to be able to comply with SEC regulations and other legal obligations, including requirements around anti-money laundering and countering the financing of terrorism imposed by the Bank Secrecy Act.”
A regulation storm approaches – but with its upcoming DAO launch and unique governance structure, Aggregated Finance is setting itself up to not only weather it, but thrive within it long into the future.
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