Regulatory conflict and hacker chaos: What is the future of the SEC and DeFi?

Author: Barter DeFi co-founder Nikita Ovchinnik, CryptoSlate; Translator: Tao Zhu, Golden Finance

As Forbes magazine recently pointed out after the SEC's action against Uniswap, DeFi may become the SEC's "crosshairs." Nonetheless, the matter has raised reasonable concerns that DeFi must address for the future.

According to Uniswap, Wells' notice hints at potential enforcement actions for allegedly acting as both an unregistered securities broker and an unregistered securities exchange. The SEC claims that certain tokens traded on Uniswap, such as those issued through ICOs, constitute investment contracts and therefore securities. Uniswap is accused of violating federal securities laws by trading these tokens without proper registration and supervision.

The SEC believes that Uniswap Labs has significant control over the operation of the platform, making it the central entity responsible for trading activities. Uniswap Labs argues that it is only a developer responsible for building the front-end portal. The Uniswap protocol itself is independent, simply releasing autonomous code for public use. The fact that one can interact with the protocol without using a front end supports this defense in my opinion.

It has to be said that the SEC’s action was not unexpected given the pre-existing rumors and signs. While concerning, Uniswap’s solid foundations and favorable position in the regulatory environment suggest that it has a strong case to present. In the short term, we may see market uncertainty impact investor confidence and token value.

For Uniswap, the ultimate consequences are unlikely to be severe. Uniswap has not only successfully navigated these challenges, but has also strengthened its role as a legitimizing and stabilizing force for DeFi. This could be a turbulent period that lasts for years for DeFi as a whole, but Uniswap at least looks ready to fight. The company’s strategic response and inherent advantages may make it even stronger, continuing its tradition as the industry’s “white knight.”

The SEC’s action against Uniswap is part of a broader regulatory trend targeting decentralized platforms, which naturally raises concerns about over-regulation. It’s unfortunate that the SEC decided to focus on such a prominent player like Uniswap; however, it should at least serve as a wake-up call to others.

Time for DeFi leaders to do their homework

While frustration over the crackdown on Uniswap is understandable, the reality is that the SEC’s concerns are significant. Recent reports paint a sobering picture of staggering losses for DeFi projects. In January, $133 million was lost to hacks and fraud; another $67 million in February; and another $136 million in March. In contrast, centralized finance platforms had zero hacks or fraud incidents during the same period.

Despite its innovativeness, DeFi’s rapid growth and adoption has outstripped its ability to effectively address fundamental security issues. Its open-source nature has been praised for its transparency and collaboration, but it has become a double-edged sword. Of course, the public availability of code promotes innovation, but it also exposes vulnerabilities to malicious actors who can study the code at their leisure.

DeFi supporters would be wise to pay attention to these concerns and take decisive action to strengthen industry security once the battle lines are drawn. Failure to do so could lead to further regulatory crackdowns, stifle innovation, and undermine the founding principles of DeFi. The Commission is determined to establish its authority and ensure that DeFi operates within the scope of securities laws. The outcome of this conflict will certainly affect the industry's future trajectory and relationship with regulators.

Stay away from CeFi, still pursuing true decentralization

In March, Munchables, an NFT game built on Ethereum Layer 2 blockchain Blast, suffered a $62.5 million attack. The attacker manipulated the proxy contract to allocate a large amount of Ethereum to himself and then withdrew most of it. The culprits were a pseudonymous rogue developer employed by the company, along with three others, all of whom vouched for the attacker.

After the hack, on-chain researcher ZachXBT investigated and determined that the four individuals were likely the same individual, possibly linked to the notorious North Korean cybercriminal group the Lazarus Group. Perhaps this revelation inspired the attackers to hand over the private keys needed to recover the stolen funds, which occurred after speaking with the hackers. The incident highlights the importance of strong security measures and due diligence in hiring practices. Maintaining control over deployment processes and thoroughly understanding the code pushed to the blockchain is critical.

From a broader perspective, the Munchables hack exposed the tension between decentralization and user protection. Initial calls for the Blast team to intervene and roll back the blockchain run counter to the ethos of decentralization, where transactions are immutable and uncensorable. In this case, however, the scale of the exploit and the potential impact on user trust understandably suggest a more interventionist approach.

Journey to a Brighter Future

Ultimately, the DeFi space must face security challenges to mature and gain mainstream acceptance. This requires both technical improvements in smart contract development and a cultural shift toward greater transparency, accountability, and risk management.

Security should permeate every layer of operations, from smart contract development to user interface design. Leaders must prioritize compliance without compromising core principles to navigate this volatile space and chart a course toward a brighter future.

DeFi protocols must undergo rigorous audits and penetration testing, leveraging the expertise of experienced cybersecurity professionals to proactively identify and mitigate vulnerabilities. Embracing bug bounty programs is another critical step. Projects can address vulnerabilities by incentivizing ethical hackers to find them before they can be exploited.

Crucially, this security-focused approach must be accompanied by a new commitment to transparency and open communication with regulators. By proactively engaging with regulators and demonstrating a willingness to collaborate to establish industry-wide standards and best practices, DeFi leaders can help shape a regulatory framework that fosters innovation while ensuring consumer protection.

The road ahead is difficult, but the rewards for a secure, compliant DeFi ecosystem are huge. By prioritizing security, embracing collaboration, and maintaining an open dialogue with regulators, the industry can pave the way for mainstream adoption and unlock its true potential.