‘If it was possible to replace the SEC with code, I would in a heartbeat,” Thesis CEO Matt Luongo writes.

Shakespeare wrote in “Henry VI:” “the first thing we do, let’s kill all the lawyers.” If you work in DeFi in 2023, you’ve likely heard similar grumbling directed at regulators. Gary Gensler may as well be the King of France.

This op-ed is part of CoinDesk’s State of Crypto Week sponsored by Chainalysis. Matt Luongo is the CEO of Thesis, a venture studio and auditing firm which has built a family of projects across fintech, DeFi, infrastructure, and zero-knowledge cryptography such as Fold, tBTC, Taho, Etcher and Embody.

The fundamental complaint is the same as in the Bard’s day: that “parchment, being scribbled o’er, should undo a man.” Or in this case, an industry.

See also: IRS Proposed Rule on Digital Asset Broker Reporting Could ‘Kill’ Crypto

I’ve spent years building and developing projects in Web3. This technology can make billions of people’s lives safer, richer and easier to navigate. So I share the frustrations of many at the recent heavy-handedness of regulatory bodies.

This year has already seen a broad assault on crypto, with the U.S. Securities and Exchange Commission (SEC) suing both Binance and Coinbase and refusing to admit defeat in its fight against Ripple. The case against Coinbase is particularly baffling, since the same SEC that’s now accusing the crypto exchange of malfeasance only a few years ago approved its Nasdaq listing.

In the U.S, the approach seems to be to enforce first and figure out the rules second. This must change.

But where does the change start? How can this challenge be overcome?

Tech is about disruption, and some argue that decentralized tech itself will eventually make regulators obsolete. If rules can be written into code, the argument goes, human enforcers and the biases they bring will no longer be needed. Trust me: if it was possible to replace the SEC with code, I would in a heartbeat.

But it’s not possible. The world needs regulators. It just needs to right-size them.

First, do no harm.

We need to start with a simple question: what is regulation for?

Constructive regulation helps ensure that people do not abuse their positions to cheat, steal or harm others. Enforcement should ensure that everyone is playing by the same rules. At its most basic level, regulation should keep ordinary people safe from bad actors and allow marketplaces to operate as beneficially as possible.

The need for regulation highlights a fundamental truth: technology is amoral. This is true of all tech, from fire to airplanes and AI to DeFi. Its morality is determined by the people who use it. And there are as many motives as there are people.

The stunning unraveling of FTX last year, and the failure of several banks earlier this year, demonstrate the multifaceted nature of risk. FTX was, based on available evidence, a classic Ponzi scheme. Bank failures were caused by a panic that spread through social media. But in each case, a crisis was precipitated by human activity rather than anything inherent to underlying technology.

And since human action is what drives these crises, it’s human behavior that must be regulated.

If crimes are committed, perpetrators must be held accountable. At the same time, honest actors should be allowed to innovate. As a rule, history has shown that adopting and regulating, rather than opposing, new technology benefits…

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For DeFi to Flourish, Right-Size the Regulators

Decentralized Finance, also known as DeFi, has been gaining significant traction in the financial world in recent years. DeFi is a revolutionary concept that aims to provide financial services without the need for traditional intermediaries such as banks or other financial institutions. Instead, DeFi relies on blockchain technology to create a peer-to-peer network where users can lend, borrow, and trade without the need for a central authority.

The growth of DeFi has been remarkable, with the total value locked in DeFi protocols reaching over $100 billion in 2021, up from just $1 billion in 2019. This rapid growth has attracted the attention of regulators around the world, who are grappling with how to effectively regulate this new and innovative space.

While the intentions of regulators are well-meaning, it is crucial for them to avoid overregulation that could stifle the growth and innovation of DeFi. Instead, regulators should focus on right-sizing their approach to ensure that DeFi can flourish while still maintaining consumer protection and market integrity.

One of the challenges for regulators is the decentralized nature of DeFi, which makes it difficult to apply traditional regulatory frameworks. Unlike traditional financial institutions, DeFi protocols are often governed by smart contracts and operate across multiple jurisdictions, making it challenging for regulators to effectively monitor and regulate them.

Regulators must acknowledge the unique characteristics of DeFi and tailor their approach accordingly. This may involve collaborating with other regulatory bodies and industry stakeholders to develop new regulatory frameworks that are suitable for the decentralized nature of DeFi.

Another consideration for regulators is the need to balance innovation with consumer protection. While it is essential to protect consumers from fraud and other risks, regulators must also avoid stifling innovation in the DeFi space. Finding the right balance may require regulatory sandboxes and pilot programs to test new regulatory approaches before fully implementing them.

Additionally, regulators should take a proactive approach to engaging with DeFi participants and industry stakeholders. By fostering open communication and collaboration, regulators can gain a better understanding of the unique challenges and opportunities in the DeFi space, and develop more effective regulatory solutions.

Ultimately, the goal of regulators should be to create a regulatory environment that fosters innovation while still protecting consumers and maintaining market integrity. This may require a shift in mindset and a willingness to adapt traditional regulatory approaches to the unique characteristics of DeFi.

In conclusion, as the DeFi space continues to grow, it is critical for regulators to right-size their approach to ensure that DeFi can flourish. By acknowledging the decentralized nature of DeFi, striking a balance between innovation and consumer protection, and collaborating with industry stakeholders, regulators can create a regulatory environment that supports the growth and innovation of DeFi while still maintaining market integrity and consumer protection.