Polygon Labs, in partnership with Arktouros law firm, has introduced a groundbreaking regulatory framework aimed at designating certain decentralized finance (DeFi) protocols as critical infrastructure essential to the national and economic security of the US.

The proposal, authored by Rebecca Rettig and Katja Gilman from Polygon Labs, along with Arktouros co-founder Michael Mosier, was released on Jan. 29. The comprehensive 45-page document focuses on addressing illicit finance activities within the DeFi space.

The framework suggests that truly decentralized DeFi protocols should fall under the oversight of the US Treasury’s Office of Cybersecurity and Critical Infrastructure Protection (OCCIP). While not a traditional financial regulator, the OCCIP plays a crucial role in strengthening the security and resilience of critical infrastructure in the financial services sector.

Polygon’s Three-Step Solution

The proposed framework by Polygon outlines a three-step solution to tackle the legal challenges surrounding DeFi. The initial step involves establishing a legal definition for “System Control Persons” (SCPs), entities with operational authority over blockchain-based systems.

According to the proposal, SCPs should comply with standard anti-money laundering (AML) requirements, irrespective of the system’s decentralization status.

Another key aspect of the framework is the creation of a new category called “critical communications transmitters” to play a vital role in genuine DeFi systems.

For DeFi systems without SCPs, categorized as “genuine DeFi,” the framework recommends classifying them as “critical infrastructure” under the supervision of the OCCIP. These entities would have specific obligations to uphold US national and economic security without being classified as financial institutions under the Bank Secrecy Act (BSA).

Contrasting Views

The proposed framework diverges from the perspective of Senator Elizabeth Warren, who has expressed concerns about crypto firms meeting AML requirements equivalent to traditional banks. Warren has also raised alarms about the potential illicit use of cryptocurrencies.

The authors also draw a distinction between centralized finance (CeFi) or traditional finance (TradFi) and DeFi, with each having distinct control mechanisms guided by FinCEN, the Treasury’s Financial Crimes Enforcement Network.

Legal expert Jake Chervinsky views this new framework as a potential solution to Washington DC’s emphasis on illicit finance over other regulatory concerns in the crypto industry.

Emphasis on Positive Actions

The authors stress the importance of maintaining a balance between preventing illicit activities and fostering positive actions, aligning with the Treasury’s goal of promoting economic prosperity and financial security in the US.

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