How SEC Puts DeFi on Notice with Rari Capital Charges

• The SEC has unveiled charges against Rari protocol in an escalating DeFi crackdown.
• The recent charges will likely give DeFi protocols operating in the U.S. pause for thought.
• While market leaders may be able to face the SEC, an enforcement barrage may spell doom for newer protocols.

Under Gary Gensler ‘s leadership, the SEC has launched a regulation-by-enforcement campaign against the crypto industry, asserting that decades-old securities regulations are sufficient to guide the nascent market. While these enforcement actions have primarily been focused on centralized entities, the turn of the year has seen DeFi enforcement efforts come into focus as the agency has issued warnings of potential enforcement actions against ConsenSys and Uniswap .

In the latest instance, on Wednesday, September 18, the agency unveiled charges against Rari Capital, a once high-flying lending protocol that had up to $1 billion in TVL at its peak.  While claims that the project lied about its pools being automated have stood out, the SEC’s claims about the tokens offered by the protocol are likely to give any decentralized application with a token pause for thought.

SEC Not Deterred By Decentralized Label

The SEC charged Rari Capital for operating as an unregistered broker through the offer and sale of yield and governance tokens, which the agency labeled unregistered securities. According to the SEC, these tokens offered Rari protocol users interest in the pool and rights to receive profits earned by the pool. According to the SEC’s Wednesday press statement , Rari Capital has settled the case for an undisclosed sum without admitting or denying any wrongdoing.

The SEC’s claim that yield and governance tokens represent unregistered securities in the Rari Protocol case should ring alarm bells for most DeFi protocols that typically have governance tokens that allow users to dictate the project’s direction. At the same time, for crypto proponents who argue that crypto assets are not securities, it is likely to serve as another example of the SEC stretching the definition of a security to expand its reach to the crypto industry. These proponents maintain that the definition of securities requires a contract.

In response to these arguments, the SEC has often argued that a contract is unnecessary if expectations are built up in the minds of token holders, usually through marketing and promotion.

Whatever the case, the Rari Capital charges offer another instance highlighting that the SEC has DeFi in its cross-hairs. Emphasizing this notion in the Wednesday press release, SEC Regional Director Monique C. Winkler asserted:

"We will not be deterred by someone labeling a product as 'decentralized' and 'autonomous,' but instead will look beyond the labels to the economic realities, as we did here, and hold the individuals behind crypto products and platforms accountable when they harm investors and violate the federal securities laws."

With the SEC hinting at a potential barrage of DeFi enforcement actions, the question becomes how the crypto industry will react.

Survival of the Biggest?

The fallout of an SEC enforcement campaign against DeFi will likely mirror what has been observed in its campaign against centralized exchanges.

Smaller protocols like Rari Capital will likely feel the most heat as they may not have the financial capacity to see out a lengthy battle with the SEC. This could lead to a plurality of outcomes. For one, these protocols could choose to bar U.S. users from accessing their platform to avoid legal confrontation or end up settling and shutting down if they are unable to avoid charges.

On the other hand, as has been observed with Uniswap’s efforts to take the fight to the SEC, larger protocols with sizable war chests will more likely take their chances in court, where the SEC has had mixed results so far.

On the Flipside

• Rari Capital had effectively wound down in 2022 after falling victim to an $80 million hack.
• In a footnote in a recent SEC filing in its case against Binance, the world’s largest crypto exchange by volume, the agency asserted that it had never described crypto assets themselves as securities.

Why This Matters

The SEC’s enforcement efforts have sparked a U.S. crypto exodus narrative in recent years. An enforcement campaign against DeFi will only help to fan the flames of this narrative. Already, most protocols try to exempt U.S. users from airdrops.

Read this for more on the SEC’s crypto enforcement efforts:
SEC Pushes Coinbase Lawsuit Discovery Past 2024 Election

See why Bitwise CIO Matt Hougan believes Fading Ethereum is a mistake:
Why Fading Ethereum Will End up “Looking Silly” According to Bitwise CIO