Are Crypto Lending, DeFi And Stablecoins The New “Lions And Tigers And Bears, Oh My!”? A Review Of Recent Crypto Legal And Regulatory Developments – Corporate/Commercial Law

Developments continue at a frenetic pace in the crypto industry.
Issues barely on the radar screen 18 months ago have come front and
center in today’s headlines. Areas with relatively small market
capitalizations a year ago have ballooned many multiples during the
past year. This advisory overviews three key areas – crypto
lending, decentralized finance (DeFi) and stablecoins – and
summarizes what key regulators have been saying about and doing in

I. Interest Bearing Accounts (or Crypto Lending)


  • A number of crypto platforms now offer interest-bearing
    opportunities permitting their customers to earn interest on
    cryptoassets that they hold with, or lend to, such platforms. On
    the back end, the platforms generally use those deposited or lent
    assets to fund digital asset loans to traders or other market
  • Many of these opportunities tout interest-rate returns far
    exceeding what traditional financial institutions currently
  • These crypto lending accounts or relationships are
    not traditional bank accounts or
    relationships and are not insured by the Federal Deposit Insurance
    Corporation (FDIC), and the platforms that offer these products are
    not members of the Securities Investor
    Protection Corporation (SIPC). Thus, these “deposit
    accounts” or lent assets are not entitled to the same
    regulatory protections that apply to conventional bank or brokerage

Canaries in the Coal Mine? Regulatory

  • Purported interest-bearing accounts offered by one major market
    player have generated significant regulatory scrutiny in recent
    months. Securities regulators in five different states have alleged
    that, or at least questioned whether, these “accounts”
    are actually unregistered securities offerings to residents of
    those states and, in some cases, have already issued
    cease-and-desist orders to the offering firm.1
  • Separately, Coinbase issued a public statement on September 7
    disclosing that it had received a Wells notice from the Securities
    and Exchange Commission (SEC) with respect to its proposed Coinbase
    Lend program (Lend program), which would have allowed users to earn
    interest on select assets held with Coinbase.2 In essence,
    the Wells notice was a warning to Coinbase that if it were to
    launch the program as proposed, the SEC would take formal action
    against it. The SEC reportedly has informed Coinbase that it views
    Lend program as a security under the Howey and
    Reves tests.3
  • Coinbase maintains that the Lend program does not constitute an
    offering of securities because “[c]ustomers won’t be
    ‘investing’ in the program, but rather lending the
    [stablecoins] they hold on Coinbase’s platform in connection
    with their existing relationship. And although Lend customers will
    earn interest from their participation in the program, [Coinbase
    has] an obligation to pay this interest regardless of
    Coinbase’s broader business activities. What’s more,
    participating customers’ principal is secure and [Coinbase is]
    obligated to repay their [stablecoins] on request.”
  • These developments may reasonably be construed as a warning to
    the many other platforms that offer interest-bearing accounts. The
    penalties for an unregistered securities offering can be steep. An
    issuer of unregistered securities is likely to be the target of an
    enforcement action by the SEC (and possibly other regulators) and
    may ultimately be required to, among other things, pay substantial
    monetary penalties and/or to provide participating investors a
    rescission right.

SEC Chairman Gensler Weighs In on Crypto Lending:
“Wild West”

  • On August 3, in his remarks before the Aspen Security Forum,4 SEC Chairman Gensler emphasized
    that “[t]he American public is buying, selling, and lending
    crypto on these trading, lending, and DeFi platforms, and there are
    significant gaps in investor protection.” He warned crypto
    platforms to “[m]ake no mistake: If a lending platform is
    offering securities, it . . . falls into SEC jurisdiction,”
    and the securities must be registered under the Securities Act of
    1933 or eligible for a registration exemption.
  • In his remarks, Chairman Gensler summarized the current state
    of play as follows: “Right now, we just don’t have enough
    investor protection in crypto. Frankly, at this time, it’s more
    like the Wild West. . . . In my view, the legislative priority
    should center on crypto trading, lending, and DeFi

II. DeFi


  • Decentralized finance, also known as DeFi, is a fast-growing
    sector of the blockchain ecosystem. DeFi protocols use smart
    contracts to create and manage financial products and services that
    are non-custodial in nature. Ideally, they do not rely on a central
    party for governance and maintenance, but many still do in
    practice.5 DeFi-related applications are
    administered via online portals, called “dApps,” and are
    often supported by individuals who pool together assets in a
    “liquidity pool.”
  • Those that deposit assets in a liquidity pool “lock their
    assets” and often earn fees and/or automatically receive
    cryptoassets in the form of “governance tokens.” The
    practice of submitting assets to a DeFi protocol is often referred
    to as “liquidity mining,” while the process of earning
    fees and/or governance tokens is referred to as “yield

Common Uses for DeFi

  • Some of the most common use cases for DeFi include:
    • Decentralized Exchanges (DEXs) that permit
      users to trade certain cryptocurrencies for other cryptocurrencies,
      without the need to transfer any tokens to a centralized exchange
      or other intermediary.7
    • Borrowing / Lending Protocols that employ
      smart contracts to allow users to borrow and lend cryptocurrencies
      (and to pay and receive interest on such transactions) without
      reliance on intermediaries such as banks.8
    • Derivatives / Synthetic Asset Protocols that
      allow users to, on a decentralized basis, create and trade in
      speculative and hedging instruments in various cryptocurrencies,
      including synthetic assets.9
    • Insurance Protocols that offer various
      safeguards against threats to cryptocurrency assets, such as
      insurance against crypto wallet theft, collateral protection for
      crypto-backed loans, and coverage for losses stemming from the
      hacking or manipulation of smart contracts, all without the
      involvement of a conventional insurance company.10
    • Prediction Markets that permit participants to
      bet on the outcome of future events, such as elections and sporting
      events, without the need for intermediaries to manage and collect
      on bets.

The open and “permissionless” aspect of DeFi
protocols, which enables anyone to list a token for exchange or
create or otherwise participate in a DeFi product, is both one of
its most appealing characteristics and the main source of
substantive regulatory concern.

Industry Developments: Investment in

  • DeFi is expanding at an astronomical rate. Over the past 12
    months, the “total value locked” in DeFi (a metric that
    measures the total value of the smart contracts underlying DeFi
    protocols converted into US dollars) has risen from less than $20
    billion to nearly $80 billion, approximately a four-fold
  • Some of the largest players in the DeFi space have fueled, and
    continue to fuel, this expansion by investing in programs that
    promote increased investment in, and understanding of, the space.

    • On August 18, the Avalanche Foundation, the organization behind
      the Avalanche blockchain, which supports the BENQi DeFi liquidity
      protocol, introduced a new $180 million incentive program,
      Avalanche Rush, to incentivize the development of more DeFi assets
      and applications on the Avalanche blockchain network. Leading DeFi
      protocols Aave and Curve are among the first to participate. The
      program will be used to distribute AVAX, the network’s
      currency, to liquidity miners working through Aave and Curve.12
    • On August 30, a consortium of DeFi protocols – including Aave,
      SushiSwap, Curve, 0x and PoolTogther – announced a $100 million
      financial inclusion venture known as “DeFi for the
      People” that will build on the Celo blockchain to provide
      educational initiatives, grants and incentives to educate people
      about DeFi.13

CFTC Commissioner Berkovitz on DeFi: Focus on Investor

  • On June 8, Commodity Futures Trading Commission (CFTC)
    Commissioner Berkovitz discussed DeFi. He noted that Wikipedia and
    Google both define the function of DeFi as the disruption of the
    current financial system’s reliance on financial
    intermediaries. He emphasized the importance of financial
    intermediaries in providing legal protections to investors in US

We have a system in which
intermediaries are legally accountable for protecting customer
funds. In many instances, such as in the clearing system, if a
counterparty fails to perform, an intermediary will make the
customer whole. In a pure “peer-to-peer” DeFi system,
none of these benefits or protections exist. There is no
intermediary to monitor markets for fraud and manipulation, prevent
money laundering, safeguard deposited funds, ensure counterparty
performance, or make customers whole when processes fail. A system
without intermediaries is a Hobbesian marketplace with each person
looking out for themselves.14

  • Commissioner Berkovitz also questioned the legality of
    unregistered DeFi markets under the Commodity Exchange Act (CEA),
    which, among other things:

    • requires futures contracts to be traded on a designated
      contract market (DCM) licensed and regulated by the CFTC;15
    • makes it unlawful for any person other than an eligible
      contract participant to enter into a swap unless the swap is
      entered into on, or subject to, the rules of a DCM;16 and
    • requires any facility that provides for the trading or
      processing of swaps to be registered as a DCM or a swap execution
      facility (SEF).17

SEC Chairman Gensler on DeFi: Projects are “Not
Immune” to Regulation

  • On July 25, 2017, the SEC published a report of investigation
    pursuant to Section 21(a) of the Securities Exchange Act of 1934
    (Securities Exchange Act) against The DAO, a Decentralized
    Autonomous Organization (the “DAO Report”). In the DAO
    Report, the SEC advised that a platform that permits the trading of
    cryptoassets that are securities and operates as an
    “exchange,” as defined under the Securities Exchange Act,
    must register with the SEC as a national securities exchange or be
    exempt from registration.18
  • On November 8, 2018, in light of the DAO Report’s findings,
    the SEC issued a cease-and-desist order and levied disgorgement and
    civil monetary penalties totaling $387,000 against Zachary Coburn,
    founder of EtherDelta, finding that the online platform for trading
    Ether and “ERC20 tokens” (which refers to a class of
    digital assets developed and traded on the Ethereum blockchain) was
    an “exchange” as defined by Section 3(a)(1) of the
    Securities Exchange Act and Rule 3b-16 thereunder and was therefore
    required to register as a national securities exchange.,19
  • On August 19, SEC Chairman Gary Gensler emphasized that DeFi
    projects are “not immune” to regulation by virtue of
    their decentralized nature. He noted that projects rewarding
    participants with valuable digital tokens or similar incentives
    could cross a line and become regulated activities, no matter how
    “decentralized” they say they are: “There’s
    still a core group of folks that are not only writing the software,
    like the open source software, but they often have governance and
    fees . There’s some incentive structure for those promoters and
    sponsors in the middle of this.”[20
  • In the past several weeks, the SEC has brought two notable
    actions against DeFi firms under the registration and antifraud
    provisions of the Securities Exchange Act, finding that both
    platforms were subject to the federal securities laws:21

    • Uulala, Inc. – On August 4, 2021, the SEC
      settled charges against Uulala, Inc. and its two founders for
      allegedly defrauding over one thousand investors in an unregistered
      offering of UULA tokens that raised over $9 million.22
    • Blockchain Credit Partners – On August 6, DEX
      Blockchain Credit Partners (BCP) and its founders were the subject
      of a cease-and-desist order that required them to, among other
      things, pay a disgorgement of $12,849,354 and civil penalties of
      $250,000, in connection with their unregistered sale of
      “mTokens,” which purportedly offered investors a return
      backed by real-world assets, and “DMG tokens,” which were
      governance tokens that purportedly gave holders certain voting
      rights and a share of profits in certain token resales.23
  • On September 3, it was reported that the SEC is conducting a
    probe into Uniswap Labs, the main developer of Uniswap, the
    world’s largest DEX; the SEC is reportedly looking into how
    investors use Uniswap and how it is marketed.24
    Separately, the SEC’s enforcement division issued letters to
    multiple DeFi startups in recent months seeking information on
    their platforms, which is suggestive of a potentially broader
    effort to bring DeFi platforms into compliance with registration

Financial Action Task Force (FATF) Draft

  • FATF is a global, intergovernmental body that establishes
    anti-money laundering and anti-terrorist financing standards and
    procedures. Over 200 countries and jurisdictions have committed to
    implementing the standards adopted by FATF (FATF Standards),
    including the United States.
  • On March 19, FATF revised its Standards to expand the
    definition of “virtual asset service provider” (VASP).
    DApps are not themselves considered VASPs, because FATF does not
    seek to regulate the underlying technology. However, FATF has taken
    the position that developers of DeFi protocols may qualify as VASPs
    and could thus be liable for the absence of, or deficiencies in,
    know-your-customer (KYC) procedures, even if the developers are not
    responsible for the DeFi protocols post-launch.26 The
    guidance also states that owners/operators of DeFi protocols are
    “likely to fall” within the expanded meaning of VASP and
    that those involved in business development activities for DeFi
    protocols could also be VASPs, because they engage in VASP
    activities both as businesses and on behalf of others.27

World Economic Forum (WEF) Whitepaper

  • As regulators worldwide seek to understand DeFi and how it
    interacts with the current regulatory space, WEF, an international
    organization encouraging public-private cooperation in the creation
    of policy, published a DeFi Policy-Maker Toolkit on June 8, 2021.
    The goal of the Toolkit is to provide regulators with an
    understanding of DeFi that could inform policy decisions.28
  • Published in coordination with the Wharton Blockchain and
    Digital Asset Project, the Toolkit breaks down DeFi, including its
    architecture and the various services that it can provide. The
    Toolkit also discusses the risks presented by DeFi from the
    financial, technical, operational, legal and other perspectives.
    Finally, the Toolkit proposes policy approaches for regulators with
    respect to DeFi. The Toolkit acknowledges that the primary
    challenge with respect to DeFi is that many DeFi protocols do not
    involve a central entity that can be easily identified and
    regulated in the traditional sense. The Toolkit proposes that an
    effective regulatory response will likely involve a combination of
    existing regulation, retrofitted regulation and new, bespoke

III. Stablecoins


  • Stablecoins are a type of cryptoasset intended to be more
    resistant to the extreme price volatility that is characteristic of
    more high-profile cryptoassets such as Bitcoin and Ether.
  • To reduce price volatility, stablecoins are generally
    collateralized by another asset or basket of assets, which may
    include commodities, securities, fiat currencies, real property, or
    other assets. Today, many stablecoins are designed to correspond to
    the value of the US dollar.30
  • Stablecoins enable investors to trade different cryptoassets
    without the need to convert their cryptoassets into fiat
    currencies. As of September 9, stablecoins had an aggregate market
    capitalization of approximately $123 billion, up more than 680
    percent year-to-date.
  • The dramatic growth of stablecoins in recent months has
    prompted some observers to warn that, “without additional
    private or public backstops, stablecoins can be subject to severe
    price discounts or self-fulfilling runs, especially when backed by
    risky or opaque assets and in times of market turmoil.” These
    observers also note that “if stablecoins were to gain
    significant usage, runs on stablecoins could provoke fire sales of
    the assets used to back their value.”31

Growing Regulatory Interest in Stablecoins

  • On July 21, SEC Chairman Gary Gensler suggested that a
    “stable value token backed by securities . . . [is] implicated
    by the securities laws and must work within [the SEC’s]
    securities regime.”32
  • In his August 3rd prepared remarks before the Aspen Security
    Forum, Chairman Gensler repeated that some stablecoins may be
    securities and that their issuers may be investment companies,
    stressing that the SEC will “apply the full investor
    protections of the Investment Company Act and the other federal
    securities to these products.”33 Chairman Gensler
    further suggested that “stablecoins may facilitate those
    seeking to sidestep a host of public policy goals connected to the
    traditional banking system: anti-money laundering (AML), tax
    compliance, sanctions, etc.”34
  • Secretary of the Treasury Janet Yellen urged regulators to
    quickly establish a regulatory framework for stablecoins during a
    July meeting of the President’s Working Group on Financial
  • Senator Elizabeth Warren suggested in an interview with the
    New York Times on September 5 that it is “worth
    considering” a prohibition on US banks from holding stablecoin
    cash reserves.36

Cash, Cash Equivalents, and . . . Commercial Paper?
Behind the Scenes of USDT, USDC and USDP

  • Tether (USDT)
    • Tether, the company behind USDT, the largest stablecoin by
      market capitalization,37 and other respondents entered
      into a settlement agreement with the New York Attorney
      General’s Office (NY AG), which imposed a fine of $18.5 million
      together with other remedial measures. Among other things, the NY
      AG alleged that the respondents made material misstatements about
      the US dollar reserves backing the issued tethers.38
    • As part of the settlement agreement, Tether agreed to provide,
      among other things, a quarterly report substantiating Tether’s
      reserve account.39 Tether published its first
      reserve report on March 31, which showed that approximately 76
      percent of its reserves were backed by cash and cash equivalents.40
    • According to Tether’s latest report as of June 30,
      approximately half of Tether’s $62.8 billion in assets were
      held in commercial paper and certificates of deposit.41
  • Circle (USDC)
    • Circle, the company behind USDC, the second largest stablecoin
      by market capitalization,42 published a reserve report,
      which showed that as of May 28, 61 percent of its reserves were
      held in cash and cash equivalents. Another 13 percent was backed by
      Yankee Certificates of Deposit issued by non-US banks, 12 percent
      by US Treasuries, 9 percent by commercial paper, and the rest by
      municipal and corporate bonds.43
    • Circle subsequently announced on August 22 that effective
      September, all USDC reserves would be held in “cash and
      short-duration US government treasuries.”44
  • Paxos (USDP)
    • Paxos, the company behind the stablecoin USDP, announced on
      August 24 that it would be rebranding its stablecoin from its
      previous name Paxos Standard (PAX) to Pax Dollar (USDP).45 As part of the announcement,
      Paxos noted that USDP “is regulated and redeemable one-to-one
      for US dollars” and that “USDP reserves are held 100% in
      cash and cash equivalents.”46
  • Gemini (GUSD)
    • At least one stablecoin company asserts that its reserves are
      backed by equivalent dollars in FDIC-insured accounts. Gemini, the
      company behind the stablecoin GUSD, states that GUSD “reserves
      are eligible for FDIC insurance up to $250,000 per user.”47

Stablecoins and CBDCs: Friends or Foes?

  • The People’s Bank of China, the central bank of the
    People’s Republic of China, is forging ahead with its Central
    Bank Digital Currency (CBDC) experiment, the e-CNY. The Bank
    released a “whitepaper” of the e-CNY in July, noting
    that, among other things, one of the main objectives of its digital
    currency is to “explore the improvement of cross-border
  • Amidst increasing government interest in both CBDCs and
    stablecoins, Federal Reserve Chairman Powell suggested in July that
    one of the main incentives for the US to launch its own CBDC would
    be to eliminate the need for stablecoins and cryptocurrencies
    generally, noting that “you wouldn’t need stablecoins; you
    wouldn’t need cryptocurrencies, if you had a digital US
    currency.”49 While no official timeline has
    been announced, Chairman Powell acknowledged that developing a
    digital dollar is a “high priority project.”50 Senator Elizabeth Warren has
    echoed similar sentiments,51 sparking debate over whether
    CBDCs would act as substitutes for, or complements to,


1. The states in question are New
Jersey, Texas, Alabama, Vermont and Kentucky. Disclosures and
(last accessed Sept. 9, 2021),

2. Paul Grewal, “The SEC Has
Told Us It Wants to Sue Us over Lend. We Don’t Know Why.”
Coinbase Blog (Sept. 7, 2021),

3. Stemming from two seminal
Supreme Court cases (SEC v. Howey Co., in 1946, and
Reves v. Ernst & Young, in 1990), courts and
regulators have developed analytical frameworks for determining
whether a financial instrument qualifies as an “investment
contract” or a “note,” respectively, within the
meaning of the definition of “security” under the
Securities Act of 1933, as amended.

4.See supra note

5. John Divine, DeFi 101: A
Guide to Decentralized Finance
(Apr. 30, 2021),

6. Alyssa Hertig, What is
(Sep. 18, 2020),

7. Alexander Osipovich,
Upstart Peer-to-Peer Crypto Exchanges Take Aim at Coinbase
(May 24, 2021),

8. Jeff Benson, What is Aave?
Inside the DeFi Lending Protocol
(May 26, 2021),

9. Jakub, Derivatives in DeFi
(Jan. 1, 2021),

10. Blockchain Simplified,
Decentralzied Insurance – An Emergin Sector in DeFi (Mar.
31, 2021),

11. DeFi Pulse. Total Value
Locked (USD) in DeFi (accessed September 10, 2021),

12. Ryan Week, Avalanche
Launches $180 Million DeFi Incentive Scheme with Aave and
(Aug. 18, 2021),

13. Tom Farren, Leading DeFi
Projects Launch $100M Global Adoption Initiative
(Aug. 30,

14. Dan Berkovitz, Commissioner,
CFTC, Keynote Address Before FIA and SIFMA-AMG, Asset Management
Derivatives Forum 2021 (Jun. 8, 2021),

15. CEA 4(a), 7 U.S.C.

16. CEA 2(e), 7 U.S.C.

17. CEA 5h(a), 7 U.S.C.

18.Report of
Investigation Pursuant To Section 21(a) Of The Securities Exchange
Act of 1934: The DAO
(Exchange Act Rel. No. 81207) (July 25,

19.In the Matter of
Zachary Coburn
, SEC No. 3-18888 (Nov. 8, 2018).

20. Dave Michaels & Paul
Kiernan, Crypto’s ‘DeFi’ Projects Aren’ts
Immune to Regulation, SEC’s Gensler Says
(Aug. 19, 2021),

21. Sections 5, 17(a), and 10(b)
of the Securities Exchange Act.

22.SEC v. Uulala,
, No. 5:21-cv-01307 (C.D. Cal. filed Aug. 4, 2021)

23.In the Matter of
Blockchain Credit Partners, SEC
No. 3-20453 (Aug. 6,

24. Dave Michaels,
Regulators Investigate Crypto-Exchange Developer Uniswap
(Sep. 3, 2021),


26. Nikhilesh De, State of
Crypt: FATF’s New Guidance Takes Aim at DeFi
(Mar. 30,
2021), h ttps://

27. Agata Ferreira, FATF
Draft Guidance Targets DeFi with Compliance
(May 16, 2021),

28. Nikhilesh De, World
Economic Forum Hopes to Explain DeFi for Regulators with White
(Jun. 8, 2021),

29. World Economic forum,
Whitepaper, Decentralized Finance (DeFi) Policy-Maker Toolkit

CoinMarketCap, Top Stablecoin Tokens by Market Capitalization,

31. BIS Working Papers,
Stablecoins: Risks, Potential and Regulation (Nov. 24,

32. SEC Chairman Gary Gensler,
Remarks Before the American Bar Association Derivatives and Futures
Law Committee Virtual Mid-Year Program (July 21, 2021),

33. SEC Chairman Gary Gensler,
Remarks Before the Aspen Security Forum (Aug. 3, 2021),


35. Pete Schroeder, Yellen
Urges Quick U.S. Adoption of Stablecoin Rules
(Jul. 19, 2021),

36. Eric Lipton & Ephrat
Livni, Crypto’s Rapid Move Into Banking Elicits Alarm in
(Sep. 5, 2021),

37.Supra note

38. In the Matter of iFINEX
Inc., BFXNA Inc., BFXWW Inc., Tether Holdings Limited, Tether
Operations Limited, Tether Limited, Tether International Limited
(Feb. 18, 2021),
(last visited Sep. 6, 2021).


40. Tether, Reserves Breakdown
at March 31, 2021 (Mar. 31, 2021),
(last visited Sep. 6, 2021).

41. Tether, Independent
Accountant’s Report (Jun. 30, 2021),
(last visited Sep. 6, 2021).

42.Supra note

43. Circle, Independent
Accountant’s Report (Jul. 16, 2021),
(last visited Sep. 6, 2021).

44. Circle, Evolving USDC
Reserves to 100% Cash and Short Duration US Treasuries
, (Aug. 22, 2021),

45. Walter Hessert, The
Digital Dollar that Always Equals a Dollar – Paxos Standard (PAX)
is Now PAX Dollar (USDP)
(Aug. 24, 2021),


47. Gemini Dollar, (last visited
Sep. 6, 2021).

48. Working Group on E-CNY
Research and Development of the People’s Bank of China,
Progress of Research & Development of E-CNY in China
(Jul. 15, 2021),

49. MacKenzie Sigalos, Why
the Fed Hates Cryptocurrencies and Especially Stablecoins

(Jul. 16, 2021),

50. Sarah Hansen, Fed Chair
Powell Says Digital Dollar is a ‘High Priority
(Feb. 23, 2021),

51.Supra note

The content of this article is intended to provide a general
guide to the subject matter. Specialist advice should be sought
about your specific circumstances.