Identifying “decentralized exchanges”: free software, open blockchain, and the role of “middleman”

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Recently, the volume of cryptocurrency transactions processed through decentralized exchanges (DEX) has surpassed that of mainstream centralized cryptocurrency exchanges.

According to data from Dune Analytics, the decentralized exchange Uniswap’s September transaction volume reached 15.371 billion U.S. dollars, while the Coinbase transaction volume during the same period was “only” 13.3 billion U.S. dollars. The substantial increase in Uniswap transaction volume is mainly due to two factors:

1. The decentralized finance (DeFi) industry has seen explosive growth, and a large number of users use DeFi governance tokens for income farming;

2. Uniswap launched the governance token UNI to promote a significant increase in platform transaction volume.

The figure above shows the monthly trading volume trend of 13 leading decentralized exchanges (Source: Dune Analytics).

In fact, the DeFi governance token boom started in June, when Compound first proposed the idea of ​​issuing governance token COMP, which surprised the entire crypto community. However, looking back, the whole process is actually relatively simple. A summary is: let Users use various cryptocurrencies (such as ETH) to “farm” DeFi protocol governance tokens. Over time, the DeFi protocol will distribute their governance tokens to relevant users in a decentralized manner.

Generally speaking, the most common practice for DeFi users after “income farming” is to hold the governance tokens they earn until these tokens are traded online on a centralized exchange. But the problem is that the tokens listed on the head centralized exchanges often evaluate many factors, such as market liquidity, track record, developer activity, etc. It is almost impossible for DeFi governance tokens to meet these requirements-the result is obvious , Uniswap, a decentralized exchange, eventually became the platform of choice for DeFi token trading, and its transaction volume soared rapidly.

Is DEX trading volume hitting a new high is a flash in the pan? Or a long-term trend?

On August 30, Uniswap’s daily transaction volume exceeded Coinbase Pro for the first time. At that time, Uniswap founder Hayden Adams excitedly tweeted:

“Wow, Uniswap’s 24-hour trading volume surpassed Coinbase for the first time in history: Uniswap: $426 million, Coinbase: $348 million, it’s hard to express how crazy this is.”

Since then, Uniswap has been competing with the leading centralized cryptocurrency exchanges in the United States. Although the boom in revenue farming and governance tokens has subsided slightly, Uniswap trading volume has always remained high, which indicates that the decentralized trading of cryptocurrencies has risen. The trend is sustainable.

鉴别「去中心化交易所」:免费软件、开放式区块链和「中间人」角色

The figure above shows the trend of active users of decentralized exchanges (Source: Digital Assets Data).

Although the prices of many DeFi tokens have begun to fall in the past few weeks, and user activity for revenue farming has continued to weaken, Dune Analytics researchers did not regard it as a bearish market signal and stated:

“Although the income farming boom has cooled somewhat, the transaction volume of decentralized exchanges has broken records in September, increasing by 100% compared to August, and the weekly transaction volume in September is higher than the peak week in August. Transaction volume.”

Anthony Sassano, the founder of Ethhub, believes that the current market reflects the positive sentiment of the vast majority of investors towards Ethereum. He concluded:

“Some people say that the market performance of decentralized exchanges is getting worse and worse-this view is absolutely wrong. In September alone, the trading volume of decentralized exchanges reached 23.5 billion US dollars!”

Three policy areas closely related to “decentralized transactions”

In fact, there are three policy areas closely related to “decentralized transactions”:

1. Financial supervision (also considered anti-money laundering)

2. Securities supervision

3. The US Constitution (including the First and Fourth Amendments)

The first two are at the regulatory level, and may or may not be applicable to persons (entities) exploring the development, implementation, and custody of decentralized transactions, while the third will provide protection in certain circumstances. Below, let us analyze one by one:

1. Financial regulation and DEX

Since the 1970s, the U.S. federal law “Bank Secrecy Act” (BSA) has been serving to supervise U.S. financial institutions, requiring them to collect certain information about customer identities and transactions, and to report to the U.S. Department of Treasury and financial crime enforcement. Network (FinCEN) report. Initially, only companies engaged in traditional financial services, such as insurance companies and banks, reported relevant data, but later their supervision was extended to pawn shops, casinos, and cryptocurrency custodians and exchanges.

You must understand-the “Bank Secrecy Act” is a law that requires exchanges to conduct KYC (Know Your Customer) checks and report all suspicious transactions to regulators and law enforcement agencies in the “Suspicious Activity Report”. It is worth noting that all these data collection, retention and reporting (which can be said to be the search and seizure of sensitive customer data) are carried out completely without guarantee or other specific circumstances, so people cannot help but ask: these financial regulatory laws can Does it apply to decentralized exchanges?

According to the results of repeated demonstrations by Coin Center, the only object of the Banking Secrecy Act that can trigger the supervision of cryptocurrency is: a person or company that has actual control over the cryptocurrency of others (or its customers) and acts on their behalf . This is actually very similar to traditional financial services industry supervision. You will see that regulated banks have actual control over individual US dollar accounts.

The cryptocurrency industry should do the same: only custodial wallets and centralized transaction service providers (such as Kraken and Coinbase) are required to comply with the Bank Secrecy Act, and those “non-third-party custodians” should not be subject to the Bank Secrecy Act. Constraints, including individual cryptocurrency holders, software developers, miners, full nodes, multi-signature providers (assuming they do not have enough keys to execute transactions).

The crypto industry should cooperate with the Uniform Law Commission to develop a model language to define escrow behavior, so that the scope of legal constraints will not be confused, because only those people and companies that “have the ability to unilaterally execute on behalf of customers or block cryptocurrency transactions indefinitely” It should be regulated. Not only that, although the purpose of this model language is to protect consumers, it can be applied in any situation related to cryptocurrency custody and control.

So far, the relationship between financial supervision and decentralized exchanges has achieved some results. In May 2019, the Financial Crime Law Enforcement Network issued guidelines, which clearly stated that entities that “have no independent control over client funds” will not be subject to the registration and regulatory requirements of the Bank Secrecy Act:

“According to the regulations of the Financial Crime Law Enforcement Network, if a person only provides payment and remittance delivery, communication or network access services, then he/she will not be recognized as a Money Transmitter. Consistent with this exemption, if the virtual The currency trading platform only provides a forum for buyers and sellers of convertible virtual currencies to post prices and offers on this forum (regardless of whether the platform automatically matches counterparties), and the parties themselves conduct transaction settlement through external venues (regardless of whether the platform automatically matches counterparties). Through independent wallets, or through other wallets hosted by the trading platform, the trading platform will not be recognized as Money Transmitter by the laws of the Financial Crime Enforcement Network.”

Therefore, at least at the level of financial regulation and regulation, if you design a software that promotes decentralized transactions, and never allow third parties to host cryptocurrencies, and only match users of P2P transactions, then the software developer will not be affected by the “Bank Confidentiality Law is bound. Moreover, the Financial Crime Law Enforcement Network mentioned in the 2013 regulatory guidelines that if software users only conduct transactions in their own name, these users will not be bound by the Bank Secrecy Act.

2. Securities regulation and DEX

Although the “Bank Secrecy Act” seems to be unable to restrict decentralized exchanges, it does not mean that “decentralized exchanges” cannot be regulated. Securities regulations may apply to those who use decentralized exchanges for certain activities.

The objectives of securities regulation and financial regulation are different:

1. The purpose of securities regulations is to protect investors from false statements and fraud;

2. The “Bank Secrecy Law” and other financial regulatory laws and legal rules are intended to prevent financial institutions from engaging in illegal activities such as money laundering.

Therefore, the “Securities Law” only applies when the assets you are trading are identified as “securities”, and the definition of “securities” is complex and flexible. Since 2015, regulators and industry think tanks have been studying whether (and when) digital currencies should be considered securities.

The current situation is that tokens that have no issuer and whose holders rely on future profits will not be regarded as securities, otherwise they will be regarded as securities. From this perspective, Bitcoin and similar cryptocurrencies are not securities, because there is no “central issuer” to manage the network, and the issuer does not promote and sell initial tokens. However, there is a gray area on the decentralized network, that is, the tokens initially sold by a certain network may belong to securities products, but as the network gradually decentralizes, the tokens that eventually run on the network may not belong to securities. EOS is a typical case. EOS issuers have reached a settlement with the U.S. Securities and Exchange Commission (SEC). They admitted that the pre-sold tokens are a kind of securities, but the tokens currently running on the network are not regarded as securities to be regulated. .

If tokens are considered securities, they cannot be legally traded on stock exchanges or alternative trading systems that have not been regulated and registered by the US Securities and Exchange Commission. The definition of an exchange in the US Securities Act is broader and more flexible than that in the Bank Secrecy Act. It not only does not rely on the concept of third-party custody, but also expands those that do not have custody rights but match buyers and sellers or facilitate transaction settlement. People-This means that if you develop a tool for decentralized trading, as long as someone uses the tool to trade tokens that are recognized as securities, they may be subject to securities regulatory laws and regulations.

For example: In 2018, the US Securities and Exchange Commission accused EtherDelta developer Zachary Coburn of operating an unregistered stock exchange, and the two parties finally reached an out-of-court settlement. EtherDelta is a DEX platform based on Ethereum, but the US Securities and Exchange Commission found that several tokens traded on the platform belong to securities products. Therefore, even if EtherDelta does not involve any third-party custody business, it is not subject to the “Bank Secrecy Act” and other financial supervision regulations, but it will still be recognized as an illegal securities transaction under the “US Securities Act”.

In theory, only decentralized trading platforms that support non-securities tokens (such as Bitcoin) can be subject to neither the US Bank Secrecy Act nor the Securities Act—in reality, it seems Few trading platforms can do it. If developers build tools for non-securities token trading, but they are ultimately used by others to trade securities, will they be held responsible? This seems to be an untested problem.

3. The U.S. Constitution and DEX

Let us continue with the above question: If someone develops or deploys a tool that supports decentralized trading, but is ultimately used by others to trade securities and is accused of violating the US Securities Act or other financial regulatory laws, then May only rely on the First Amendment and Fourth Amendment of the US Constitution to defend.

If the developer is creating and releasing decentralized trading software to the public, and the developer does not promote the illegal use of the software, but only charges the people who use the software (not the transaction fee), then the software release should be subject to the United States Protection of the First Amendment and Fourth Amendment of the Constitution.

Why is there no such thing as a “decentralized exchange” at all?

In fact, Coin Center released an analysis report on decentralized exchanges in 2019, in which it has foreseen the trend of policy changes in the decentralized exchange market:

“Regulators have expected that any exchange (if necessary) from one cryptocurrency to another will be carried out through a trusted third party…because of the need for a trusted legal entity to maintain banking relationships to handle sovereign currencies , So the exchange method between sovereign currency and cryptocurrency is unlikely to change, but the same situation may not happen in the transaction between cryptocurrency and any other blockchain assets.”

The difference between currency transactions and fiat currency transactions is largely due to the Ethereum-based DeFi boom, and this transition occurs much faster than we thought.

But the problem is that if a decentralized exchange is truly “decentralized,” then from a grammatical point of view, “decentralization” should actually be an action, not a thing. It is a verb rather than a noun. and so–

What you should say is:

I made a decentralized transaction.

Instead of saying:

I am using a decentralized exchange.

When we use free software and an open blockchain network to directly interact with another trader and exchange one token for another token, we have actually participated in a decentralized transaction, which is like people making transfers or payments same. But if we have a kind of “decentralized exchange” as an event rather than a behavior, it is easy to trigger a certain wrong habit, because we will fall into the fixed thinking framework of centralized services. For example, you can think of Coinbase as a “thing”, a company, a company. This is not a problem at all, because Coinbase is a centralized exchange, but if the transaction is peer-to-peer, then what you use The “decentralized exchange” is actually software and Internet connection-in this case, there is actually no such thing as a “decentralized exchange”, because there is no “decentralized exchange” at all , There are only trading software, open blockchain, and the Internet, you just use these tools to make a decentralized transaction, nothing more.

Calling trading software, open blockchains, and the Internet “decentralized exchanges” and treating them as a type of thing that exists in the real world (rather than a type of transaction) is actually not beneficial to the crypto industry. Because we are wrongly portraying software tools as individuals or businesses with agency and legal obligations. Companies with legal or natural person representatives and individual entities have agents and obligations, but software tools do not. Companies and individuals must be responsible for their actions, but software tools do not.

Of course, we are not saying that people who use (or do not use) these tools in a certain way do not need to bear any obligations and responsibilities at all, but at the same time, we cannot attack these tools just because someone uses these tools to engage in illegal activities. If someone uses a hammer to commit an attack or drives a car in violation of regulations, we should punish the perpetrator or the driver instead of making the hammer or the car bear legal obligations, just as the Internet itself cannot be regarded as an object of regulation.

If a “decentralized exchange” does not use free software and open blockchain, or even has some key “middleman” roles, then it is not a decentralized exchange at all. To make a long story short, we should not use the term “decentralized exchange” to describe any service or thing, because “decentralized exchange” is an action, and it is wrong to regard it as an entity name.