Historic FIT21 crypto bill passed: What does it mean for DeFi protocols?

On May 22, 2024 the U.S. House of Representatives passed the landmark Financial Innovation and Technology for the 21st Century Act (FIT21), a significant step towards establishing a clear regulatory framework for the digital asset ecosystem. This bill, hailed as one of the most comprehensive crypto regulations to date, is set to reshape the landscape of cryptocurrency and decentralized finance (DeFi) in the United States​ (CoinDesk)​​​.

Understanding the FIT21 Bill

The FIT21 Act aims to provide much-needed regulatory clarity and consumer protections within the digital asset space. Here are the key components of the bill:

1. Regulatory Clarity: The bill delineates the jurisdictions of the Commodity Futures Trading Commission (CFTC) and the Securities and Exchange Commission (SEC) over digital commodities and securities, respectively. This clarity is expected to reduce the regulatory uncertainty that has often stifled innovation in the crypto industry​ (Cryptopolitan)​.
2. Consumer Protections: FIT21 introduces stringent consumer protection measures. These include requirements for accurate disclosures from digital asset developers and the segregation of customer funds by exchanges. Such measures are designed to enhance investor confidence and safeguard user assets​ (House Financial Services Committee)​.
3. Market Structure and Stability: By establishing a structured framework for digital asset markets, the bill aims to ensure long-term stability and growth within the sector. This framework is crucial for fostering innovation while maintaining a secure environment for all participants​ (PYMNTS.com)​.

Potential Implications for DeFi Protocols

DeFi lending & borrowing protocols across public blockchain networks stand to benefit from the regulatory clarity and protections introduced by FIT21. Here’s our interpretation of how this legislation may affect token-based DeFi protocols:

1. Classification of Governance Tokens: The bill's approach to classifying various digital assets will be crucial for DeFi. Governance tokens, which often serve as both utility tokens and a means of decentralized control, may face heightened scrutiny. Protocols will need to closely examine the bill's criteria for distinguishing securities from commodities and ensure their token designs and functionalities align with the appropriate regulatory treatment.
2. Decentralization and Regulatory Scope: The bill seeks to tailor requirements based on the level of decentralization and automation of particular protocols or networks. More decentralized protocols and networks may be subject to lighter touch oversight or be outside the scope of certain provisions. As a result, lending and borrowing protocols will need to carefully consider how regulators are likely to assess their level of decentralization based on factors like token distribution, governance structures, and reliance on key intermediaries. Protocols may need to make design choices or adjustments to optimize their regulatory positioning.
3. Custody Requirements and Asset Segregation: The bill sets forth requirements for the custody of customer digital assets, including the use of qualified custodians and segregation of customer funds. While the exact application to DeFi lending and borrowing protocols remains to be seen, these provisions could influence how protocols handle user collateral, liquidity pools, and other funds escrowed by smart contracts. Protocols may need to implement additional safeguards, auditing, or disclosures around asset custody to align with regulatory expectations.
4. Disclosure Obligations and Customer Protection: Digital asset brokers and dealers are subject to various disclosure and customer protection requirements under the bill, including around the risks of particular assets, conflicts of interest, and material aspects of their operations. To the extent that lending and borrowing protocols rely on or integrate with regulated and potentially centralized intermediaries, they may need to ensure adequate transparency and user education. Protocols might also consider aligning their own disclosures and risk warnings with the bill's standards to proactively meet customer protection goals.
5. Reporting and Recordkeeping: The bill imposes reporting and recordkeeping obligations on digital asset market participants, which could extend to certain DeFi protocols or their partner entities. Lending and borrowing protocols should assess whether they may be subject to any such requirements based on their specific activities, transaction volumes, or user base. Developing robust data management and reporting capabilities could help protocols navigate these potential obligations and provide transparency to regulators and users alike.
6. Risk Management and System Safeguards: For centralized digital commodity exchanges, the bill requires adequate risk management procedures, conflict of interest policies, and system safeguards around cybersecurity, business continuity, and disaster recovery. While not directly applicable to DeFi protocols, these provisions signal regulatory priorities that platforms may wish to proactively address. DeFi protocols could benefit from assessing their own risk management frameworks, stress testing their smart contracts, and ensuring the resilience of their infrastructure.

Adapting to a Changing Regulatory Landscape

The DeFi landscape is evolving rapidly, and the introduction of new regulations like FIT21 is set to have a significant impact on the industry. Bonzo Finance views these changes as an opportunity to continually strengthen the protocol to best serve its ecosystem and users.

By adapting to the changing regulatory environment, Bonzo Finance aims to increase trust and participation, enhance compliance and security, and foster innovation and growth.

1. Increased Trust and Participation: The regulatory clarity provided by FIT21 is likely to attract more institutional and retail users to the on-chain DeFi space. If true, this increased participation will help drive the adoption and growth of Bonzo Finance, allowing the protocol to serve a broader user base.
2. Enhanced Compliance and Security: Bonzo Finance is committed to maintaining the highest standards of compliance and security. The new regulations will help refine the protocol’s practices, ensuring it continues to provide a safe and reliable service for users.
3. Fostering Innovation and Growth: With a stable regulatory environment, Bonzo Finance can focus on innovation and expansion of its services. Clear regulatory frameworks support the protocol’s efforts to introduce new features and functionalities, enhancing the overall user experience and solving user problems.

Join Us on the Testnet

As Bonzo Finance continues to align itself with the latest regulatory standards, we invite you to join us on the testnet. User participation and feedback are invaluable as refinements of the protocol’s offering are made to ensure a seamless launch.

Start Testing

1. Download the HashPack Wallet and set up a testnet account
2. Join the official Bonzo Finance Discord #Testnet-Faucet channel and follow the instructions to get access to testnet HTS assets for use with the protocol
3. Visit https://testnet.bonzo.finance to test out supply, borrowing, repaying, and withdrawing assets.
4. Post a screenshot of your testnet activity on Twitter and tag @Bonzo_Finance to be added to the “allowlist” for the official Bonzo Finance NFT Collectibles sale.

For more details on the FIT21 bill and its implications, you can read the Press Release here.