Author: cmDeFi
Core point: Understand under what circumstances DeFi will be identified as a "broker", explore the underlying logic and living space in decentralization and regulatory attitudes, and find the perfect exit.
Expanding the definition of brokers: Regulations believe that DeFi transactions have great similarities with securities trading processes. DeFi brokers need to submit information reports to the IRS, help customers accurately declare taxes, and ensure compliance (KYC, anti-money laundering, etc.).
Determine DeFi brokers: provide services to facilitate transactions and have the ability to obtain customer information.
Impact on DeFi: Choose to accept broker identification or decentralize the project. The higher the degree of decentralization, the lower the possibility of being identified as a broker.
The perfect future export of DeFi: decentralized front-end, non-upgradable contracts, on-chain governance, token functionality to build their own networks.
Research Report
1/4 · Background and Reasons
This regulation is initiated by the U.S. Treasury and the IRS. Due to decentralization and anonymity, digital asset transactions often lack the information transparency found in traditional financial systems, leading to significant challenges in tax regulation. The regulation lists the similarities in operational processes between the securities industry and the DeFi industry:
Transaction instruction -> Trade matching and execution -> Transaction settlement.
In the securities industry, brokers send clients' trade instructions to trading centers (such as the New York Stock Exchange or NASDAQ), which are responsible for matching buy and sell orders. In the DeFi industry, the regulation also recognizes such a 'broker' role, and brokers are required to submit information reports to the IRS, assist clients in accurately reporting taxes, and ensure compliance (KYC, anti-money laundering, etc.).
Thus, we primarily discuss under what conditions which roles in DeFi would be recognized as 'brokers'. Regardless of whether the regulation will be approved and implemented, and in what form, our main analytical goal is the underlying logic and survival space within decentralization and regulatory attitudes.
2/4 · Expanding the definition of 'broker'
Traditionally, the definition of 'broker' is limited to trading agents in the securities industry or intermediaries that directly hold client assets. The main content of this regulation is to extend this definition to apply to the digital asset space. The new regulations require brokers to submit reports to the IRS, detailing clients' transaction information, including earnings and transaction details, with the aim of improving tax compliance, which implies potential liability for taxation.
Here, one layer of regulatory inclination can be interpreted: although there is a preliminary definition and distinction between 'securities' and 'commodities' when the ETH ETF is approved, digital assets that meet the criteria are more likely to be defined as commodities and cannot be directly classified as securities. However, the proposed extension of 'broker' in this regulation aims to establish a reporting mechanism similar to that in securities trading, so fundamentally, it still returns to how to define DeFi protocols and assets.
The regulation expands the definition of 'broker' to explicitly include the following types of participants:
Digital asset intermediaries: Individuals or entities providing services to clients to complete digital asset trades, including exchanges, custodial wallet service providers, etc.
DeFi platform participants: Including those who do not hold client private keys but provide trading services through protocols or smart contracts on non-custodial platforms.
The core here lies in the term 'intermediary'; individuals or entities providing services to clients do not need further explanation, as exchanges and custodial wallets are not particularly controversial. The controversy lies in how to define the 'intermediary role' in DeFi activities. In summary, there are two key factors:
Providing services that facilitate trades.
Possessing the capability to obtain client information.
Remember these two judgment factors, and let’s further analyze the roles of various parties in a DeFi project:
Front-end service providers: Provide users with a friendly interface for convenient interaction or trading.
Protocol operators: Provide core protocols or smart contracts (such as AMMs like Uniswap, Curve, etc.) for executing trades.
Validators or settlers: Responsible for recording transactions on the distributed ledger (blockchain).
The regulation particularly focuses on front-end service providers and protocol operators, as their services directly 'facilitate' the completion of trades. As for validators or settlers, if a participant only provides verification services for the distributed ledger (such as blockchain nodes or miners) and does not directly participate in or facilitate trades, they will not be considered brokers. Therefore, only discussing 1 and 2 is sufficient.
The entire analysis process will revolve around Uniswap as an example, as it is the only case that covers all situations.
Basically undisputed, front-end service providers must belong to the 'broker' intermediary role. Especially in the current state of Uniswap's front-end charging, it will strengthen the tendency to be recognized as a broker.
The status of protocol operators is more controversial because, strictly speaking, non-upgradable smart contracts are not controlled by any individual or entity. They possess characteristics of permissionless and immutability. Will the project parties/developers providing such smart contracts be defined as brokers?
Returning to the two key defining factors: providing services that facilitate trades + possessing the capability to obtain client information.
Taking the current Uniswap as an example, the front-end service is provided and maintained by the project party, which fully facilitates trading services and charges for this service. It also has the ability to record and obtain user information (such as adding KYC or trading terms on the front-end).
Now let's assume a scenario where the Uniswap team abandons all services and completely withdraws from the project. Theoretically, users can still complete trades by directly accessing the AMM smart contracts deployed by Uniswap. This is because once a smart contract is deployed, it will forever exist on-chain; thus, AMM becomes a decentralized tool. In a decentralized environment, the project party also cannot obtain user information, which does not meet the second defining factor. Although Uniswap deployed the AMM contract allowing users to trade, it no longer has the 'active' ability to facilitate trades and obtain user information, making it difficult for the regulations to find applicable broker entities.
Therefore, the conclusion is that the higher the degree of decentralization of the project, the lower the likelihood of being recognized as a broker.
In summary, several core characteristics of decentralized projects:
Self-executing nature of smart contracts: Core trading functionalities are realized through smart contracts deployed on the blockchain, which are immutable and can be interacted with by anyone without permission.
No centralized management: If the project party withdraws (e.g., stops maintaining the front-end interface), the smart contract can still operate independently without relying on any centralized entity.
Independence of front-end services: Even if the official front-end (e.g., Uniswap's official website) goes offline, third-party developers can build their own front-ends to interact with the smart contracts.
Inability to control client information: Since on-chain interactions are fully trustless, the project party generally cannot obtain clients' identity information or transaction data.
3/4 · Impact on DeFi
In the early days of DeFi, the endpoint for most projects was still to move towards decentralization, ultimately handing the project over to community governance, running entirely on-chain. However, as time passed, it became clear that achieving this ideal was not as simple as imagined. Most projects gradually disappeared from the market's view after leaving the project party for several reasons:
The project party itself leaves a mess in the name of decentralization, soft rug.
Overall market perception is insufficient, requiring centralized guidance and promotion.
The project itself is not problematic, but it is not mature enough; the community lacks the ability for self-governance and promoting project development.
(1) DeFi requiring centralized participation
Therefore, in this cycle, many ceDeFi projects have begun to rise. Since pure DeFi projects currently cannot achieve the goal of 'decentralized finance', it is better to directly introduce relatively professional and compliant centralized entities and strategies. In this case, these centralized entities are likely to be recognized as 'brokers'. If this regulation is approved and implemented, it means that these projects may
Requiring users to provide KYC.
Under compliance burdens, opening up front-end fees or service charges.
But it also implies that 'brokers' can reasonably and legally conduct activities, with the cost being the compliance burden that requires them to enhance their income capabilities, such as charging clients.
(2) DeFi with the ability to decentralize
Decentralized front-end
Smart contracts are fixed and non-upgradable.
On-chain governance
Achieving the above points makes it difficult to be determined as a 'broker', so from this perspective, even if the regulation is implemented, the primary targets are those projects that are more reliant on centralized leadership. Although this type of project currently occupies the majority in the market, in the long run, it also promotes decentralization in DeFi, and the requirements for centralized entities entering this industry are becoming increasingly high.
4/4 · DeFi Export
First, the clarity of regulation and compliance for DeFi is only a matter of time. Of course, this clarity may have the advantage during Trump's presidency, and the market expects a more relaxed regulatory environment. Here, based on existing bills or drafts, we discuss an optimal solution for DeFi projects facing regulation and compliance—perfect export.
(1) Broker determination aspects
This aspect is the focus of this discussion, and the conclusion is either to turn this into a legitimate business, comply with IRS reporting requirements, and accept the designation of broker, or gradually decentralize the project.
(2) Token nature determination aspects
In the context of the ETH spot ETF application being approved, along with the previous content in the FIT-21 Century Financial Innovation and Technology Act, there is a basic basis for determining how to classify project tokens as securities or commodities.
Currently, the definition of ETH leans more towards functional use, with its staking and governance nature being more about maintaining network operation rather than economic returns, making it more likely to be defined as a commodity rather than a security.
From this perspective, for DeFi protocols, if the governance direction leans more towards obtaining economic returns or dividends, it is more likely to be defined as securities. If it tends towards functionality, technological upgrades, etc., it is more likely to be defined as commodities.
We still take Uniswap as an example. If you want to avoid being determined as a 'broker' while maximizing the likelihood of defining its tokens as commodities rather than securities, what perfect export should it pursue?
Removing the front-end and charging, trading relies on third-party front-ends or educating users to interact directly with the smart contracts.
Launching their own chain, gradually 'Ethereum-izing' the tokens, as a functional use and network maintenance, avoiding security designation.
Regardless of whether these regulations will be approved and advanced, DeFi will not be affected as long as it continues to progress towards decentralization. Of course, in this process, there are still some projects that require centralized entities to participate and lead, and currently, these make up the majority; they may need to face choices and balances, which is a necessity to adapt to the times. Decentralization is not achieved in a day.