Crypto community concerned over impact of infrastructure bill on DeFi

Members of the crypto community have been up in arms recently about the $1 trillion infrastructure bill that the United States House of Representatives was expected to vote on this week. The legislation includes a crypto-tax reporting provision, along with the establishment of a definition for the term “broker.” 

House lawmakers stated that a vote for the infrastructure bill would take place on Thursday, Sept. 30, yet Congresswoman Nancy Pelosi announced on Sept. 29 that the infrastructure bill vote would be delayed beyond Thursday. Media sources have since noted that the infrastructure bill could be voted on during Friday, Oct. 1.

While the looming implications of the infrastructure bill may seem obvious, some members of the crypto community voiced specific concerns regarding the legislation during an “ask me anything” panel hosted by the Enterprise Ethereum Alliance on Sept. 29.

Ryan Selkis, chief executive officer and co-founder of Messari — a crypto asset data and research company — believes that the infrastructure bill aims to designate anyone participating in DeFi platforms as brokers: “This includes stakers, validators, software developers and more. The language here is technically unworkable.”

Jeremy Sklaroff, general counsel of Edge & Node — the team that works across The Graph ecosystem on decentralization and governance initiatives — added that although the language in the infrastructure bill is likely to pass, it unfairly demonstrates a broad way of defining participants within a blockchain ecosystem:

“Network validators and miners provide a service and oftentimes earn a transaction fee for their work. If this bill passes, the validors and miners would essentially be acting as brokers. Even more worrisome for me though are software developers. If a team maintains smart contracts for a DeFi platform and earns a fee or has incentive with a governance token, then this team likely becomes a broker.”

According to Sklaroff, network validators, miners, software developers and other members of a decentralized ecosystem should not be considered traditional brokers since these are anonymous participants. As such, Sklaroff believes that compliance for this section of the infrastructure bill would be virtually impossible.

In addition to defining who qualifies as a broker, Sklaroff pointed out that the infrastructure bill’s reference to anti-money laundering (AML) and know-your-customer (KYC) could also be detrimental for DeFi protocols. Specifically speaking, the bill mandates that a broker would be required to report KYC for any digital-asset transaction over the amount of $10,000.

Although the new legislation aims to put emphasis on a broker’s KYC and tax information reporting systems, Sklaroff explained that those who fail to comply could be faced with penalties or even time in jail. In turn, Selkis commented that the infrastructure bill would likely shut down DeFi innovation in the U.S. “The bill would modify IRC Section 6050I giving KYC and AML a broad range for peer-to-peer transactions. Recipients of $10,000 or more in digital assets would need to report this information to the IRS, otherwise potentially face felony [charges].”

To Sklaroff’s point, Selkis added that regulators seem to be more concerned with DeFi protocols rather than with Bitcoin (BTC) and nonfungible tokens, or NFTs:

“Bitcoin and NFTs are in a relatively safe position. The infrastructure bill really focuses on financial instruments built using smart contract platforms that are trying to reengineer traditional banking and lending.”

Infrastructure bill attacks every level of crypto industry

While DeFi protocols may be the hardest hit by the infrastructure bill, Sklaroff remarked that the proposed legislation attacks every industry within the crypto ecosystem.

For example, the proposed language in the bill could define miners as brokers. If this is the case, the bill would require mining companies to provide information to the IRS, such as taxable net gain or less, the identity of buyers and sellers, transaction amounts, the location of transactions and more. Yet miners would have no way of collecting this data since they only validate the blocks and not the information inside of them. As a result, miners would not be able to comply with the law and would therefore have to cease operations in the U.S.

This is particularly concerning to Sklaroff as he mentioned that the U.S. generally attempts to set the regulatory tone for the rest of the world: “If we aren’t successful in clarifying the language in this bill, I wouldn’t be surprised if other nations adopt something similar.”

Related: The infrastructure bill is hanging in the balance. What would its enactment mean for crypto?

On a lighter note, John Whelan, chair of the Enterprise Ethereum Alliance, told Cointelegraph that institutions adopting DeFi measures ensure that KYC and AML are accounted for, which could help advance the DeFi ecosystem even if the infrastructure bill passes: “All the pain goes away with AML and KYC from an institutional standpoint. Once you know who you’re interacting with and understand that there is no possibility of funds going where they’re not supposed to go is what banks do anyway.”

Selkis further told Cointelegraph that more institutions becoming interested in DeFi can indeed be a positive development for the broader ecosystem, but only if these systems are interoperable:

“We’re starting to see more institutional interest in DeFi, and I think that can be a net positive for the development of the broader ecosystem, but it only works if these systems are interoperable and the policy framework doesn’t strip away the ability to do peer to peer experimentation. […] A common sense regulatory framework would be ensuring that you have centralized intermediaries continue to be regulated the way they already are.”

Although this may be, Sklaroff told Cointelegraph that a key question when talking about the infrastructure bill then becomes whether or not a DeFi project is truly decentralized:

“If the IRS is looking to enforce certain requirements, one must be able to point to an identifiable person, company, or group of people that they can say, ‘Okay, you as this identifiable group violated this part of the tax code, and then here’s your fines.’”

Yet Sklaroff remarked that if a DeFi project is truly decentralized, then there is no entity to look to for enforcement or to expect compliance from: “That’s really where all of these regulatory questions are headed right now.”

Long-term impacts of the infrastructure bill

While the fallout from the infrastructure bill is yet to be determined, Sklaroff noted that if the U.S. continues to push unworkable legislation, then the country will ultimately miss out on an important next wave of innovation: “Other countries will be there to pick up the slack and they may not share the same values as the U.S. does around democracy, human rights and more.”

While the negative implications of the infrastructure bill are apparent, Selkis added that a good long-term effect is the fact that the crypto community is now focused on developing committees for policymaking and discussions to help educate regulators on how the industry works: “The only good long-term effect is that the U.S. crypto community is developing antibodies and actually organizing for policy-making discussions.”

Although this is a step in the right direction, Sklaroff commented that the infrastructure bill demonstrates that the crypto industry must continue to ramp up its efforts to educate policymakers:

“They need to know the difference between proof-of-stake and proof-of-work. This is a fundamental part of the industry and how people do things. This technical education will help policymakers see how absurd these poorly drafted bills are, while also allowing them to learn how these technologies can help make their jobs better.”