Core idea: Understand the circumstances under which DeFi will be considered a “broker,” explore the underlying logic and survival space in decentralized systems and regulatory attitudes, and find the perfect exit strategy.

• Expanded definition of a broker: Regulations suggest that DeFi transactions share many similarities with securities trading processes. DeFi brokers need to submit information reports to the IRS, assist clients in accurate tax reporting, and ensure compliance (KYC, anti-money laundering, etc.).
• Determining DeFi brokers: Providing services that facilitate transactions and having the ability to access client information.
• Impact on DeFi: Choosing to accept broker recognition or decentralize the project. The higher the level of decentralization, the lower the likelihood of being recognized as a broker.
• Future perfect exit for DeFi: Decentralized front-end, non-upgradable contracts, on-chain autonomy, and token functionality to build its own network.

Research Report

1/4 · Background and reasons

The regulation, initiated by the U.S. Department of Treasury and the IRS, addresses the challenges posed by the lack of information transparency in digital asset trading due to decentralization and anonymity, which creates significant obstacles for tax regulation. The regulation highlights the similarities between the operational processes of the securities industry and the DeFi industry:

Trade orders -> Trade matching and execution -> Trade settlement

In the securities industry, brokers send client trade orders to trading centers (such as the New York Stock Exchange or NASDAQ), and these platforms are responsible for matching buy and sell orders. In the DeFi industry, the regulation identifies a similar “broker” role, where brokers are required to submit information reports to the IRS, assist clients in accurate tax reporting, and ensure compliance (KYC, anti-money laundering, etc.).

Therefore, the focus of the discussion is on under what conditions certain roles in DeFi would be recognized as “brokers.” Regardless of whether the regulation is approved or how it is implemented, our primary analytical goal is to explore the underlying logic and survival space within decentralization and regulatory attitudes.

2/4 · Expanding the Definition of “Broker”

Traditionally, the definition of a “broker” has been limited to transaction agents or intermediaries who directly hold client assets in the securities industry. The main content of this regulation is to expand this definition to apply to the digital asset space. The new regulation requires brokers to submit forms to the IRS, reporting detailed client transaction information, including profits and trade details, with the aim of improving tax compliance, which implies potential tax obligations.

The regulatory inclination here is that, although the passage of the ETH ETF led to an initial distinction between “securities” and “commodities,” with qualifying digital assets more likely to be classified as commodities, and not directly as securities, the “broker” expansion proposed by this regulation still aims to establish an information reporting mechanism similar to that of securities trading. Thus, it ultimately returns to the issue of how to define DeFi protocols and assets.

The regulation expands the definition of a “broker,” clearly including the following types of participants:

• Digital asset intermediaries: Individuals or entities providing services to complete digital asset transactions for clients, including exchanges, custodial wallet service providers, etc.
• DeFi platform participants: Including non-custodial platforms that do not hold client private keys but provide transaction services through protocols or smart contracts.

The key point here is the term “intermediary.” There’s no major controversy over entities such as exchanges or custodial wallet providers that offer services to clients. The debate arises over how to define the “intermediary role” within DeFi activities. In summary, there are two key factors 🚩:

1. Providing services that facilitate transactions
2. Having the ability to access client information

Keep these two judgment factors in mind as we further break down the roles within a DeFi project:

• Front-end service providers: Offer users a user-friendly interface, enabling them to easily interact or trade.
• Protocol operators: Provide the core protocols or smart contracts that execute transactions (e.g., Uniswap, Curve, etc., as AMMs).
• Validators or settlement agents: Responsible for recording transactions on the distributed ledger (blockchain).

The regulation particularly focuses on front-end service providers and protocol operators because their services directly “facilitate” the completion of transactions. For validators or settlement agents, if a participant only provides verification services for the distributed ledger (e.g., blockchain nodes or miners) and does not directly participate in or facilitate transactions, they will not be considered brokers. So, we will only discuss points 1 and 2.

The entire analysis will use Uniswap as an example, as it is the only case where each scenario is somewhat represented.

1. This is mostly undisputed. Front-end service providers undoubtedly fall into the “intermediary” role of brokers, especially with the current front-end fee model used by Uniswap, which strengthens the likelihood of being recognized as a broker.

2. Protocol operators are more controversial because, strictly speaking, non-upgradable smart contracts are not controlled by any individual or entity. They have characteristics of being permissionless and immutable. The question is whether the project team/developers providing such smart contracts would be classified as brokers.

Returning to the two key judgment factors: providing services that facilitate transactions + having the ability to access client information.

Taking Uniswap as an example, the front-end services are provided and maintained by the project team, and they undoubtedly provide services that facilitate transactions. Additionally, they charge for these services and have the ability to record and access user information (e.g., adding KYC or transaction terms on the front end).

Now, assuming a situation where the Uniswap team completely withdraws from providing any services, theoretically, users could still complete transactions by directly accessing the AMM smart contract deployed by Uniswap. This is because once a smart contract is deployed, it will always exist on the blockchain. In this case, the AMM would become a decentralized tool. In a decentralized environment, the project team cannot access user information, thus not satisfying the second judgment factor. While the AMM contract deployed by Uniswap allows users to trade, the team no longer has the “active” ability to facilitate transactions or access user information. Therefore, the regulation may not be able to find an applicable broker in this case.

The conclusion is that the more decentralized the project is, the lower the likelihood of being recognized as a broker.

Summary: Key characteristics of decentralized projects:

• Self-executing smart contracts: Core transaction functions are implemented through smart contracts deployed on the blockchain. The contracts are immutable, and anyone can interact with them without permission.
• No centralized management: If the project team withdraws (e.g., by stopping the maintenance of the front-end interface), the smart contract can still operate and does not depend on any centralized entity.
• Front-end service independence: Even if the official front-end (e.g., Uniswap’s official website) goes offline, third-party developers can build their own front-end to interact with the smart contract.
• Inability to control client information: Since on-chain interactions are fully trustless, the project team generally cannot access clients’ identity information or transaction data.

3/4 · Impact on DeFi

In the early days of DeFi, most projects aimed to eventually achieve decentralization, turning the project over to community governance and operating fully on-chain. However, over time, it became clear that achieving this ideal was not as simple as imagined. Many projects gradually faded from the market after the project team stepped away, mainly due to the following reasons:

• The project team left behind unresolved issues, effectively soft rug-pulling under the guise of decentralization.
• The overall market lacked sufficient understanding and needed centralized guidance and promotion.
• The project itself was not problematic, but it was immature, and the community lacked the capacity for self-governance and driving the project forward.

(1) DeFi projects that need centralized participation

In this cycle, many ceDeFi projects began to rise. Since pure DeFi projects currently cannot achieve the goal of “decentralized finance,” it may be better to directly involve relatively professional and compliant centralized entities and strategies. In such cases, these centralized entities are highly likely to be recognized as “brokers.” If the regulation is approved and implemented, these projects may

• Require users to provide KYC.
• Open up front-end or service fees under the burden of compliance.

At the same time, this means that “brokers” can legally and reasonably carry out their activities, but the cost is the compliance burden, which requires increasing their revenue capacity, such as charging customers.

(2) DeFi with the ability to decentralize

• Decentralized front-end
• Non-upgradable, fixed smart contracts
• On-chain autonomy

Achieving these three points makes it difficult to be classified as a “broker.” So from this perspective, even if the regulation is implemented, it mainly targets projects that are more reliant on centralized leadership. While these projects make up the majority of the current market, they will also drive decentralization in the long term, raising the standards for centralized entities entering this industry.

4/4 · DeFi Exit

First, clear regulation and compliance for DeFi is only a matter of time. Of course, this clarity may have an advantage during Trump’s term, with the market expecting a more relaxed regulatory approach. Here, we discuss the optimal solution and perfect exit for a DeFi project in the face of regulation and compliance, based on existing bills or drafts.

(1) Broker determination

This is the focus of this discussion. The conclusion is that the project should either be formalized into a legitimate business, comply with IRS reporting requirements, and accept the designation as a broker, or gradually decentralize the project.

(2) Token nature determination

With the approval of the ETH spot ETF application, along with content from the previous FIT-21st Century Financial Innovation and Technology Act, a basic framework has emerged for determining whether project tokens are classified as securities or commodities.

Currently, ETH is more likely to be defined as a commodity due to its functional use. Its staking and governance properties serve to maintain network operation rather than providing economic returns, making it more likely to be classified as a commodity rather than a security.

From this perspective, for DeFi protocols, if governance leans toward economic returns or dividends, it is more likely to be classified as a security. If it focuses more on functionality, technical upgrades, and other aspects, it is more likely to be classified as a commodity.

Let’s take Uniswap as an example. If it aims to avoid being classified as a “broker” and maximize the chances of its token being defined as a commodity rather than a security, what would be the perfect exit?

1. Remove the front-end and charges, relying on third-party front ends for trading or educating users to interact directly with the smart contract.
2. Launch its own chain, gradually “Ethereumizing” its token, positioning it as a functional use for network maintenance, thereby avoiding a securities designation.

Regardless of whether these regulations are approved and implemented, DeFi, if it continues to move toward the goal of decentralization, will not be affected. Of course, some projects that still require centralized entities for participation and leadership exist and are currently the majority. These projects may need to make choices and balance, which is a necessary adaptation to the times. Decentralization is not achieved overnight.

Disclaimer:

1. This article is reprinted from [cmDeFi Research]. All copyrights belong to the original author [Chen Mo cmDeFi]. If there are objections to this reprint, please contact the Gate Learn team, and they will handle it promptly.
2. Liability Disclaimer: The views and opinions expressed in this article are solely those of the author and do not constitute any investment advice.
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