Why the DeFi Settlement Matters

The US Securities and Exchange Commission (SEC) charged Rari Capital, a decentralized finance (DeFi) protocol, and its executives, citing actions misleading investors and operating as unregistered brokers.

The Wednesday settlement includes various forms of relief, a capped ban, and a cease-and-desist order subject to court approval.

SEC Charges DeFi Protocol Rari Capital

According to the filing, the regulator’s charges against the now defunct DeFi protocol stem from its actions misleading investors and operating as unregistered brokers. It claims Rari launched earn pools and fuse pools, two investment products that operated as cryptocurrency investment funds, with investors generating returns. At their peak, the products handled upwards of $1 billion in crypto assets.

The SEC claims Rari deceived investors on earning pool returns, saying that they would automatically rebalance assets into the best yield opportunities. While this often required manual intervention, Rari Capital often failed to initiate. Further, they promoted high annual percentage yields (APY) intended to lure investors without disclosing certain fees. Resultantly, some earn pool investors lost money.

Read more: Top 11 DeFi Protocols To Keep an Eye on in 2024

The charges extend to its co-founders, Jai Bhavnani, Jack Lipstone, and David Lucid. The regulator alleges that the three executives engaged in unregistered broker activities. Rari Capital Infrastructure LLC, which took control of the platform in 2022, is also cited for unregistered securities offerings and broker activities.

“We allege that Rari Capital and its co-founders misled investors about both the features and profitability of certain of the crypto asset investments Rari Capital offered, and acted as unregistered brokers. We will not be deterred by someone labeling a product as decentralized’ and autonomous. Instead, we will look beyond the labels to the economic realities, as we did here, and hold the individuals behind crypto products and platforms accountable when they harm investors and violate the federal securities laws,” an excerpt in the official SEC press release read.

As the SEC and Rari Capital settle, terms include permanent injunctions, civil penalties, disgorgement with interest, and a five-year ban on the co-founders serving as officers or directors. Additionally, the SEC imposed a cease-and-desist order, which Rari agreed to but neither admitted nor denied the regulator’s findings. The settlements remain subject to court approval.

Rari Collapse and Implications of SEC Charges To DeFi

Following its launch in 2020 to offer automated yield farming, Rari Capital steadily ascended the ranks. The DeFi protocol achieved more than $1 billion in total value locked (TVL) by 2021,ascribed to its high-yielding liquidity pools.

However, the firm was plagued with challenges, which ultimately culminated in its collapse. In 2021, Rari was exploited for around $11 million following an integration issue with Alpha Finance.

In 2022, the firm suffered another massive exploit, this time losing upwards of $80 million from its Fuse pools with bad actors using a reentrancy bug. The effects of the reentrancy bug affected several other DeFi protocols, including Babylon Finance, which also shut down.

“Babylon Finance is shutting down. Despite our efforts, we haven’t been able to revert the negative momentum caused by the Rari hack. The market has not helped,” Babylon Finance founder Ramon Recuero said at the time.

The SEC’s action highlights the regulator’s ongoing efforts to regulate decentralized finance platforms. Some of these platforms’ operations indicate an inadvertent assumption that their decentralized nature places them outside traditional regulatory frameworks.

Read more: Crypto Regulation: What Are the Benefits and Drawbacks?

Therefore, this settlement’s implications are significant for the DeFi sector. They reflect broader themes in the regulatory environment, including investor protection, operational challenges, legal and compliance considerations, and regulatory scrutiny.