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Peer-to-Pool-to-Peer Business Models

DeFi platforms that pool client assets (Aave, Compound) create a securities product under the Howey Test and require SEC registration. SmartCredit.io's peer-to-peer model avoids this classification.

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Key Takeaways

  • Most DeFi lending platforms (Aave, Compound) use a peer-to-pool-to-peer model: client assets are pooled and yield is offered on the pool.
  • Pooling assets automatically classifies the investment product as a security under the Howey Test - it creates a "common enterprise."
  • Two regulatory licenses are required for pooled models: a license to offer a security product and a license to operate as an investment company.
  • Enforcement has materialized: Celsius, BlockFi, and Genesis filed for bankruptcy; Nexo exited the U.S. market; Coinbase Lend was shut down before launch - all over unregistered pooled lending.
  • Custodial status is irrelevant: non-custodial pooled platforms face the same securities obligations as custodial ones.

Most DeFi lending platforms pool client assets and offer yield on these assets. These are peer-to-pool-to-peer business models. For example, Aave and Compound do this. Their model can be visualized as this:

Peer-to-pool-to-peer business model

Although this sounds common sense, this approach automatically classifies the investment product as a security.

This is because:

  • by pooling retail investors’ assets, and
  • by offering a return on these assets to retail investors

one is creating security, which needs to be registered by the SEC (Securities Exchange Commission) if there is at least one user from the U.S. And not only this, the provider of this product-be it a DAO or a limited company-will need to register as an investment company (sometimes called an investment fund manager)

This means two regulatory licenses are required:

  • A license to offer a security product
  • A license to become an investment company

Securities regulations are a complicated process. The securities offering prospectus must be prepared, audits are required, quarterly reporting is required, and so on. It’s a costly and time-consuming process, very often with unclear outcomes.

More details about the regulatory analysis in DeFi are available in the SmartCredit.io blog article "DeFi Liquidity Pooling Regulatory Risks and Alternatives".

In June 2020 SmartCredit.io published an extensive analysis of the custodial lending platforms, with a focus on regulatory licenses. Custodial platforms require even more licenses because of digital asset custody. Those reviews now serve as historical context — both companies' situations have changed significantly:

SmartCredit.io's forecasts materialized in 2022-2023. The following companies received Cease and Desist orders or collapsed entirely due to their unregistered lending businesses in the U.S.:

  • Celsius — filed for bankruptcy (2022)
  • BlockFi — filed for bankruptcy (2022)
  • Genesis — filed for bankruptcy (2023)
  • Nexo — exited the U.S. market (2022)
  • Coinbase Lend — shut down before launch
  • Gemini Earn — wound down following Genesis collapse

Conclusion: it does not matter if the platform is custodial or non-custodial. Asset pooling, in both cases, requires regulatory licenses — and enforcement has proven that regulators will act.

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