Polygon decries ‘back-end way’ to regulate smart contracts in EU legislation

The European Union’s Data Act represents an existential threat to permissionless blockchains that uphold networks like Ethereum, Rebecca Rettig, chief policy officer at Polygon Labs, told DL News.

And time is running out to forestall an onerous situation.

Rettig’s comments underscore the burgeoning push by the industry to prevent a potential ban of smart contracts, the lifeblood of decentralised finance and the Ethereum ecosystem.

Seven days left

With seven days left before policymakers plan to agree on the 900-page draft bill, tension is mounting. Up until now, the EU had become an attractive alternative to the US thanks to the clarity of MiCA, a sweeping new regulatory regime for crypto in the 27-nation bloc.

The crypto industry is alarmed the data bill may move to the next stage of approval if changes aren’t made.

“This almost feels like a back-end way to regulate those or not allow any smart contract-based systems to be fully decentralised,” Rettig said, adding that this is probably not an intentional move.

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There is one article of the Data Act in particular — Article 30 — that has long drawn the ire of the crypto industry. It would require smart contracts used for data sharing to have a built-in feature to halt or interrupt transactions.

‘This almost feels like a back end way to regulate those or not allow any smart contract-based systems to be fully decentralised.’

—  Rebecca Rettig

“If you put restrictions for a termination provision on all smart contracts, you basically require some point of centralisation and you eliminate the permissionless, autonomous, automatic nature of smart contracts,” said Rettig, a lawyer and former chief legal and policy officer at Aave.

Article 30 is meant to cover data shared between smart devices, which is sometimes called the internet of things. The scope is not clearly defined, however, opening the door for smart contract regulation.

Popular blockchain

The provision is intended to cover software, and “is not limited to data coming from [Internet of Things] objects,” a European Commission spokesperson said.

This is not the first time Polygon Labs has opposed the Data Act. The blockchain developer raised its concerns in a letter to EU policymakers in April.

Polygon, one of the most popular blockchain networks in crypto, holds $886 million in investor deposits on-chain and has 338,000 active users, according to DeFiLlama. Its token, MATIC, has a market cap of $5.6 billion.

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In June, Polygon joined Binance, Coinbase and Kraken to raise concerns in another letter urging legislators to keep blockchains — or at least permissionless blockchains — out of the regulation.

Rettig said she wanted to avoid permissionless systems being banned “at all costs in the EU and everywhere else in the world,” saying that the technology holds unfulfilled promise.

“It’s extremely operationally resilient in a way that other technology is not, and it’s also still in its infancy,” she said.

‘I do think there is a push, especially in the EU, for finding someone to hold responsible in these permissionless systems.’

—  Rebecca Rettig

Policymakers are currently racing to wrap up talks on the Data Act on June 27, before the European Council’s rotating presidency will switch from Sweden to Spain. Any delay could postpone the bill from coming into effect.

Senior diplomats from EU member states will meet to approve any technical issues discussed in a meeting with experts in the coming week. After the final inter-institutional meeting at the end of June, the text is unlikely to see significant changes.

Should not be problematic

The European Commission, which first put out the legislation in February 2022, doesn’t see the big deal.

The requirements of Article 30 “should not be problematic for the vendors of smart contracts software,” a spokesperson told DL News, adding that there is “no reason to fear existing smart contracts would become illegal upon the entry into force of the Data Act.”

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The final stretch of Data Act negotiations comes after the EU’s Markets in Crypto-Assets became law last month. The MiCA framework regulates stablecoin issuance, establishes standards for consumer protection and harmonises licensing across the 27-nation bloc, but leaves the supervision of decentralised protocols out of the scope.

Faster pace

MiCA took many years to put together and went through many iterations, which resulted in a clear way to build the industry in the EU, Rettig noted. Other bills which can impact crypto, like the Data Act or the Anti-Money Laundering Regulation, are whizzed through at a faster pace.

For Rettig, the potential spillover from the Data Act into blockchains is “antithetical” to the provisions in MiCA.

She hopes the the eventual legislation “will not detract from the benefits that MiCA has brought to the EU in terms of both attracting talent, business and investment,” Rettig said.

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While MiCA was designed to enable businesses to grow, the Data Act’s limits on smart contracts are “disabling”, according to an EU source close to the matter but not directly involved in negotiations.

If negotiations conclude successfully, the Data Act will be reviewed by legal experts over the summer period and could be adopted with a final vote by September.

If passed into law, smart contracts would need to have the possibility to be switched off, and protocols where transactions are guaranteed may not be able to exist, the EU source said.

Blockchain overlooked?

Policymakers involved in the Data Act negotiations aren’t concerned with blockchain, according to the EU source.

Smart contracts are only a sliver in the scope of the legislation, and blockchains are not explicitly mentioned. That means the technology is far from the forefront of policymakers involved.

There are advantages to reining in smart contracts, as regulators and businesses managing data look for ways to prevent protocols from spinning out of control.

Elusive responsibility

The discussions under the Data Act are indicative of a global policy trend when it comes to DeFi, Rettig said, as regulators attempt to clarify who is responsible if something goes wrong.

While centralised platforms have an entity controlling the product, fully decentralised protocols are not owned by anyone, making the question of responsibility elusive.

“I do think there is a push, especially in the EU, for finding someone to hold responsible in these permissionless systems,” Rettig said.

Have a tip on EU crypto regulation? Contact the author at inbar@dlnews.com.