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The U.S. Securities and Exchange Commission (SEC) is aiming to expand its approach in identifying exchanges that fall under its regulatory oversight. However, the agency has been inundated with letters from the crypto industry, alleging that the SEC is overstepping its legal authority and potentially imposing regulations on essential services for these platforms, such as electric companies.
In the latest revision of its exchange proposal in April, the agency has explicitly included decentralized finance (DeFi) within the scope of exchanges subject to SEC regulations and oversight. The argument put forth is that updating the rule would enable the securities regulator to modernize its approach in response to evolving markets. The SEC has set a deadline of Tuesday for public feedback on this matter.
However, proponents and lobbyists in the crypto industry contend that if the new rule is ultimately implemented, it would infringe upon the First Amendment rights of developers and exacerbate what they perceive as the SEC's persistent mistake of not recognizing this sector as an innovative domain.
“The proposal would operate as a blanket de facto banishment of DeFi from the United States,” the DeFi Education Fund, a lobbying group, wrote in its comment letter. “The actions and words of the commission and agency personnel have created great confusion.”
The proposal put forth by the agency suggests that communication protocol systems, which are designed to facilitate the interaction between buyers and sellers of securities, now fulfill a role similar enough to that of exchanges, warranting their regulation under the same framework.
“Investors in the crypto markets must receive the same time-tested protections that the securities laws provide in all other markets,” said SEC Chair Gary Gensler, when the SEC voted to release the latest version of the proposed rule in April.
However, DeFi protocols “intuitively possess none of the defining hallmarks of stock exchanges,” according to the DeFi Education Fund’s letter. “Beyond DeFi, the commission’s proposal has no logical limit and would sweep third-party and utility service providers who contract with exchange providers into the exchange regulatory regime.”
The group argued for the integration of essential external services, such as messaging platforms and utility companies responsible for supplying electricity to the SEC's web.
Crypto investment firm Paradigm has stepped forward to support decentralized exchanges (DEXs) that lack centralized management, a departure from the traditional securities rules they are accustomed to dealing with.
“It thus appears that after suing Coinbase for failing to do the impossible – registering as a securities exchange when it was incapable of doing so – the commission now intends to force DEXs into the same Hobson’s choice,” the company argued, invoking the recent SEC enforcement action that accused Coinbase (COIN) of running an illegal exchange. “The newfound definition of ‘exchange’ is so far-reaching that it would facially encompass entities that are plainly nothing like exchanges.”
Coin Center, a research group advocating for the cryptocurrency movement, raised concerns about the potential risks posed by the proposal, particularly in relation to software developers and their freedom of expression. The group warned of the possibility that the government may target coders who advocate for political positions.
“The vagueness and breadth of the proposed standard affords the SEC near unlimited discretion to pick and choose targets for enforcement,” the Coin Center letter contended. “The SEC could easily use the proposed vague standard to target certain publishers of open source software who advocate for the use of that software for certain political ends.”
