DeFi on the Verge of SEC Oversight: Proposed Regulations Reopened in the U.S.

"SEC's Proposed Regulation Expansion Targets Decentralized Finance Platforms as Exchanges"

The U.S. Securities and Exchange Commission (SEC) is considering reopening a proposal from last year that would explicitly target decentralized finance (DeFi) platforms for crypto transactions as exchanges that need to be regulated. The SEC proposed expanding the definition of the word “exchange” in January 2022 to capture a broader swath of trading activity in the U.S. The agency said in its proposed rulemaking that certain entities engaging in trading activity were not regulated as exchanges, creating a “regulatory disparity.”

Last year, the SEC received comment letters from the crypto industry calling the initial proposal an overreaching power grab that failed to provide enough clarity about its meaning to be legitimate. The commission is going to vote Friday on what amounts to a response to that criticism. If approved, the updated proposal would use more direct language that includes DeFi in the widening definition of regulated exchanges. The specific changes will be published after the meeting ends with a vote later today.

SEC Chair Gary Gensler contends that most crypto platforms are already operating as unregistered securities exchanges, with or without the latest tweaks to the definition of what it means to be an exchange. But he and the commission are poised to “reiterate the applicability of existing rules to platforms that trade crypto asset securities, including so-called ‘DeFi’ systems,” according to an SEC fact sheet outlining the changes.

“Calling yourself a DeFi platform is not an excuse to defy the securities laws,” Gensler said in remarks prepared ahead of the meeting. SEC officials, speaking to reporters ahead of Friday’s meeting, said the reopening and additional information came after a number of market participants asked for more information about the proposed amendments and how exactly they would be applied to crypto assets and DeFi. The agency isn’t looking to actually define DeFi in the rule, according to SEC officials, but will evaluate each situation by how the activity is being handled, including whether there’s an intermediary and exactly what service that intermediary is providing.

The crypto industry has long advocated for U.S. rules that can bring certainty to how the companies and activities need to operate, though prominent crypto executives and their lobbyists have also said that the SEC’s position that they need to register and follow existing securities laws won’t work for this industry. The SEC has broadly chosen against a tailored approach to the cryptocurrency sector that would acknowledge how it differs from the rest of finance, with Gensler routinely arguing that longstanding securities laws are sufficient.

The SEC had pushed this exchange-definition rule and other proposals last year that – without detailing its intentions with crypto specifically – had suggested that the agency meant to formalize its reach into the digital assets sector. Later, the agency became more explicit about having its eyes on digital assets, when it issued another proposal in February that could bar investment advisers from keeping assets at crypto firms.

The agency received almost 400 comment letters on this week’s revisited proposal and disclosed 35 staff meetings and calls with Wall Street lobbyists, industry self-regulatory organizations, the Bank of England and others regarding the effort. A reopened comment period would give crypto lawyers and lobbyists another 30 days to argue against the rule before the agency will review those responses and decide whether to approve a final rule.

Some in the crypto industry oppose the SEC’s move. “The proposal fails to adapt to – let alone acknowledge – the fundamentally new ways in which individuals can conduct asset exchanges using DeFi protocols,” the Blockchain Association and the DeFi Education Fund argued in a 2022 letter to the SEC. “Instead, it would improperly apply regulations designed for intermediating exchanges like the New York Stock Exchange to software or software developers.”

Rep. Patrick McHenry (R-N.C.), the chairman of the House Financial Services Committee that oversees the SEC, wrote a letter to Gensler with another committee member that said the agency seemed to be trying “to expand the SEC’s jurisdiction beyond its existing statutory authority to regulate market participants in the digital asset ecosystem, including in decentralized finance”

Circle Internet Financial sought the chance to ask for more specific rules for crypto. “In view of the unique architecture of digital asset markets, we suggest that the commission would benefit the most from a wide-ranging concept release focused on digital assets markets and how best to achieve its policy goals in light of the unique architecture of such markets,” the company’s comment letter suggested.

Better Markets, a Washington-based group advocating for tougher protections in the financial system, wrote in a comment letter last year that the cryptocurrency industry is rapidly expanding, and some industry lobbyists insist that their offerings and platforms fall outside the securities laws and regulations, but clearly, the commission must apply securities regulation equally to all securities regardless of how novel, ‘innovative,’ popular, or profitable such offerings may be.

It’s been a tough month for DeFi in U.S. policy circles, after the U.S. Treasury Department also made clear last week that DeFi services should be regulated.

Martin Reid

Martin Reid

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