New SEC Proposal Could Be a Disaster for DeFi Exchanges

A new proposal from the U.S. Securities and Exchange Commission is looking to expand the organization’s definition of a securities exchange. In doing so, the SEC may be looking to lay the groundwork for regulating decentralized crypto exchanges. 

SEC Proposal Threatens DeFi

The SEC’s attack on DeFi continues. 

In a new proposal published Thursday, the SEC is looking to expand its definition of a securities exchange. The proposal aims to move the SEC’s definition away from systems that match securities orders using a traditional order book to any system allowing buyers and sellers to communicate their securities trading interest.

In addition to broadening the definition of a securities exchange, the proposal also asserts that the new definition will overrule previous SEC no-action letters and guidance, assuring certain kinds of systems are not securities exchanges. 

Under this new definition, decentralized exchanges such as Uniswap would be subject to SEC regulations and would therefore need to register with the SEC as a securities broker. As decentralized exchanges have no way of complying with the current demands placed on securities exchanges by the SEC, the new legislation would effectively kill decentralized exchanges operating within the United States.

DeFi enthusiast Gabriel Shapiro highlighted the potential devastating effects of the proposal in a blog post, noting that “because the proposal achieves this expansion by providing new restraints on ‘communication protocols,’ I believe it may also be unconstitutional as a restraint on free speech,” taking a strong stance against the proposed changes. He also suggested that under the new definition, the SEC could class block explorers, such as Etherscan, as securities exchanges because they allow users to interact with smart contracts to communicate trading interests.

Shapiro is not the only prominent figure to come out against the SEC’s proposed legislation. In her dissenting statement on the proposal, SEC Commissioner Hester Peirce has echoed Shapiro’s concerns over labeling communication protocols as securities exchanges. Along with criticizing the broad scope of the SEC’s proposed changes, she also details that the 650-page document goes well beyond the SEC’s scope of government and fixed-income securities.

Peirce also pointed out that the Commission has only given the public 30 days to read, understand, and consider the proposal. She commented that it would be “unconscionably reckless” to limit discussion to one month for a decision that will likely affect the $22 trillion Treasury market in new and unforeseeable ways.

Over the past several months, the SEC has moved against DeFi protocols in an attempt to bring them under its purview. In September last year, the SEC was rumored to be investigating Uniswap Labs, the company behind the biggest decentralized exchange, Uniswap. 

More recently, the SEC served Terraform Labs co-founder Do Kwon two subpoenas when he attended the Messari Mainnet conference held in New York last October. In Kwon’s case, The SEC appears to be concerned about Mirror Protocol, a DeFi platform that allows users to mint synthetic assets on Terra.

SEC chair Gary Gensler has frequently stated that he believes the SEC should be regulating DeFi protocols and exchanges. Gensler has asserted that many DeFi tokens likely fall under the category of securities, while also stating that DeFi will need to operate under a public policy framework in order have “any relevance five and 10 years from now.”

As regulatory scrutiny from U.S. government agencies increases, those defending the growing DeFi sector will need to pull out all the stops to ensure sweeping proposals from organizations like the SEC don’t crush crypto innovation in the U.S. 

Disclosure: At the time of writing this feature, the author owned ETH, LUNA and several other cryptocurrencies.