For the second time in a month, the Securities and Exchange Commission has the crypto industry up in arms about what it calls an attempt at backdoor regulation that, depending on who you ask, falls anywhere on the spectrum between opaque and unconstitutional.
At issue is an expansion of the definition of a stock exchange to fit what the SEC calls “communications protocol systems” that “bring together buyers and sellers of securities” — which many experts believe would include cryptocurrency exchanges, and specifically, decentralized exchanges (DEXs).
Digital assets are not mentioned anywhere in the bill — mirroring complaints made in late March about another rule change that would define the automated market maker (AMM) smart contracts that act as liquidity providers in decentralized finance (DeFi) projects like lending/borrowing platforms.
That rule, which would encompass even software developers to register as securities dealers, according to, Delphi Digital Labs’ general counsel Gabriel Shapiro, who called it “an all-out shadow attack on decentralized finance.” Digital assets were mentioned in one footnote in that 200-page rule.
As for the exchange-focused rule, Shapiro said in a Twitter chain Monday (April 18) that it was “more regulation-by-enforcement” that is “far from technology-neutral” and will ensnare even DeFi software developers.
The result, he said, will be “to entrench incumbents who have legacy centralized business models and amount to a de facto prohibition on the decentralized finance models that have arisen.”
Unfair and Unlawful?
In a series of tweets highlighting other crypto companies and lobbying organization comments, Blockchain Association Head of Policy Jake Chervinsky noted that his organization’s comments on the proposed rule said that it exceeds that SEC’s authority, is overly vague and is being unlawfully rushed through without enough time for public comment.
Among the other comments, the politest came from Ethereum developer ConsenSys, whose attorney, Bill McHughes, started out by saying that the firm believes the “over-broad language is inadvertent,” as blockchain is mentioned nowhere in the proposal. McHughes continued that the problem “can be easily remedied by making it clear in any final rule that blockchain systems are explicitly excluded.”
It strikes us as highly unlikely that @SECGov actually wants this rule to cover blockchain systems, because they are entirely unlike the centralized securities exchanges the Exchange Act was enacted to address. 3/21
— wchughes.eth 🦊 (@BillHughesDC) April 18, 2022
McHughes then said that in “the unlikely event that the broad language intentionally covers blockchain systems,” it violates both the SEC’s governing Exchange Act and the First Amendment.
Coinbase’s Chief Legal Officer, Paul Grewal, didn’t go the First Amendment route, but said “the SEC is going beyond its authority under the Exchange Act in redefining exchange. An exchange is a facility that performs the ‘functions of a stock exchange, as that term is generally understood.’”
And, Grewal added, the SEC should provide clearer guidance in the future about how the market should apply its rules.
Two Republicans on the House Financial Services Committee, ranking member Patrick McHenry of North Carolina and Bill Huizenga of Michigan, jumped on the bandwagon with an April 18 letter, criticizing both the expansiveness of the rule and the briefer-than-usual 30-day comment period, saying that 60 days is the standard.
“DeFi has the potential to reduce market participants’ reliance on intermediaries,” they said. “If these two rule makings are left unaddressed, they have the potential to stifle innovation and harm market participants.”
Tame the Wild West
The rule-making may or may not be an attempt to take control of crypto trading while a broader crypto regulatory proposal is being written under President Joe Biden’s recent executive order, which mandated a September proposal from all agencies.
However, it’s hard to argue that SEC Chairman Gary Gensler has been anything but forthright about the need to regulate crypto trading to protect the public, calling it the “Wild West” of finance on several occasions.
“I’ve asked staff to look at every way to get these platforms inside the investor protection remit,” Gensler said last September. “If the trading platforms don’t come into the regulated space, it’d be another year of the public being vulnerable.”
Beyond this, it’s also hard to argue that DeFi is doing a great job of overseeing itself. Just this year, several DeFi projects — admittedly not DEXs, although plenty of those have been hit — were hacked to the tune of more than $1 billion.