US SEC Poised to Move Against DeFi Oversight as It Reopens Proposed Regulations

The US Securities and Exchange Commission (SEC) may be coming for decentralized finance (DeFi) as it considers reopening a proposal from last year that would now explicitly target platforms for these crypto transactions as exchanges that need to be regulated.

The SEC proposed to expand the definition of the word “exchange” in January 2022 to capture a broader range of trading activity in the United States. At the time, the agency said in its proposed rulemaking that certain entities engaged in trading activity were not regulated as exchanges, creating a “regulatory disparity.”

The securities agency read last year’s comment letter from the crypto industry that called the original proposal a sweeping power grab that failed to provide enough clarity on its meaning to be legitimate. On Friday, the commission will vote on what constitutes a response to that criticism. If approved, the updated proposal would use more direct language that includes DeFi in the expanded definition of regulated exchanges, and it would detail its estimates of how much that change is expected to cost the industry.

The specific changes will be published after the meeting ends with a vote later today.

SEC Chairman Gary Gensler claims that most crypto platforms already operate as unregistered stock exchanges, with or without the latest adjustments 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 dealing in 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 securities laws,” he 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 changes and exactly how they would be applied to cryptoassets and DeFi.

The agency is not looking to actually define DeFi in the rule, according to SEC officials, but will evaluate each situation by how the activity is handled, including whether there is an intermediary and exactly what service that intermediary provides.

In the prepared remarks, Gensler reiterated his view that “the vast majority of crypto tokens are securities” and that crypto trading platforms already meet existing requirements for securities exchanges.

“These platforms match orders from multiple buyers and sellers of crypto-securities using established, non-discretionary methods,” he said. “That’s the definition of an exchange – and today most crypto trading platforms meet it. That’s the case whether they call themselves centralized or decentralized.”

The crypto industry has long advocated for U.S. rules that could provide certainty for how companies and activities must operate, although prominent crypto executives and their lobbyists have also said the SEC’s stance that they need to register and follow existing securities laws will not work for the industry . The SEC has largely opted against a tailored approach to the cryptocurrency sector that would recognize how it differs from the rest of the financial sector, with Gensler routinely arguing that longstanding securities laws are sufficient.

With each proposed rule, the SEC’s walls are closing in on crypto businesses that insist there is no path for them to regulated finance.

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

Even when the new exchange definition does not mention crypto explicitly, the industry opposed it with the assumption that it had digital assets in mind.

“The proposal fails to accommodate – let alone acknowledge – the fundamentally new ways individuals can perform 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 brokerage exchanges like the New York Stock Exchange to software or software developers.”

Rep. Patrick McHenry (RN.C.), the chairman of the House Financial Services Committee that oversees the SEC, wrote a letter to Gensler with another committee member saying the agency appeared to be trying “to expand the SEC’s jurisdiction beyond its existing statutory authority to 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 light of the unique architecture of digital asset markets, we suggest that the Commission would benefit most from a comprehensive concept paper focused on digital asset markets and how best to achieve its policy objectives in light of the unique architecture of such markets. “, suggested the company’s comment letter.

But some were excited last year about the possibility that crypto could be folded into this SEC scrutiny.

“The cryptocurrency industry is expanding rapidly with some industry lobbyists insisting that their offerings and platforms fall outside securities laws and regulations,” Better Markets, a Washington-based group that advocates for tougher protections in the financial system, wrote in a comment letter last year. “But it is clear that the Commission must apply securities regulation equally to all securities regardless of how new, ‘innovative’, popular or profitable such offerings may be.”

It has been a tough month for DeFi in US political circles, after the US Treasury also made it clear last week that DeFi services should be subject to anti-money laundering laws, saying the platforms have been used by criminals and for terrorist financing.