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US SEC looks to expand definition of securities exchange, will it end up regulating DeFi?

The proposed rules have been met with criticism as an SEC commissioner herself warned that its scope is too broad.

The US Securities and Exchange Commission (SEC) has proposed rules to extend Regulation ATS (Alternative Trading Systems) to include “systems that offer the use of non-firm trading interest and provide protocols to bring together buyers and sellers for trading any type of security”, according to a press release. It means that the agency is looking to expand the definition of a securities exchange to include decentralised exchanges.

The commission said that the proposal would “protect investors and enhance cybersecurity by bringing more various securities and treasuries under the regulatory umbrella.” The draft rules require entities to either register as exchanges or register as broker-dealers and comply with Regulation ATS.

What is a decentralised exchange? DEXs are peer-to-peer marketplaces where cryptocurrency traders make transactions directly without handing over management of their funds to an intermediary or custodian. These transactions are facilitated through the use of self-executing agreements written in code called smart contracts.

This is the first time that a major economy like the US has proposed to regulate decentralised exchanges and if enacted, the proposal is likely to threaten the ability of decentralised exchanges to comply with SEC regulations. It could also serve as a blueprint for other countries that are contemplating crypto regulations.

Why are the proposed rules being criticised?

Many in the crypto community suggest that the SEC’s definition moves 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.

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One of the reasons fuelling their fear is that decentralised exchanges have no way of complying with the current demands placed on securities exchanges by the SEC, so the new legislation would effectively kill decentralised exchanges operating within the United States.

Gabriel Shapiro, a DeFi expert and consultant, urged the SEC to “revise the proposal to make clear that it is not intended to, in effect, prohibit the creation and deployment of mere code for peer-to-peer token trading.

But the SEC commissioner Gary Gensler said it is really important for people in the crypto space who are operating, or planning to set up, any kind of trading venue to look at the proposal despite its daunting length. In the past, Gensler has asserted that many DeFi tokens fall under the category of securities, as per an article in Crypto Briefing. He has also stated that DeFi will need to operate under a public policy framework in order to have “any relevance five and 10 years from now.”

The SEC has invited people to provide their feedback on the proposal within 30 days.

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SEC commissioner Hester Peirce has submitted a dissent note against the proposal, in which she disagrees with the labelling of communication protocols as securities exchanges. She termed the scope of the SEC’s proposed rules as broad.

SEC’s scrutiny of DEXs

The SEC initiated action against DeFi protocols in September last year when it investigated Uniswap Labs, the company behind the biggest decentralised exchange— Uniswap. It was looking to gather more information on how investors use Uniswap, the report added.

The SEC has also eyed Terraform Labs co-founder Do Kwon in November after it served him two subpoenas. The SEC was investigating Mirror Protocol, a DeFi platform that allows users to mint synthetic assets on Terra.

The agency is trying to asecertain if the protocol violates laws such as selling unregistered securities. The subpoena asked Kwon to hand over documents and offer his testimony.

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Written By

I cover several beats such as crypto, telecom, and OTT at MediaNama. I will be loitering at my local theatre and consuming movies by the dozen when I am off work.

MediaNama’s mission is to help build a digital ecosystem which is open, fair, global and competitive.

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