SEC DeFi Rule May Force Liquidity Providers to Register Threatening Decentralization
Gary Gensler praised the SEC's new dealer rule. | Credit: Tom Williams/CQ-Roll Call, Inc via Getty Images.
Key Takeaways
- SEC expands “dealer” definition, bringing more crypto activities under its regulatory thumb.
- The regulator rejects the exemption for DeFi, sparking concerns and legal challenges from the industry.
- New rules pose registration and compliance challenges, potentially hampering DeFi operations.
The U.S. Securities and Exchange Commission (SEC) recently expanded its definition of a dealer , extending its regulatory reach to encompass a broader range of financial activities.
This expansion notably includes operations dealing in crypto securities, as highlighted in a footnote of the original proposal, signaling the SEC’s intent to bring such activities under its oversight.
SEC Expands Definition of “Dealer,” No Exception for Crypto Assets
The SEC clarified that its commission does not exempt any specific category of securities from the purview of the final rules, including those related to crypto assets. It added that the framework for dealers is centered around a functional analysis that focuses on the securities trading activities conducted by an individual or entity, rather than the specific type of security being traded.
The dealer regulation is part of various regulatory initiatives related to cryptocurrencies that have been under consideration by the SEC and other bodies, such as the Internal Revenue Service. Although it received less public scrutiny compared to IRS tax initiatives and SEC proposals concerning the broadening of the exchange definition and limitations on crypto custody, this regulation could have significant impacts on the digital asset industry, especially within the area of decentralized finance (DeFi).
According to the SEC’s Chair Gary Gensler:
“Absent an exemption or exception, if anyone trades in a manner consistent with de facto market making, it must register with us as a dealer – consistent with Congress’s intent.”
Each Case Judged Individually, Technology No Safe Harbor
The agency highlighted feedback from some commentators suggesting that the proposed rules should not apply to what is referred to as decentralized finance (DeFi). However, it emphasized that determining whether a dealer is involved in any specific transaction or arrangement, regardless of its association with DeFi, requires an analysis based on the facts and circumstances of each case.
The agency stated that the use of any particular technology, including protocols based on distributed ledger technology that utilize smart contracts, does not exempt crypto asset securities activities from being considered within the scope of dealer activities.
SEC Citing Competitive Concerns
The SEC deliberated on a potential exemption for cryptocurrency-related activities from its expanded dealer definition but ultimately decided against it, citing concerns over “negative competitive effects” that such a carve-out could create by providing crypto firms with an unfair advantage over registered entities.
This decision is part of a broader regulatory effort set to take full effect in April of next year, initially aimed at electronic participants in the U.S. Treasuries market.
However, the new requirements demand that any entity falling under the widened definition must register with the SEC, adhere to securities laws, and become a member of an industry-supported self-regulatory organization. This poses a significant challenge to the crypto industry, particularly DeFi operations, which have frequently argued that meeting SEC registration and compliance requirements could be unfeasible.
Commissioners Cry Foul, Industry Calls Rule “Unworkable”
SEC Commissioners Mark Uyeda and Hester Peirce expressed their opposition to the rule on Tuesday. Uyeda criticized the Commission’s broad approach, highlighting that according to their definition, anyone engaged in the purchase and sale of securities as part of their regular business activities could be classified as a ‘dealer.’ He emphasized that this expansive interpretation could lead to further regulatory ambiguity across various markets, notably including those involving crypto asset securities.
Peirce added :
“Not surprisingly, the rule reflects little thought regarding its practical application in the crypto markets.”
The DeFi Education Fund , representing interests within the cryptocurrency sector, was among the groups that voiced opposition to the SEC’s initial proposal. Following the release of the final version on Tuesday, the organization criticized it as “misguided and unworkable.”
According to the statement :
“The SEC not only failed to confront the substance of our concerns but also failed altogether to articulate any discernible path to compliance for DeFi market participants. Imposing obligations on entities in the DeFi ecosystem that cannot be complied with is wrong, impractical, and hostile to innovation.”
The cryptocurrency industry is engaged in legal disputes with the regulator in federal courts, challenging the SEC’s authority by questioning which cryptocurrencies fall under the definition of a security. The resolution of this contentious issue could significantly influence the ongoing debate regarding which entities should be considered dealers according to the latest regulatory requirements.
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