U.S. SEC Out-of-Bounds in Dragging DeFi Into Proposed Exchange Rule, Industry Says

The U.S. Securities and Exchange Commission (SEC) wants to stretch how it identifies exchanges it needs to regulate, and the agency’s inbox is jammed with crypto industry letters accusing it of reaching well beyond its legal powers and potentially forcing rules on services the platforms need, such as electric companies.

The most recent re-write of the agency’s exchange proposal in April would explicitly absorb decentralized finance (DeFi) into the world of exchanges subject to SEC rules and oversight, arguing that an updated rule would help modernize the securities regulator’s approach to the changing markets. The SEC set a Tuesday deadline for public input.

But crypto industry advocates and lobbyists argue that the new rule – if finalized – would violate the First Amendment rights of coders and would double down on what they see as the SEC’s ongoing error of failing to treat this sector as something new.

“The proposal would operate as a blanket de facto banishment of DeFi from the United States,” the DeFi Education Fund, a lobbying group, wrote in its comment letter. “The actions and words of the commission and agency personnel have created great confusion.”

The agency’s proposal suggests that protocols designed to bring together buyers and sellers of securities – so-called communication protocol systems – now perform a similar enough role to exchanges that they should be regulated as such.

“Investors in the crypto markets must receive the same time-tested protections that the securities laws provide in all other markets,” said SEC Chair Gary Gensler, when the SEC voted to release the latest version of the proposed rule in April.

However, DeFi protocols “intuitively possess none of the defining hallmarks of stock exchanges,” according to the DeFi Education Fund’s letter. “Beyond DeFi, the commission’s proposal has no logical limit and would sweep third-party and utility service providers who contract with exchange providers into the exchange regulatory regime.”

That could pull key outside services into the SEC’s web, such as messaging services and the utility companies that provide electricity to platforms, the group argued.

Crypto investment firm Paradigm weighed in to defend decentralized exchanges (DEXs) that don’t have the centralized management the securities rules are accustomed to dealing with.

“It thus appears that after suing Coinbase for failing to do the impossible – registering as a securities exchange when it was incapable of doing so – the commission now intends to force DEXs into the same Hobson’s choice,” the company argued, invoking the recent SEC enforcement action that accused Coinbase (COIN) of running an illegal exchange. “The newfound definition of ‘exchange’ is so far-reaching that it would facially encompass entities that are plainly nothing like exchanges.”

And Coin Center, a research group that supports the cryptocurrency movement, warned of the proposal’s danger to those who write and publish software – including the potential that the government could go after coders who advocate for political positions.

“The vagueness and breadth of the proposed standard affords the SEC near unlimited discretion to pick and choose targets for enforcement,” the Coin Center letter contended. “The SEC could easily use the proposed vague standard to target certain publishers of open source software who advocate for the use of that software for certain political ends.”

Read More: SEC Lays Its Cards on the Table With Assertion That DeFi Falls Under Securities Rules