Recently, the Securities and Exchange Commission reopened the public comment period on its proposal to widen the definition of “exchange,” indicating that it intends to include DeFi exchanges. Circle reacted on June 13th, 2023, and encouraged the SEC not to finalize the plan owing to its broad, potential negative effects for the entire crypto asset market and investors.
Circle favors sensible and controlled DeFi regulation. They recently backed regulations that would make it simpler for authorized financial institutions to employ DeFi, as well as extra safeguards for DeFi consumers. In this situation, however, Circle asks the SEC to study the challenges raised by DeFi further and warns against over-applying standard financial rules to this novel market.
Circle’s Key Points
Critical questions concerning how DeFi should be regulated have not been adequately investigated by the SEC.
The SEC seems to have forgotten that DeFi exchanges would be subject to all of its other regulations. Among other things, the SEC has not addressed the following issues:
- Would becoming custodial be necessary to register a DeFi exchange as an alternative trading system (ATS) due to broker-dealers’ obligations under the Customer Protection Rule?
- Who, according to the SEC, will register a decentralized exchange if service providers do not or cannot coordinate?
- The SEC will regulate immutable protocols in what way?
DeFi is an innovative, user-beneficial technology that does not exist in the traditional financial industry. These include the capacity to self-custody assets and the ability to disaggregate financial service supply. Circle believes that if the SEC is going to regulate DeFi, it must carefully study these benefits to guarantee that they are protected in any new regulatory system.
The economic study by the SEC is inadequate.
The economic costs and advantages of their regulations must be taken into account by regulatory authorities. To the best of an agency’s capacity, this analysis aids in the foundation of empirical evidence-based rulemaking and ensures the fairness of the rulemaking process. However, Circle believes that the SEC has not fully examined the pertinent economic issues in this proposal. For instance, the SEC claims it is difficult to produce any estimate of the entire trading volume on cryptocurrency exchanges despite the abundance of market data. While Circle acknowledges that confounding variables like wash trade volume may exist, they don’t believe this is a significant enough obstacle to justify withholding any estimate at all.
The SEC additionally claims that the regulation wouldn’t significantly affect the economy of a sizable number of small businesses, a claim that would result in the imposition of additional SEC obligations. Given the number of startups that are anticipated to be affected by this regulation, Circle thinks that this is inappropriate.
The SEC’s proposed definition of ‘exchange’ needs to be disregarded. The final regulation, assuming this happens, ought to eliminate any uncertainty that could impair US markets and economic competitiveness.
Independent software developers should be explicitly excluded by the SEC from the concept of a “group of persons” capable of running an exchange. Even though the proposal suggests that the SEC “may be less likely” to view such developers as falling under its purview, the SEC should make it clear that it would not make an effort to imprison open-source developers. Software developers will only have the clarity they need to keep providing free code for the common good with a precise declaration of intent.
Circle asks the SEC to clarify that the provision of pair trading is not specifically prohibited by law. Pairs trading, which is the practice of pricing agreements for one crypto asset in other crypto assets such as BTC or USDC, is widespread in the market for crypto assets due to their growing utility and investor demand. Any DeFi exchange without access to other payment channels must also have it. It is unknown what, if any, law prohibits the activity, but according to the SEC, stock exchanges do not currently provide deals priced in or paid for using non-US currency instruments. Contrarily, Dodd-Frank developed a unified regulatory framework for situations like these. The SEC’s recommendation suggests that the practice ought to end but doesn’t explain why.
DeFi is a brand-new concept, but technological regulation is not.
Ironically, the SEC’s new regulation anticipates DeFi exchanges registering as ATSs under a 1998 statute developed in response to the financial markets’ effect of the internet. The SEC then collaborated with Congress and business for nearly five years to study markets and develop a new regulatory framework that would, as it put it in 1998, “better integrate these systems into our national market system structure, and make the benefits of these systems available to more investors.” Circle thinks that the SEC and Congress should follow a similar process right now.
You can read the full comment letter here.
