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SEC looks to modify exchange rules to include DeFi platforms

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(Kitco News) - The U.S. Securities and Exchange Commission (SEC) looks poised to tackle the world of decentralized finance (DeFi) as its next area of focus based on a press release announcing the reopening of the comment period for proposed amendments to the definition of “exchange” under Exchange Act Rule 3b-16.

The amendments were originally proposed in January 2022 and are designed to “better protect investors and enhance cybersecurity by bringing more Alternative Trading Systems (ATS) that trade Treasuries and other government securities under the regulatory umbrella.”

Included in the proposal was a plan to expand the definition of the word “exchange” in order to include a wider array of the trading activity that occurs in the U.S. The SEC claimed that certain entities engaging in trading activities were not regulated as exchanges, which created a “regulatory disparity.”

More specifically, the SEC reopened the comment period so that the agency could reiterate “the applicability of existing rules to platforms that trade crypto asset securities, including so-called ‘DeFi’ systems, and provide supplemental information and economic analysis for systems that would be included in the new, proposed exchange definition.”

If the proposal is ultimately approved, language that includes DeFi would be included in the widening definition of “exchange systems” that bring together buyers and sellers of securities. The proposed amendments would require these systems to register as national securities exchanges or as broker-dealers and comply with Regulation ATS.

According to a fact sheet released by the SEC, the agency received a large number of requests following the previous comment period seeking information “about the application of the existing rules and the application of the proposed amendments to systems that trade crypto asset securities and meet the proposed definition of exchange or trading systems that use distributed ledger or blockchain technology, including systems commenters characterize as decentralized finance or ‘DeFi.’”

The reopening of the comment period was meant to provide additional information regarding these trading systems for crypto asset securities.

“Today, the Commission is considering whether to issue a supplemental release to our January 2022 proposal requiring significant trading platforms—including in the Treasury markets—to come under important rules for the markets,” said SEC Chair Gary Gensler. “I believe this supplemental release would help address comments on the proposal from various market participants, particularly those in the crypto markets.”

Gensler said that the proposed amendments will help modernize the agency’s rule regarding the definition of an exchange and account for “the evolving nature and electronification of trading platforms.”

He went on to note that any venue that brings together buyers and sellers of securities through structured methods to negotiate a trade is required to comply with the rules for exchanges. “Make no mistake: many crypto trading platforms already come under the current definition of an exchange and thus have an existing duty to comply with the securities laws,” he said.

“As I’ve said numerous times, the vast majority of crypto tokens are securities,” Gensler added. “These platforms match orders of multiple buyers and sellers of crypto securities using established, non-discretionary methods. That’s the definition of an exchange – and today, most crypto trading platforms meet it. That’s the case regardless of whether they call themselves centralized or decentralized.”

SEC committee encourages 'aggressive enforcement' against crypto firms

The SEC boss said that many of these platforms are acting as if they have a choice to comply with U.S. laws. “They don’t,” he emphasized.

“Congress gave the Commission a mandate to protect investors, regardless of the labels or technology used,” he added. “Investors in the crypto markets must receive the same time-tested protections that the securities laws provide in all other markets. Calling yourself a crypto platform is not an excuse to ignore the securities laws. Calling yourself a DeFi platform is not an excuse to defy the securities laws.”

Gensler also noted that the proposed amendments would apply to communication protocols in the crypto market as these services provide structured methods to negotiate a trade and function like exchanges. “Requiring these exchange-like platforms to comply with our exchange-related rules would help protect investors,” he said.

It’s worth noting that the SEC isn't looking to actually define DeFi in the rule, but will instead evaluate each situation by how the activity is being handled, including whether there's an intermediary and exactly what service that intermediary is providing.

“I welcome additional public comment on all aspects of the proposal in light of the information in this supplemental release,” Gensler said. “I believe that, if adopted, the proposal would promote resiliency, access, and fairness in the markets.”

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