The Securities and Exchange Commission has opened a new front in its campaign against crypto. In its latest gambit, the agency is targeting the entire domestic decentralized finance industry by proposing a fundamental change to how it defines an exchange. If successful, the SEC could drive one of the most innovative sectors of financeas The Economist highlighted with its 2021 DeFi coverfrom American shores.
The new legal fight over exchanges is similar to the dispute over which crypto entities should be considered brokers, a saga that united much of the industry in opposition in the summer of 2021.
Specifically, the SECs latest proposed rulemaking seeks to amend existing rules regarding Alternative Trading Systems, or ATSs, to broaden the definition of a securities exchange to bring in many digital asset industry participants that havent been included. The new definition would include a group of persons who make available communication protocol systems that allow people to express interest in potentially trading a security.
This raises the obvious question of what a communication protocol system is in the first place. But the proposed rule never defines the ambiguous term, and instead contends that a group of persons can exist whenever people act in concertthrough even an informal agreementeven if none of them individually, or as a group, exercise any control over an exchanges functions or facilities. This comically broad interpretation means that even an unassociated collection of individuals with no actual participation in an exchanges core functions could be subject to securities regulation for operating an exchange.
This contorted definition of exchange would fundamentally alter the traditional understanding of how we conceive of one. Its akin to expanding the definition of a baseball team from the group of people directly associated with itthe players, possibly the manager, the coaches, and front office staffto one in which the teams fans and even third-party sportscasters who perform certain function[s] associated with putting on a game become part of the team. Its doubtful that anyone would consider a ticket scalper in the parking lot part of the team, but in the SECs new view, its possible depending on the facts and circumstances. Its easy to imagine other examples of how this language could become stretched to absurd degrees. Does a power company that supplies electricity to servers powering a communication protocol system count as a partner in the exchange? And so on.
The SECs exchange initiative is the agencys latest, and most egregious, attempt to expand its regulatory power beyond the authority granted by Congress. For example, there is no law on the books right now that classifies digital assets as securities, and it therefore remains an open question as to whether the agency has the authority to regulate digital assets. This rulemaking proposal does a convenient end-run around this question, establishing a new interpretation of an exchange that gives the agency broad new leeway to regulate a wide array of industry participants, far beyond the statutory limits established by the Exchange Act. Indeed, Republicans from the House Financial Services Committee filed their own letter to push the SEC to withdraw the proposal because of concerns about regulatory overreach.
You can make the case that its best to take SEC Chair Gary Gensler at his word and give the commission the benefit of the doubt that its pursuing this rulemaking to reflectchangessince Congress put in place the definition of an exchange. However, given that the agencys proposal comes after a history of enforcement actions and very little forward-looking guidance provided to the digital asset industry, Gensler doesnt deserve the benefit of the doubt.
While there has been a lot of attention paid to the SECs recent enforcement actions, its important that the agencys crypto rulemaking effortsincluding its push to expand the agencys powersnot fly under the radar. Congress must monitor Genslers efforts closely and hold him accountable if theyre not based in law and commonsense.
By attempting to broaden the SECs regulatory authority and open a new front in his ongoing war against crypto, Gensler exposes the agency to increased Congressional scrutinyexactly the opportunity for crypto advocates to make their strongest case. The exchange definition may seem niche and technical, but the anti-tech impulse and regulatory overreach behind the proposal should concern every Americanregardless of how they feel about crypto.
Amanda Tuminelli is chief legal officer for the Defi Education Fund, where she leads the organizations impact litigation and policy efforts. The opinions expressed in Fortune.com commentary pieces are solely the views of their authors and do not necessarily reflect the opinions and beliefs of Fortune.
