The US Securities and Exchange Commission (SEC) continues to roll out regulations that encompass the nuances of transactions in decentralized finance (DeFi), as the regulator on Tuesday adopted new rules that redefine the terms “dealer” and “government securities dealer” to include DeFi to include. market makers.
According to s Press release of the SEC, the two new rules “require market participants engaged in certain dealer roles, particularly those that assume significant liquidity-providing roles in the markets, to register with the SEC, become members of a self-regulatory organization (SRO), and comply to federal securities laws and regulatory obligations.”
“These measures are common sense,” SEC Chairman Gary Gensler said. “Congress did not intend for registration and regulatory requirements to apply to some dealers and not to others. Absent an exemption or exception, if someone is trading in a manner consistent with de facto market making, it must register with us as a trader—consistent with congressional intent.
The rules were first proposed in 2022 and received significant backlash from the crypto community, who say the rules lack clarity on the definition of crypto-securities. Another major bone of contention is the new definition of “dealer,” which could force liquidity providers controlling more than $50 million in capital to register as securities dealers.
SEC Commissioner Hester Pierce released an official statement in response to the rule change, saying she “cannot support the final rule” as it “defines trader in a way that is inconsistent with the statutory framework within which it sits and would distort market behavior and weaken market quality.”
“This rule turns dealers, many of whom are customers, into dealers,” she said. “To do so is contrary to the statute, as the Commission and market participants have read it for decades.”
She noted that the rule excludes individuals who buy or sell securities for their own account, “either individually or in a fiduciary capacity, but not as part of a regular business.”
“In addition to harming the market participants who find themselves being turned into traders, this rule harms the broader market,” Pierce said. “It penalizes liquidity provision, which means there will be less of it. The penalty comes from an expensive and inappropriate regulatory regime for liquidity-providing market participants.”
“The Commission is introducing this rule as part of an effort to protect competition, but the rule will drive competitors out of the markets,” she added. “By penalizing trading and investment strategies that have the effect of providing liquidity to the markets, the rule will dampen liquidity provision.”
Jake Chervinsky, Chief Legal Officer of Variant Fund, continued explore the implications of the new rules on X.
“The theory for regulating traders is that they are such a large and powerful part of the market that the SEC has to step in to protect their customers,” he said. “This may be valid for the bond markets of the 1930s. For DeFi, not at all. [Decentralized exchange liquidity providers] is nothing like traditional traders.”
Noting that the proposed dealer rule defines a dealer as any person who “engages in a regular pattern of buying and selling securities that has the effect of providing liquidity to other market participants,” he said, “It sounds like DEX MPs.”
“The proposed rule makes no legal sense: it is much broader than the definition of ‘dealer’ in the statute, which limits the SEC’s authority,” he said. “It also makes no policy sense: it destroys decades of precedent to arrest people who cannot and should not register as traders.”
But all is not lost, according to Chervinsky, as “even though [the new dealer rule] take effect [in 2025], it will not give the SEC jurisdiction over DeFi. The SEC’s claim to authority over DeFi traders relies on the assumption that digital assets are securities. That core issue is the subject of litigation across the country, and mostly the SEC is losing.”
In a rare case of agreement, even Bitcoin and crypto critic Peter Schiff have sided with the crypto community in their pushback against perceived overreach by the SEC.
How can the #SEC, a government agency, on its own change the definition of a “securities dealer” so that it can regulate something that is not actually a securities dealer, without any law being passed to authorize such regulation? We are a nation of laws, not bureaucrats.
— Peter Schiff (@PeterSchiff) February 6, 2024
Chervinsky further elaborated on the matter, saying, “The SEC and CFTC are in a turf war over who regulates crypto. The problem is neither of them has the legal authority to do so. The CFTC mostly accepts reality. The SEC try to rewrite the law.”
“The SEC is trying to rewrite the law in two ways: regulation through enforcement, trying to get courts to write judicial opinions that give the SEC more authority; and rulemaking, to try to grab more authority for himself by writing new powers directly into the regulations,” he said.
But they faced three main problems, he added. “The law, which simply does not give it the authority it claims; the courts, which tend to restrain the administrative state; and the crypto industry, which is willing to fight with everything we have until we win or die.”
“Meanwhile, there are some smart people in Congress working hard on new legislation that could actually make sense for crypto,” Chervinsky said. “But given the level of dysfunction and partisanship in DC, plus the fact that it’s an election year, it’s unlikely anything will get done in 2024.”
“So once again the action is in the courts,” he concluded. “Wins by Ripple and Grayscale in 2023 validated the strength of arguments that crypto-lawyers have been making for years (and which the SEC has rejected). They also showed that federal judges are perfectly happy to go against the SEC. In my view, the heart of the battle is SEC v. Coinbase. Coinbase filed a motion last August arguing that digital assets are not securities and explaining how the SEC is misapplying the Howey test and should lose the case. A win there would be massive.”
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