The Securities and Exchange Commission (SEC) is making a “shadow attack” that is designed to kill decentralized finance, according to several prominent attorneys in the cryptocurrency industry.
At issue are couple of paragraphs in a 200-page proposed rule change affecting the definition of a regulated securities dealer.
It would require the smart contract-controlled automated market makers (AMM) — which decentralized exchanges use as liquidity providers (LP) in place of the large banks, financial institutions and principal trading firms that traditional markets use — to register with the SEC as dealers.
Those that do not will be marked as unregistered dealers — a felony.
The “SEC will argue that all AMM LPs are unregistered dealers,” tweeted Gabriel Shapiro, general counsel of Delphi Digital Labs, on Monday (March 28). “It’s an all-out shadow attack on decentralized finance.”
it’s an all-out shadow attack on decentralized finance https://t.co/MSfwDYftgU
— _gabrielShapir0 (@lex_node) March 28, 2022
The problem is that AMMs are not funded by wealthy institutions, but by liquidity pools made up of individual investors who lock cryptocurrency into a decentralized exchange’s AMM protocol in exchange for fees — meaning that thousands of individual liquidity providers would have to register, he said.
Read more: PYMNTS DeFi Series: What is Yield Farming and Liquidity Mining?
“Can you imagine FINRA processing 10,000 dealer applications from individual DeFi liquidity providers,” Shapiro asked, referring to the Financial Industry Regulatory Authority.
He added that the change “would be like saying all Bitcoin miners are [virtual asset service providers] — if enforced, it would kill the tech” — referring to the rule change defining Bitcoin miners as virtual asset service providers like crypto exchanges and Bitcoin ATMs, which are required to collect personal identifying data from all clients.
That sparked last year’s uproar, when the $1 trillion infrastructure bill’s definition of brokers caused 99 senators to vote (unsuccessfully) to fix it.
See also: Crypto’s Influence Shows as Treasury Promises Protection for Miners, Stakers
All The Same
While the SEC didn’t respond to a request for comment, there’s a basic logic to the action.
Specifically, that AMMs are liquidity providers, and all liquidity providers should be treated the same, which means registering with FINRA.
The rule change explains that while “all market participants who buy or sell securities in the marketplace arguably contribute to a market’s liquidity,” the proposed rule change focuses on market participants for whom “liquidity provision is not incidental to their trading activities. Rather, these persons are “in the business” of buying and selling securities for their own account and providing liquidity as part of a regular business.”
Related reading: Gensler: SEC Is Coming for Crypto Exchanges
This has been a hallmark of the SEC’s approach to cryptocurrency in general: equal treatment for providers of products or services using new technology to reach investors.
Sneaking It Through
Besides the actual impact on the functioning of decentralized finance’s (DeFI) cryptocurrency and derivatives exchanges, Jake Chervinsky, head of policy for the Blockchain Association, accused the SEC of trying to sneak the rule through as part of larger, non-cryptocurrency-related measure.
The SEC’s proposal “would expand the definition of regulated ‘dealers’ to include people who ‘employ passive market making strategies’ that have ‘the effect of providing liquidity’ to others,” Chervinsky tweeted yesterday. “It’s 200 pages but doesn’t say ‘DeFi’ even once.”
The SEC just proposed a rule that would expand the definition of regulated “dealers” to include people who “employ passive market making strategies” that have “the effect of providing liquidity” to others.
It’s 200 pages but doesn’t say “DeFi” even once. https://t.co/nB9TVQrZ7R
— Jake Chervinsky (@jchervinsky) March 28, 2022
The SEC did not respond to a request for comment.
“Unfortunately, the SEC continues to introduce massive confusion & uncertainty into the very same markets it seeks to regulate,” Chervinsky said. “In a healthy rulemaking process, we wouldn’t have to guess at the SEC’s intent or its underlying goals.”
This rule proposal is, he added “far from a healthy rulemaking process.”
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