The U.S. Securities and Exchange Commission (SEC) continues to roll out regulations that incorporate the nuances of transacting in decentralized finance (DeFi) as the regulator adopted new rules on Tuesday that redefine the terms “dealer” and “government securities dealer” to include DeFi market makers.
According to a press release from the SEC, the two new rules “require market participants who engage in certain dealer roles, in particular those who take on significant liquidity-providing roles in the markets, to register with the SEC, become members of a self-regulatory organization (SRO), and comply with federal securities laws and regulatory obligations.”
“These measures are common sense,” said SEC Chair Gary Gensler. “Congress did not intend for registration and regulatory requirements to apply to some dealers and not to others. Absent an exemption or exception, if anyone trades in a manner consistent with de facto market making, it must register with us as a dealer – consistent with Congress’s intent.”
The rules were first proposed in 2022 and have received significant pushback from the crypto community, who say the rules lack clarity on the definition of crypto securities. Another major point of contention is the new definition of ‘dealer’, which could force liquidity providers that control 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 dealer in a way that is inconsistent with the statutory framework within which it sits and will distort market behavior and degrade market quality.”
“This rule turns traders, many of whom are customers, into dealers,” she said. “Doing so runs counter 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 transformed into dealers, this rule harms the broader market,” Pierce said. “It penalizes liquidity provision, which means there will be less of it. The penalty comes from a costly and ill-fitting regulatory regime for liquidity-providing market participants.”
“The Commission casts 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 investing 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, further explored the implications of the new rules on X.
“The theory for regulating dealers is that they're such a big and powerful part of the market, the SEC should step in to protect their customers,” he said. “That may be valid for the securities markets of the 1930s. For DeFi, not at all. [Decentralized exchange liquidity providers] are nothing like traditional dealers.”
He noted 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,” and said, “That sounds like DEX LPs.”
“The proposed rule makes no legal sense: it's much broader than the definition of ‘dealer’ in the statute, which sets a limit on the SEC's authority,” he said. “It also makes no policy sense: it overturns decades of precedent to capture people who can't and shouldn't register as dealers.”
But all is not lost, according to Chervinsky, as “even if [the new dealer rule] takes effect [in 2025], it won’t give the SEC jurisdiction over DeFi. The SEC's claim of authority over DeFi dealers relies on the premise 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 instance of agreement, even Bitcoin and crypto critic Peter Schiff sided with the crypto community in their pushback against the perceived overreach by the SEC.
How can the #SEC, a government agency, on its own change the definition of a "security dealer," so that it can regulate something that is not actually a security dealer, without any law having been passed to authorize such regulation? We are a nation of laws, not bureaucrats.
— Peter Schiff (@PeterSchiff) February 6, 2024
Breaking the matter down further, Chervinsky said, “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 it. The CFTC mostly accepts reality. The SEC is trying to rewrite the law.”
“The SEC is trying to rewrite the law in two ways: regulating by enforcement, trying to get courts to write judicial opinions that give the SEC more authority; and rulemaking, trying to seize more authority for itself by writing new powers directly into the regulations,” he said.
But they’ve run into three main problems, he added. “The law, which simply doesn't give it the authority it claims; the courts, which lean toward restraining the administrative state; and the crypto industry, which is prepared 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 actually could make sense for crypto,” Chervinsky said. “But considering the degree of dysfunction and partisanship in DC, plus the fact that it's an election year, it's unlikely anything gets done in 2024.”
“So once again, the action is in the courts,” he concluded. “Victories by Ripple and Grayscale in 2023 validated the strength of arguments that crypto lawyers have made for years (and that the SEC had 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 mis-applies the Howey test and must lose the case. A victory there would be massive.”