SEC adopts rule to have stricter oversight over dealers, looping in crypto and DeFi 

The Securities and Exchange Commission voted to adopt rules that require market participants who have significant liquidity-providing roles to comply with federal securities laws, looping in cryptocurrency to the mix.

The SEC voted 3-2 to adopt that rulemaking in a meeting on Tuesday, which in its proposed 194-page form included one mention of crypto in a footnote. The 247-page rule adopted on Tuesday will apply to people transacting in crypto assets that meet the definition of securities or government securities, with the exception of having assets less than $50 million. The rules would affect decentralized finance, according to the adopted rule. 

"If a person’s trading activities in crypto asset securities, including products, structures and activities involved in the so-called DeFi market, meet the definition of 'as part of a regular business' as set forth in the final rules (i.e., the person engages in a regular pattern of buying and selling crypto asset securities that has the effect of providing liquidity to other market participants as stated in the qualitative standard), and no exception or exclusion applies, that person would be required to register as a dealer or government securities dealer," according to the rule.

The crypto industry pushed back on the rule in comment letters to the SEC after the rulemaking was first proposed in March 2022. Some commenters said the rule was unreasonable for DeFi products because they do not have a central controlling body and are just software. 

The DeFi Education Fund delved into the role of automated market makers in its comment letter, calling it an "execution protocol." Automated market makers, or AMMs, implement a liquidity pool of crypto and other digital assets and lock them in a smart contract that then facilitates trading, according to the fund. 

Industry response 

The DeFi Education Fund called the adopted rulemaking on Tuesday "misguided and unworkable." 

"While the SEC acknowledged receiving comments discussing DeFi, including our concerns, the SEC not only failed to confront the substance of our concerns but also failed altogether to articulate any discernible path to compliance for DeFi market participants," CEO Miller Whitehouse-Levine said in an emailed statement. "Imposing obligations on entities in the DeFi ecosystem that cannot be complied with is wrong, impractical, and hostile to innovation." 

 Cody Carbone, vice president of policy for the Chamber of Digital Commerce, called Tuesday's vote "another example of the SEC’s continued hostility towards the digital asset industry."

"We’re asking additional market participants to register as dealers, abandoning decades of precedent to apply impossible rules on digital asset market participants," Carbone said in a statement. "The SEC did not want the digital asset industry’s perspective on this rule, despite its impact, as the 200-page proposed rule only mentioned digital assets in a footnote." 

The crypto industry tried to address the SEC's concerns to update the definition of a dealer, said Marisa Coppel, the Blockchain Association's head of legal, in a statement. 

"Unfortunately, the final rule does little to engage constructively with industry concerns, cementing an unworkable rule that overturns an established framework in favor of an amorphous focus on whether a person acts as a 'de facto' market maker," Coppel said. "The revised 'dealer' definition imposes impossible requirements onto DeFi projects, provides no clarity to market participants, and could lead to withering innovation across the digital asset ecosystem.”

Pushback from Commissioner Peirce

Republican Commissioner Hester Peirce, who voted against the rule, pushed back against some aspects of the rule during Tuesday's meeting.

"The release doesn't spend a lot of time talking about crypto, but does explain that an automated market maker might have to register as a dealer under the final rules," Peirce said. "An AMM is, as I understand, is just a software protocol, so how does it register as a dealer?"

An SEC official, in response to Peirce, said an AMM is more than software.

After some back and forth, Peirce then asked how many people who are posting liquidity in AMM pools would be looped into the rule.

"This is a market that's not transparent or compliant, so we don't really have great data unfortunately," the SEC official said.

"I mean, I think one of the reasons they're not compliant is because they can't figure out what our rules are and they can't even figure out when we think that something is a security," Peirce said in response. 

SEC Chair Gary Gensler noted the $50 million exception cap, and said there is demand in both the crypto and non-crypto space. 

Earlier, in opening statements, Gensler said the rule as a whole is needed to protect investors and noted that markets have evolved to become faster with the advent of electronification and algorithmic trading. He said that firms are acting as "de facto market makers" and have not registered with the SEC as dealers, which would require them to report data and keep books and records. 

"These measures to me are just common sense," 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 anyone trades in a manner consistent with de facto market making, it must register as a dealer — that is consistent with Congress’s intent but is also sort of competitively makes it fair and level," Gensler added. 

The final rules will become effect 60 days after being published in the Federal Register. The compliance date will be one year after the effective date of the final rules. 

Updated at 1:15 p.m. on Feb. 7 to include comments