Apr. 17, 2023
April 17, 2023 Altering the definition of 'exchange' in the proposed way is a bad idea because trying to bring new technology within the existing framework will not be effective and could be a detriment to US investors. Why ineffective? Because as the technology has evolved, we've discovered that just about ANYONE can create an exchange by forking some pretty simple code. Creating an exchange will, in short time, be one of the homework assignments in a smart-contract programming course in every major university. There could be as many exchanges as there are people in the United States, if those people so choose. Your banker could be your programmer neighbor who develops and updates an exchange for her neighbors with a volume in the hundreds or low thousands. While you could indeed make such homework \"illegal\" (in some sense), declaring things to be \"illegal\" doesn't stop the behavior, it only sends that behavior underground. Investors will use whatever exchange serves their interest, regardless of whether it's approved by regulators or not. In short, you cannot stop people from actually creating and deploying code. And the creation of such code can be done anywhere on earth, such as the middle o f the Pacific Ocean, putting it beyond the reach of US regulators much like how riverboat gambling came about. The time-tested regulations you're trying to bring crypto under simply cannot work. While in traditional brick-and-mortar finance you could send enforcement officers into a building to physically shut down exchanges, you cannot do this with DeFi exchanges. American citizens will find a way to use those non-compliant exchanges if they want to, just as they find a way to pirate music, software, movies, and to acquire drugs and other contraband. The existing regulatory framework requires that centralized actors are in control of markets and exchanges when the markets and exchanges are in control of themselves -- when there is no one PERSON or small group in control -- there is no one except innocent users of the platform (the people who you are trying to protect) to be punished by the regulatory framework you hope to impose, with its emphasis on enforcement action. That is to say, shutting down a DeFi exchange, if even possible, does nothing but force its users to go to a different, perhaps riskier, DeFi exchange. In sum, expanding the definition of 'exchange' to include DeFi protocols will be ineffective because it will not prevent the development of DeFi protocols and it will not prevent US citizens from engaging in DeFi activities. It will only annoy investors and innovators, encouraging non-compliance: the opposite of what the intended alterations to the definition of 'exchange' are for. Why a detriment to US investors? There are several reasons. The first and simplest reason stems from the ineffectiveness of the definitional change argued above. Attempting to impose enforcement actions on non-compliant DeFi protocols simply encourages developers and DAO participants of those protocols to use technology to anonymize themselves, which increases risks to retail investors by making it more difficult for investors to tell the difference between good developers and malicious developers. In this way, the SEC will INCREASE risks to retail investors by changing the definition of 'exchange' to cover DeFi protocols: when the DAO and developers are anonymized, the SEC can only threaten and harm the holders of the DAO tokens who are otherwise honest hardworking citizens in search of new value sources. Another reason the definitional change is a detriment to US investors is because the existing \"time-tested\" regulations you're trying to apply to decentralized cryptocurrency exc hanges are based on assumptions that, in some cases, don't apply to those exchanges. Which DeFi platform is capable of producing a 10Q, for example? Few, if any. But this isn't a problem for investors. Traditionally, PEOPLE are what needed regulating because of the risk of centralized bad actors: incompetence, laziness, and fraud. Those risks are somewhat (but not entirely) mitigated via decentralization which, at the same time, makes the need for 10Qs and other filings unnecessary. And entirely new risks (like exploitable/hackable code) can fly under the existing compliance radar. Entirely new regulations are needed to mitigate the new risks, and to recognize that some of the traditional risks have become negligible with advances in technology. In short, unless a new regulatory scheme is laid out, investors are harmed by needless OVERregulation of certain products and services and are potentially harmed by new risks to which the existing regulatory framework is blind. Lastly, as a regular joe who has been using both traditional markets and DeFi crypto markets for a few years, my experience with DeFi is much better than with traditional markets. To deprive me access to crypto markets, as they are now, harms my income generating potential. There are entirely new ways of creating value that were not possible before crypto-technology came into being. OVERregulation risks snuffing out such value-creation, and hence, your regulatory proposals impose a new risk to investors rather than new protections. In sum, the proposed change to the definition of 'exchange' is a detriment to investors for three reasons: it prompts anonymization, increasing risks to investors by making it more difficult to tell the difference between an honest project and a dishonest project it involves outdated assumptions which misidentify, and are blind to, many of the risks inherent in the new technology and it risks snuffing out new paths to value-creation, thereby harming the prosperity to US residents, including US investors, entrepreneurs and job-seekers. What WOULD be effective regulatory approach to decentralized markets and exchanges? In my view, the SEC cannot demand that any US citizen who wants to develop and engage with crypto (which, in 30 years, might be nearly every US citizen) come in and register upon pain of threats of excruciating legal problems. Instead, it would be more effective for the SEC to INCENTIVIZE developers and crypto users to register with the SEC with the promise of added benefits from registration: access to insurance, access to traditional sources of capital (e.g., if a DeFi exchange wants a good working relationship with the FED, then they have to register), help with security audits, tax breaks, getting a good consumer report/rating that enhances the marketability and popularity (and hence profitability) of an exchange, etc. That would make the SEC an agency that securities-based businesses want to impress rather than being an agency that such businesses want to avoid or hide from. DeFi, in my view, is best left as the wild west until a more appropriate regulatory regime can be devised by congress and crypto economic experts, which will take several years I expect. For now, the SEC must focus their efforts on fighting actual fraud, not mere non-compliance. Thank you for your time.