Oct. 18, 2023
The proposed rule to expand the definition of "exchange" to include certain decentralized finance (DeFi) systems does little to benefit investors and subjects the government to expensive legal and constitutional challenges. Lack of benefit to investors The proposed rule claims to benefit investors by protecting them from fraud and market manipulation. However, the proposed rule is unlikely to achieve these goals. First, the proposed rule is too broad and would capture a wide range of platforms that do not pose the same risks to investors as centralized exchanges. For example, the proposed rule would capture decentralized exchanges (DEXs) and peer-to-peer (P2P) trading platforms. DEXs and P2P platforms are non-custodial, meaning that users do not deposit their funds with the platform. This makes DEXs and P2P platforms less risky than centralized exchanges, which hold customer funds in custody. Second, the proposed rule does not address the unique risks posed by crypto asset securities. Crypto asset securities are often highly volatile and speculative, and they may be illiquid, meaning that it can be difficult to buy or sell them. The proposed rule does not provide any additional protections for investors in crypto asset securities, such as requirements for disclosure or market manipulation prevention. Third, the proposed rule is not enforceable against decentralized exchanges. DEXs are not controlled by a single entity, and they are often operated on a global scale. This makes it difficult for regulators to enforce any rules against DEXs. The proposed rule is also likely to face expensive legal and constitutional challenges. One of the main legal challenges to the proposed rule is that it is too broad and vague. The proposed rule does not clearly define what constitutes a "decentralized finance system." This vagueness could lead to arbitrary enforcement and could discourage innovation. Another legal challenge to the proposed rule is that it may violate the First Amendment. The First Amendment protects the right to free speech, and this includes the right to express oneself through code. The proposed rule could be seen as a restriction on this right, as it could discourage developers from creating new DeFi systems. The proposed rule is also likely to face constitutional challenges. The Tenth Amendment to the Constitution reserves all powers not expressly delegated to the federal government to the states. The proposed rule could be seen as an overreach of federal power, as it would give the Securities and Exchange Commission (SEC) the authority to regulate DeFi systems that are not operated by centralized entities. In conclusion, the proposed rule to expand the definition of "exchange" to include certain DeFi systems is likely to do little to benefit investors and subjects the government to expensive legal and constitutional challenges. The proposed rule is too broad and vague, and it does not address the unique risks posed by crypto asset securities. Additionally, the proposed rule is not enforceable against decentralized exchanges and may violate the First and Tenth Amendments to the Constitution.