Will the Expanded Definition of a Broker-Dealer Stifle the DeFi Industry?

highlighting its intention to regulate the industry rather than completely stifle it. The concern arises from the lack of clarity in the rule-making process and the potential impact it may have on the decentralized finance (DeFi) industry.

The recently passed rule by the U.S. Securities and Exchange Commission (SEC) expands the definition of a broker-dealer, requiring more firms that work with securities to register as dealers and submit to stricter oversight. The rule was initially proposed by the U.S. Treasury Department to address liquidity issues in the Treasury bond market caused by the rise of electronic trading.

Traditionally, there has been a distinction between investors who make directional trades and dealers who provide liquidity by buying both sides of the market. The old definition of a broker included companies engaged in buying and selling securities as part of a regular business, with market making being a key aspect. The new rule expands this definition to include institutions that make a significant amount of money capturing bid-ask spreads, such as quant funds and high-frequency traders.

According to Reuters, only a limited number of firms are expected to come into compliance with the new rule, as they trade enough in both directions through automated trading software to be considered dealers. However, the rule has raised concerns within the crypto industry.

One major concern is that the rule will apply to institutions that regularly trade cryptocurrencies, as the SEC currently considers most cryptocurrencies and tokens to be securities. This could potentially impact decentralized protocols like Uniswap and other automated market makers (AMMs), which may fit the expanded definition of a broker without an explicit exemption.

Crypto advocates, including the Blockchain Association and DeFi Education Fund, have raised jurisdictional concerns about the SEC’s ability to oversee crypto in a similar manner to centralized exchanges like Coinbase and Binance. These concerns are similar to the ongoing legal challenges faced by Coinbase and Binance, which argue that the SEC’s regulatory actions should require explicit congressional approval.

The SEC’s announcement specifically mentions crypto and highlights the so-called DeFi organizations that requested exemption when the expanded definition was first proposed. Two SEC Commissioners, Hester Peirce and Mark Uyeda, rejected the decision partly due to the regulatory spillover and confusion it may cause for the crypto industry. They also expressed concerns about the blurring of the distinction between regular investors and brokers in traditional markets.

During discussions, Commissioner Peirce questioned how AMMs and automated software could be expected to register with the SEC. The response from SEC Director of the Trading and Markets Division, Haoxiang Zhu, indicated that the decision would depend on the specific facts and circumstances.

While the explicit mention of crypto in the SEC’s communications raises alarm, it is important to note that the rule itself was not intended to harm the industry. The inclusion of crypto in the rule may simply indicate the SEC’s intention to regulate the industry rather than completely hinder its growth.

Overall, the concerns surrounding the expanded definition of a broker-dealer and its potential impact on the DeFi industry stem from the lack of clarity in the rule-making process. The crypto industry will closely monitor the implementation of the rule and its implications for decentralized protocols and automated market makers.