SEC Divided as DeFi Platforms Face Regulatory Stranglehold: Innovation on the Brink of Extinction?"

U.S. Securities and Exchange Commission (SEC) member Hester Peirce has criticized the regulatory agency for its proposal to expand the definition of an "exchange" to decentralized platforms trading cryptocurrencies. In a statement titled "Rendering Innovation Kaput," Peirce accused the SEC of attempting to stymie the development of new technology.

The SEC reopened a 30-day public comment period last Friday for an amendment to the regulatory definition of "exchange" to bring decentralized finance (DeFi) platforms under its control. SEC commissioner and lawyer Hester Peirce panned the move, calling it an attack on the development of new technology. "Rather than embracing the promise of new technology as we have done in the past, here we propose to embrace stagnation, force centralization, urge expatriation, and welcome extinction of new technology. Accordingly, I dissent," wrote Peirce in her statement.

The amendment, first proposed in January 2022, states that the term "exchanges" includes platforms using "communication protocol systems." The SEC defines these systems as "trading systems that offer the use of non-firm trading interest and provide protocols to bring together buyers and sellers of securities" in a fact sheet. SEC Chair Gary Gensler emphasized that many crypto trading platforms already fall under the current definition of an exchange.

The SEC's five commissioners voted 3 to 2 for the proposal, with Peirce and commissioner Mark T. Uyeda dissenting. Uyeda argued that the proposal raises more questions than it addresses "in terms of what is, and what is not, an exchange for purposes of the Exchange Act." Peirce claimed that the regulator's failure to provide clear examples of "communication protocol systems" would lead to ambiguity and disruptions for numerous businesses and the market.

Peirce, nicknamed "crypto mom" for her active support of the industry, further argued that the proposal introduces broad and blurry standards that restrict the scope of activities for participants in the cryptocurrency sector, undermining the country's First Amendment rights. With Peirce and Uyeda opposing the proposal, there appears to be significant conflict within the SEC regarding how to proceed.

In contrast, the Investor Advisory Committee under the SEC urged the federal regulator in an open letter published on April 6 to continue its aggressive enforcement against crypto businesses to protect investors from illegal activities.

In February, the SEC fined cryptocurrency exchange Kraken US$30 million for providing crypto staking services, which the agency believes to be unregistered provision of securities. Peirce called this approach "paternalistic and lazy." The same month, the SEC said it might take legal action against Binance USD stablecoin issuer Paxos, viewing the token as a form of unregistered securities. In March, the SEC warned Coinbase of potential legal action for violating securities laws with its cryptocurrency staking services. Coinbase CEO Brian Armstrong responded by tweeting that the exchange's staking services are not securities and expressed his readiness to defend that position in court.

As the debate continues, it remains to be seen how the SEC's proposal and differing opinions within the agency will impact the future of DeFi platforms and the wider cryptocurrency sector.