Apr. 19, 2022
I am writing with concern about the SEC’s proposal to expand its definition of an “exchange” and an “alternative trading system” (ATS). As written, the proposed rulemaking does not clarify what additional trading systems or protocols the SEC intends to regulate under the expanded definitions. Since existing SEC rules and regulations applicable to exchanges and ATSs are essentially designed to regulate physical stock exchanges, this ambiguity causes grave concern. It is also completely unclear how any trading system or protocol not already regulated by the SEC could possibly comply with the rules designed for exchanges and ATSs - this is especially true for decentralised exchanges (DEX). That the Commission felt the need to clarify the expanded definition would not capture platforms like web chat platforms and utilities exemplifies the problem: if the expanded definition of a securities exchange could be interpreted to capture such software, what software couldn’t be? Accordingly, it seems to me that this proposed rulemaking will be unable to accomplish successfully the SEC’s policy objectives. The severe regulatory uncertainty this rule would create would not enhance oversight, nor would it improve regulatory outcomes; instead, it would stifle innovation, entrench existing businesses and business models, and harm the public, who might otherwise have benefited from a flourishing and competitive market ecosystem. Nowhere else is the inappropriateness of this regulatory ambiguity more pointed and punishing than in the realm of decentralized finance (DeFi) and decentralised exchanges (DEX). Within DeFi and DEX, parties transact using open-source software. DeFi and DEX software is often built by multiple parties; one developer may create only a single part of the ultimate protocol, and developers have no ongoing oversight or control over either the further development of that protocol or its operation. It would simply be difficult for such a developer to fulfill the supervisory responsibilities for trading activity that the SEC requires of an exchange; nay, it would be impossible. That means the expanded definition in the proposed rulemaking would have but one inevitable outcome: developers would have to second-guess—at the very least—contributing to these kinds of open-source projects. Of course, without these contributors, many of whom are outside the US, these open-source projects cannot develop appropriately. This is a clear example of the regulatory uncertainty the Commission would create with this rule. Merely making software available to the public should not be captured under the SEC’s exchange or ATS registration framework, and the SEC should clearly state that. As a policy matter, SEC regulations should not prohibit the public from benefiting from innovations in financial markets. While relatively new, DeFi and DEX protocols have already provided significant benefits and innovations, like offering people the security and transparency of blockchains in an accessible, nondiscriminatory, democratic way. Moving forward with this proposal as written would create a regulatory advantage for incumbents in traditional finance. What’s more, it would cede the future of these DeFi and DEX markets to other countries—including significant competitors to the United States who are already seeking to create more attractive regulatory regimes for open-source financial software development. For all of these reasons, I stand opposed to the SEC’s proposal, and respectfully request that the SEC take actions to reconsider the proposal. Regards, Karthik Mahalingam