# 88 FR 29448: Supplemental Information and Reopening of Comment Period for Amendments Regarding the Definition of “Exchange”

> Federal · Regulations · In force

URL: https://www.frixlaw.com/law-library/statutes/FR_PRORULE_2023-08544

## Section

- **Citation:** 88 FR 29448
- **Heading:** Supplemental Information and Reopening of Comment Period for Amendments Regarding the Definition of “Exchange”
- **Jurisdiction:** Federal
- **Kind:** Regulations
- **Status:** In force
- **Text as of:** August 14, 2026
- **Source:** Compiled text
- **Location:** Federal Register / Vol. 88 / 88 FR 29448

## Text

SECURITIES AND EXCHANGE COMMISSION 17 CFR Parts 232, 240, 242, and 249 [Release No. 34-97309; File No. S7-02-22] RIN 3235-AM45 Supplemental Information and Reopening of Comment Period for Amendments Regarding the Definition of “Exchange” AGENCY:
Securities and Exchange Commission.

ACTION:
Proposed rule; reopening of comment period.

SUMMARY:
The Securities and Exchange Commission (“Commission”) is reopening the comment period for its proposal (“Proposed Rules”) to amend the rule under the Securities Exchange Act of 1934 (“Exchange Act”) that defines certain terms used in the statutory definition of “exchange.” The reopening provides supplemental information and economic analysis regarding trading systems that trade crypto asset securities that would be newly included in the definition of “exchange” under the Proposed Rules. The Commission is requesting further information and public comment on certain aspects of the Proposed Rules as applicable to all securities and the compliance dates and other alternatives for the Proposed Rules. The Proposed Rules were set forth in Release No. 34-94062 (“Proposing Release”), and the related comment period, which was reopened in Release No. 34-94868 on May 9, 2022, ended on June 13, 2022. The reopening of this comment period is intended to allow interested persons further opportunity to analyze and comment on the Proposed Rules in light of the supplemental information provided herein (“Reopening Release”).

DATES:
The comment period for the proposed amendments published on March 18, 2022, at 87 FR 15496, which was initially reopened on May 12, 2022, at 87 FR 29059, is again reopened. Comments should be received on or before June 13, 2023.

ADDRESSES:
Comments may be submitted by any of the following methods:
Electronic Comments
• Use the Commission's internet comment form ( https://www.sec.gov/regulatory-actions/how-to-submit-comments ); or
• Send an email to rule-comments@sec.gov. Please include File Number S7-02-22 on the subject line
FR 29059, is again reopened. Comments should be received on or before June 13, 2023.

ADDRESSES:
Comments may be submitted by any of the following methods:
Electronic Comments
• Use the Commission's internet comment form ( https://www.sec.gov/regulatory-actions/how-to-submit-comments ); or
• Send an email to rule-comments@sec.gov. Please include File Number S7-02-22 on the subject line.
Paper Comments
• Send paper comments to Secretary, Securities and Exchange Commission, 100 F Street NE, Washington, DC 20549-1090.
All submissions should refer to File Number S7-02-22. This file number should be included on the subject line if email is used. To help the Commission process and review your comments more efficiently, please use only one method of submission. The Commission will post all comments on the Commission's website ( https://www.sec.gov/rules/proposed.shtml ). Comments are also available for website viewing and printing in the Commission's Public Reference Room, 100 F Street NE, Washington, DC 20549, on official business days between the hours of 10 a.m. and 3 p.m. Operating conditions may limit access to the Commission's Public Reference Room. All comments received will be posted without change. Persons submitting comments are cautioned that we do not redact or edit personal identifying information from comment submissions. You should submit only information that you wish to make available publicly. Studies, memoranda, or other substantive items may be added by the Commission or staff to the comment file during this rulemaking. A notification of the inclusion in the comment file of any materials will be made available on the Commission's website. To ensure direct electronic receipt of such notifications, sign up through the “Stay Connected” option at www.sec.gov to receive notifications by email
dies, memoranda, or other substantive items may be added by the Commission or staff to the comment file during this rulemaking. A notification of the inclusion in the comment file of any materials will be made available on the Commission's website. To ensure direct electronic receipt of such notifications, sign up through the “Stay Connected” option at www.sec.gov to receive notifications by email.
FOR FURTHER INFORMATION CONTACT:
Tyler Raimo, Assistant Director, Matthew Cursio, David Garcia, Eugene Hsia, Megan Mitchell, Amir Katz, Special Counsels, and Joanne Kim, Attorney Advisor, at (202) 551-5500, Office of Market Supervision, Division of Trading and Markets, Securities and Exchange Commission, 100 F Street NE, Washington, DC 20549.

SUPPLEMENTARY INFORMATION:

I. Background
A. Exchange Regulatory Framework
Exchange Act section 3(a)(1) states that the term “exchange” means any organization, association, or group of persons, whether incorporated or unincorporated, which constitutes, maintains, or provides a market place or facilities for bringing together purchasers and sellers of securities or for otherwise performing with respect to securities the functions commonly performed by a stock exchange as that term is generally understood, and includes the market place and the market facilities maintained by such exchange. 1
1 See 15 U.S.C. 78c(a)(1).
Title 17 section 240.3b-16(a) (“Rule 3b-16(a)”) defines certain terms in the definition of “exchange” under section 3(a)(1) of the Exchange Act to include any organization, association, or group of persons that: (1) brings together the orders for securities of multiple buyers and sellers; and (2) uses established, non-discretionary methods (whether by providing a trading facility or by setting rules) under which such orders interact with each other, and the buyers and sellers entering such orders agree to the terms of a trade
Exchange Act to include any organization, association, or group of persons that: (1) brings together the orders for securities of multiple buyers and sellers; and (2) uses established, non-discretionary methods (whether by providing a trading facility or by setting rules) under which such orders interact with each other, and the buyers and sellers entering such orders agree to the terms of a trade. 2 Title 17 section 240.3b-16(b) (“Rule 3b-16(b)”) explicitly excludes certain systems from the definition of “exchange.” 3 Title 17 section 240.3b-16 (“Rule 3b-16”) provides a functional test to assess whether a trading platform meets the definition of exchange and, if so, triggers exchange registration. Section 5 of the Exchange Act 4 requires an organization, association, or group of persons that meets the definition of “exchange” under section 3(a)(1) of the Exchange Act, unless otherwise exempt, to register with the Commission as a national securities exchange pursuant to section 6 of the Exchange Act. 5
2 See 17 CFR 240.3b-16(a).
3 See Securities Exchange Act Release No. 40760 (Dec. 8, 1998), 63 FR 70844, 70852 (Dec. 22, 1998) (“Regulation ATS Adopting Release”). Specifically, Rule 3b-16(b) excludes from the definition of “exchange” systems that perform only traditional broker-dealer activities, including: systems that route orders to a national securities exchange, a market operated by a national securities association, or a broker-dealer for execution, or systems that allow persons to enter orders for execution against the bids and offers of a single dealer if certain additional conditions are met. 17 CFR 240.3b-16(b).
4 15 U.S.C. 78e. Registered national securities exchanges are also self-regulatory organizations (“SROs”), and must comply with regulatory requirements applicable to both national securities exchanges and SROs.
5 15 U.S.C. 78f
or systems that allow persons to enter orders for execution against the bids and offers of a single dealer if certain additional conditions are met. 17 CFR 240.3b-16(b).
4 15 U.S.C. 78e. Registered national securities exchanges are also self-regulatory organizations (“SROs”), and must comply with regulatory requirements applicable to both national securities exchanges and SROs.
5 15 U.S.C. 78f.
Title 17 section 240.3a1-1(a)(2) (“Rule 3a1-1(a)(2)”) exempts from the Exchange Act section 3(a)(1) definition of “exchange” an organization, association, or group of persons that complies with Regulation ATS, which requires, among other things, meeting the definition of an alternative trading system (“ATS”) and registering as a broker-dealer. 6 As a result of the exemption, an organization, association, or group of persons that meets the definition of an exchange and complies with Regulation ATS is not required by section 5 of the Exchange Act to register 7
6 “Regulation ATS” consists of 17 CFR 242.300 through 242.304 (Rules 300 through 304 under the Exchange Act).
7 An ATS that fails to comply with the requirements of Regulation ATS would no longer qualify for the exemption provided under Rule 3a1-1(a)(2), and thus, risks operating as an unregistered exchange in violation of section 5 of the Exchange Act. See Securities Exchange Act Release No. 83663 (July 18, 2018), 83 FR 38768, 38772 n.36 (Aug. 7, 2018) (“NMS Stock ATS Adopting Release”).
B
ange Act).
7 An ATS that fails to comply with the requirements of Regulation ATS would no longer qualify for the exemption provided under Rule 3a1-1(a)(2), and thus, risks operating as an unregistered exchange in violation of section 5 of the Exchange Act. See Securities Exchange Act Release No. 83663 (July 18, 2018), 83 FR 38768, 38772 n.36 (Aug. 7, 2018) (“NMS Stock ATS Adopting Release”).
B. January 2022 Proposed Amendments to Exchange Act Rule 3b-16
As described more fully in the Proposing Release, 8 the Commission proposed to amend Exchange Act Rule 3b-16 to, among other things, replace “orders” with “trading interest” and define “trading interest”; 9 remove the term “multiple” before “buyers and sellers”; 10 add “communication protocols” as an example of an established, non-discretionary method that an organization, association, or group of persons can provide to bring together buyers and sellers of securities; simplify and align the rule text with the statutory definition of “exchange” under section 3(a)(1) of the Exchange Act; and add an exclusion under Exchange Act Rule 3b-16(b) for systems that allow an issuer to sell its securities to investors.
8 See Securities Exchange Act Release No. 94062 (Jan. 26, 2022), 87 FR 15496 (Mar. 18, 2022). The Proposed Rules also: (1) re-proposed amendments to Regulation ATS for ATSs that trade government securities as defined under section 3(a)(42) of the Exchange Act or repurchase and reverse repurchase agreements on government securities (“Government Securities ATSs”); (2) proposed amendments to Form ATS-N for NMS Stock ATSs and Government Securities ATSs; (3) proposed amendments to 17 CFR 242.301(b)(5) (“Rule 301(b)(5)”) of Regulation ATS (“Fair Access Rule”) for ATSs; (4) proposed to require electronic filing of and to modernize Form ATS and Form ATS-R; and (5) re-proposed amendments to regulations regarding systems compliance and integrity to apply to ATSs that meet certain volume thresholds in U.S
r NMS Stock ATSs and Government Securities ATSs; (3) proposed amendments to 17 CFR 242.301(b)(5) (“Rule 301(b)(5)”) of Regulation ATS (“Fair Access Rule”) for ATSs; (4) proposed to require electronic filing of and to modernize Form ATS and Form ATS-R; and (5) re-proposed amendments to regulations regarding systems compliance and integrity to apply to ATSs that meet certain volume thresholds in U.S. Treasury Securities or in a debt security issued or guaranteed by a U.S. executive agency, or government-sponsored enterprise.
9 As proposed, “trading interest” (defined in proposed Rule 300(q) of Regulation ATS) would include “orders,” as the term is defined under 17 CFR 240.3b-16(c) (“Rule 3b-16(c)”), or any non-firm indication of a willingness to buy or sell a security that identifies at least the security and either quantity, direction (buy or sell), or price. See Proposing Release at 15540.
10 The Commission proposed removing the word “multiple” from Exchange Act Rule 3b-16(a)(1) to mitigate confusion as to its application to non-firm trading interest, including request-for-quote (“RFQ”) systems, and align the rule more closely with the statutory definition of “exchange,” which does not contain the word “multiple” but includes the plural terms “purchasers and sellers.” See id. at 15506. The Commission also stated in the Proposing Release that the use of plural terms in “buyers and sellers” in Rule 3b-16(a) and “purchasers and sellers” in the statutory definition of “exchange” makes sufficiently clear that an exchange need only have more than one buyer and more than one seller participating on the system to meet this prong. See id. at 15506 n.105
rs and sellers.” See id. at 15506. The Commission also stated in the Proposing Release that the use of plural terms in “buyers and sellers” in Rule 3b-16(a) and “purchasers and sellers” in the statutory definition of “exchange” makes sufficiently clear that an exchange need only have more than one buyer and more than one seller participating on the system to meet this prong. See id. at 15506 n.105.
Specifically, the Commission proposed to amend Exchange Act Rule 3b-16(a) to include within the definition of “exchange” an organization, association, or group of persons that constitutes, maintains, or provides a market place or facilities for bringing together buyers and sellers of securities or for otherwise performing with respect to securities the functions commonly performed by a stock exchange if it is not subject to an exception under Rule 3b-16(b) and it: (1) brings together buyers and sellers of securities using trading interest; and (2) makes available established, non-discretionary methods (whether by providing a trading facility or communication protocols, or by setting rules) under which buyers and sellers can interact and agree to the terms of a trade. For purposes of this Reopening Release, trading systems that meet the criteria of Exchange Act Rule 3b-16(a), as proposed to be amended ( i.e., offer the use of non-firm trading interest and provide non-discretionary protocols), 11 are referred to throughout the release as “New Rule 3b-16(a) Systems.” New Rule 3b-16(a) Systems would be subject to the definition of “exchange” and be required to register as a national securities exchange or comply with the conditions to an exemption to such registration, such as Regulation ATS.
11 Such systems were referred to as “Communication Protocol Systems” in the Proposing Release. See id. at 15497 n.5.
C. Purpose of the Reopening Release
In response to the Proposing Release, the Commission received many comments
“exchange” and be required to register as a national securities exchange or comply with the conditions to an exemption to such registration, such as Regulation ATS.
11 Such systems were referred to as “Communication Protocol Systems” in the Proposing Release. See id. at 15497 n.5.
C. Purpose of the Reopening Release
In response to the Proposing Release, the Commission received many comments. 12 In particular, the Commission received requests for information about the application of the Proposed Rules to trading systems for crypto asset securities 13 and trading systems that use distributed ledger or blockchain technology (broadly referred to as “DLT”), 14 including systems commenters characterize as decentralized finance or “DeFi.” 15 Commenters request information about whether and how such systems can comply with existing federal securities laws and the Proposed Rules. 16 Given these comments, the Commission is issuing this Reopening Release regarding the potential effects of the proposed amendments to Exchange Act Rule 3b-16 on trading systems for crypto asset securities and trading systems using DLT, including systems commenters characterize as various forms of “DeFi,” and requesting further information and public comment on aspects of the Proposed Rules, more generally. This Reopening Release also supplements the economic analysis in the Proposing Release by providing additional analysis on the estimated impact of the Proposed Rules on trading systems for crypto asset securities and those using DLT, which include various so-called “DeFi” trading systems, and requests further comment.
12 See infra sections II.A and II.B. Comment letters cited in this Reopening Release are comment letters received in response to the Proposing Release, which are available at https://www.sec.gov/comments/s7-02-22/s70222.htm.
13 See infra note 26
trading systems for crypto asset securities and those using DLT, which include various so-called “DeFi” trading systems, and requests further comment.
12 See infra sections II.A and II.B. Comment letters cited in this Reopening Release are comment letters received in response to the Proposing Release, which are available at https://www.sec.gov/comments/s7-02-22/s70222.htm.
13 See infra note 26.
14 The terms DLT and blockchain, a type of DLT, generally refer to databases that maintain information across a network of computers in a decentralized or distributed manner. Blockchain networks commonly use cryptographic protocols to ensure data integrity. See, e.g., World Bank Group, “Distributed Ledger Technology (DLT) and Blockchain,” FinTech Note No. 1 (2017), available at https://openknowledge.worldbank.org/bitstream/handle/10986/29053/WP-PUBLIC-Distributed-LedgerTechnology-and-Blockchain-Fintech-Notes.pdf?sequence=1&isAllowed=y.
15 Commenters vary in their definitions of “DeFi,” or what makes a product, service, arrangement or activity “decentralized.” See generally The Board of the International Organization of Securities Commissions, IOSCO Decentralized Finance Report (Mar. 2022) (“IOSCO Decentralized Finance Report”), available at https://www.iosco.org/library/pubdocs/pdf/IOSCOPD699.pdf. Trading systems for crypto assets that are colloquially referred to as “decentralized” typically combine more traditional technology (such as web-based systems that accept and display orders and servers that store orders) with distributed ledger technology (such as “smart contract” provisioned blockchains—self-executing code run on distributed ledgers that carry out “if/then” type computations). See id. at 1. See also infra note 44.
16 See, e.g., infra notes 25, 58, 80, 82-84, and 86-87.
II. Exchange Activity Involving Crypto Asset Securities and DLT Under the Proposed Rules
A
s and servers that store orders) with distributed ledger technology (such as “smart contract” provisioned blockchains—self-executing code run on distributed ledgers that carry out “if/then” type computations). See id. at 1. See also infra note 44.
16 See, e.g., infra notes 25, 58, 80, 82-84, and 86-87.
II. Exchange Activity Involving Crypto Asset Securities and DLT Under the Proposed Rules
A. Crypto Asset Securities
Commenters reflecting a broad range of market participants shared feedback on the application of the Proposed Rules to all securities, including crypto assets that are securities. Some commenters agree with the Commission's view 17 that the Proposed Rules should apply to trading in any type of security, regardless of the specific technology used to issue and/or transfer the security. 18 Several commenters request 19 Commenters point to the lack of any explicit references in the Proposing Release to systems that trade crypto asset securities, including so-called “DeFi” trading systems, with some suggesting that such systems would be outside the scope of the Proposed Rules. 20 One commenter states that the Proposed Rules should not apply to crypto asset securities. 21 Some commenters state their view that there is supposed regulatory uncertainty as to which crypto assets are securities. 22 Some commenters state that as a result of such supposed uncertainty, it is unclear whether the Proposed Rules would apply to so-called “DeFi” protocols. 23 One commenter states that the Commission should defer action on any rulemaking impacting crypto assets until, among things, such supposed uncertainty is eliminated. 24 Some commenters state that the existing exchange regulatory framework is incompatible with systems that trade crypto asset securities using so-called “DeFi protocols.” 25
17 See Proposing Release at 15503.
18 See, e.g., Letters from Marcia E. Asquith, Executive Vice President, Board and External Relations, FINRA, dated Apr. 19, 2022 (“FINRA Letter”) at 4; Stephen W
ncertainty is eliminated. 24 Some commenters state that the existing exchange regulatory framework is incompatible with systems that trade crypto asset securities using so-called “DeFi protocols.” 25
17 See Proposing Release at 15503.
18 See, e.g., Letters from Marcia E. Asquith, Executive Vice President, Board and External Relations, FINRA, dated Apr. 19, 2022 (“FINRA Letter”) at 4; Stephen W. Hall, Legal Director and Securities Specialist, and Scott Farnin, Legal Counsel, Better Markets, Inc., dated Apr. 18, 2022 (“Better Markets Letter”) at 8; Tyler Gellasch, Executive Director, Healthy Markets Association, dated June 13, 2022 (“Healthy Markets Letter”) at 6 n.21 (stating that the Proposed Rules should apply
19 See, e.g., Letters from Jai Ramaswamy, Chief Legal Officer and Miles Jennings, General Counsel, a16zCrypto, A.H. Capital Management, LLC, dated Apr. 18, 2022 (“a16z Letter”) at 3; Kristin Smith, Executive Director and Jake Chervinsky, Head of Policy, Blockchain Association, dated Apr. 18, 2022 (“Blockchain Association Letter II”) at 7-8; Brett Kitt, Associate Vice President, Principal Associate General Counsel, Nasdaq, Inc., dated Apr. 18, 2022 (“Nasdaq Letter”) at 5; Joanna Mallers, Secretary, FIA Principal Traders Group, dated Apr. 21, 2022 (“FIA PTG Letter”) at 2; Sheila Warren, Chief Executive Officer, Crypto Council for Innovation, dated Apr. 18, 2022 (“Crypto Council Letter”) at 2; Sasha Hodder, Hodder Law Firm, P.A., dated Feb. 25, 2022; Tim Lau, dated Apr. 4, 2022; Zachary Stinson, dated Apr. 18, 2022 (“Stinson Letter”); Karthik Mahalingam, dated Apr. 19, 2022.
20 See, e.g., Letters from Michelle Bond, Chief Executive Officer, Association for Digital Asset Markets, dated Apr. 18, 2022 (“ADAM Letter II”) at 14; Gus Coldebella and Gregory Xethalis, dated Apr. 18, 2022 (“Coldebella and Xethalis Letter”) at 1-2; Crypto Council Letter at 3; a16z Letter at 7.
21 See ADAM Letter II at 3, 9-12
2022 (“Stinson Letter”); Karthik Mahalingam, dated Apr. 19, 2022.
20 See, e.g., Letters from Michelle Bond, Chief Executive Officer, Association for Digital Asset Markets, dated Apr. 18, 2022 (“ADAM Letter II”) at 14; Gus Coldebella and Gregory Xethalis, dated Apr. 18, 2022 (“Coldebella and Xethalis Letter”) at 1-2; Crypto Council Letter at 3; a16z Letter at 7.
21 See ADAM Letter II at 3, 9-12.
22 See, e.g., a16z Letter at 3, 15-16 (stating that the Commission has not made clear which digital assets it believes are “securities”); Blockchain Association Letter II at 3, 9 (stating whether and when a given digital asset may qualify as a security under federal securities laws remains unclear); Letter from LeXpunK, dated Apr. 18, 2022 (“LeXpunK Letter”) at 2 n.4 (stating that given the “lack of clarity with respect to the Commission's classification of digital assets and transactions involving digital assets,” “there remains a looming uncertainty as to whether the same would be regarded as securities and securities transactions, respectively”).
23 See, e.g., a16z Letter at 3, 15-16 (stating that given the uncertainty on which digital assets are “securities,” some so-called “DeFi systems or protocols” that do not clearly meet the definition of “Communication Protocol Systems” or facilitate transactions in digital assets could endeavor to comply with the Proposed Rules while other “DeFi systems or protocols” might not, which raises the danger of inconsistency and could create unforeseen consequences in the market for digital assets); Blockchain Association Letter II at 3, 9 (stating that given the Commission's “expansive view of what may be deemed a security, there remains a risk that certain digital assets that users trade through Decentralized Protocols may (ex post) be deemed by the [Commission] to be securities”). See also Damien G. Scott, Deputy General Counsel, CoinList, dated Apr
ences in the market for digital assets); Blockchain Association Letter II at 3, 9 (stating that given the Commission's “expansive view of what may be deemed a security, there remains a risk that certain digital assets that users trade through Decentralized Protocols may (ex post) be deemed by the [Commission] to be securities”). See also Damien G. Scott, Deputy General Counsel, CoinList, dated Apr. 18, 2022 (“CoinList Letter”) at 1-2 (explaining that crypto asset industry needs clarity about how the rules written for traditional paper securities secured and validated by intermediaries apply in practice to new digital technology).
24 See Letter from Jay H. Knight, Chair of the Federal Regulation of Securities Committee, Federal Regulation of Securities Committee of the Business Law Section of the American Bar Association, dated Apr. 18, 2022 (“ABA Letter”) at 5-6 (suggesting the Commission defer the application of the Proposed Rules to digital asset intermediaries and their underlying technology pending completion of coordination among a broad range of government agencies to develop an appropriate approach to digital assets, pursuant to the Executive Order on Ensuring the Responsible Development of Digital Assets).
25 See, e.g., a16z Letter at 9 (“But even casting aside the practical challenges that DeFi protocols would confront in attempting to follow Regulation ATS, the Commission seems to overlook the fact that the purposes behind Regulation ATS would not be served by imposing its requirements on DeFi protocols.”); Letter from William C. Hughes, Senior Counsel & Director of Global Regulatory Matters, ConsenSys Software Inc., dated Apr. 14, 2022 (“ConsenSys Letter”) at 8 (“The '34 Act's requirements, tailored as they are to the centralized nature of exchanges, make no sense when applied to decentralized blockchain-based systems.”); Letter from Delphi Digital, dated Apr
g its requirements on DeFi protocols.”); Letter from William C. Hughes, Senior Counsel & Director of Global Regulatory Matters, ConsenSys Software Inc., dated Apr. 14, 2022 (“ConsenSys Letter”) at 8 (“The '34 Act's requirements, tailored as they are to the centralized nature of exchanges, make no sense when applied to decentralized blockchain-based systems.”); Letter from Delphi Digital, dated Apr. 18, 2022 (“Delphi Digital Letter”) at 6 (stating that “systems lacking order-book logic, or which are sufficiently decentralized ( i.e., lacking any particular owner/operator who could rationally be expected to comply with the SEC's intermediaries-based regulatory regime)” have been viewed by participants in the digital asset marketplace as outside the scope of securities exchange regulation). One commenter cites a paper stating that “[s]ome characteristics of DeFi may be incompatible with the existing regulatory framework, particularly given that the current framework is designed for a system that has financial intermediaries at its core.” See Letter from Jake Chervinsky, Head of Policy, Blockchain Association and Miller Whitehouse-Levine, Policy Director, DeFi Education Fund, dated June 13, 2022 (“Blockchain Association/DeFi Education Fund Letter”) at 4 (citing Org. for Econ. Cooperation and Dev., Why Decentralised Finance (DeFi) Matters and the Policy Implications (2022) at 12).
Crypto assets 26 generally use DLT as a method to record ownership and transfers. 27 Further, a crypto asset that is a security is not a separate type or category of security ( e.g., NMS stock, corporate bond) for purposes of federal securities laws based solely on the use of DLT. The definition of “exchange” under section 3(a)(1) of the Exchange Act and existing Rule 3b-16 thereunder, and the requirement that an exchange register with the Commission pursuant to section 5 of the Exchange Act, apply to all securities, including crypto assets that are securities, which include investment contracts or any other type of security
l securities laws based solely on the use of DLT. The definition of “exchange” under section 3(a)(1) of the Exchange Act and existing Rule 3b-16 thereunder, and the requirement that an exchange register with the Commission pursuant to section 5 of the Exchange Act, apply to all securities, including crypto assets that are securities, which include investment contracts or any other type of security. 28 The Commission understands that currently certain trading systems for crypto assets, including so-called “DeFi” systems, operate like an exchange as defined under federal securities laws—that is, they bring together orders of multiple buyers and sellers using established, non-discretionary methods (by providing a trading facility, for example) under which such orders interact and the buyers and sellers entering such orders agree upon the terms of a trade. 29 Because it is unlikely that systems trading a large number of different crypto assets are not trading any crypto assets that are securities, 30 these 31 Indeed, the President's Executive Order on Ensuring Responsible Development of Digital Assets acknowledged that “many activities involving digital assets are within the scope of existing domestic laws and regulations” and systems trading such assets “should, as appropriate, be subject to and in compliance with regulatory and supervisory standards that govern traditional market infrastructures and financial firms.” 32 The proposed amendments to Exchange Act Rule 3b-16 do not change any existing obligation for these systems to register as a national securities exchange or comply with the conditions to an exemption to such registration, such as Regulation ATS
propriate, be subject to and in compliance with regulatory and supervisory standards that govern traditional market infrastructures and financial firms.” 32 The proposed amendments to Exchange Act Rule 3b-16 do not change any existing obligation for these systems to register as a national securities exchange or comply with the conditions to an exemption to such registration, such as Regulation ATS. 33
26 For purposes of this Reopening Release, the Commission does not distinguish between the terms “digital asset securities” and “crypto asset securities.” The term “digital asset” refers to an asset that is issued and/or transferred using distributed ledger or blockchain technology, including, but not limited to, so-called “virtual currencies,” “coins,” and “tokens.” See Securities Exchange Act Release No. 90788 (Dec. 23, 2020), 86 FR 11627, 11627 n.1 (Feb. 26, 2021) (“Commission Statement on Custody of Digital Asset Securities by Special Purpose Broker-Dealers”). A digital asset may or may not meet the definition of a “security” under the federal securities laws. See, e.g., Report of Investigation Pursuant to Section 21(a) of the Securities Exchange Act of 1934: The DAO, Securities Exchange Act Release No. 81207 (July 25, 2017) (“DAO 21(a) Report”), available at https://www.sec.gov/litigation/investreport/34-81207.pdf. See also SEC v. W.J. Howey Co., 328 U.S. 293 (1946). To the extent digital assets rely on cryptographic protocols, these types of assets also are commonly referred to as “crypto assets.”
27 See Investment Advisers Act Release No. 6240 (Feb. 15, 2023), 88 FR 14672, 14676 n.25 and accompanying text (Mar. 9, 2023); Securities Exchange Act Release No. 96496 (Dec. 14, 2022), 88 FR 5440, 5448 n.94 and accompanying text (Jan. 27, 2023).
28 Section 3(a)(1) of the Exchange Act and Rule 3b-16 thereunder do not apply to market places or facilities that do not trade securities. This would also remain unchanged under Exchange Act Rule 3b-16, as proposed to be amended
14676 n.25 and accompanying text (Mar. 9, 2023); Securities Exchange Act Release No. 96496 (Dec. 14, 2022), 88 FR 5440, 5448 n.94 and accompanying text (Jan. 27, 2023).
28 Section 3(a)(1) of the Exchange Act and Rule 3b-16 thereunder do not apply to market places or facilities that do not trade securities. This would also remain unchanged under Exchange Act Rule 3b-16, as proposed to be amended.
29 In addition to its exchange obligations, depending on the facts and circumstances, an organization, association, or group of persons engaging in crypto asset securities business may also have legal and regulatory obligations under the federal securities laws for broker-dealer, custodial, clearing, or lending activities, among others. See U.S. Securities and Exchange Commission v. Beaxy Digital, Ltd., et al., No. 23-cv-1962 (N.D. Ill. Mar. 29, 2023) (Docket Entries 1, 4) (final judgment entered on consent enjoining crypto asset trading platform from operating an unregistered exchange, broker, and clearing agency).
30 See Fin. Stability Oversight Council, Report on Digital Asset Financial Stability Risks and Regulation 119 (2022) (“FSOC Report”) at 97, available at https://home.treasury.gov/system/files/261/FSOC-Digital-Assets-Report-2022.pdf. Each system should analyze whether the crypto assets that it offers for trading meet the definition of a security under the federal securities laws and prior Commission statements. See supra note 26. The Commission will continue to evaluate whether currently operating systems are acting consistent with federal securities laws and the rules thereunder.
31 See, e.g., DAO 21(a) Report at 17 (“The Platforms that traded DAO Tokens appear to have satisfied the criteria of Rule 3b-16(a) and do not appear to have been excluded from Rule 3b-16(b).”); In the Matter of Zachary Coburn, Securities Exchange Act Release No. 84553 (Nov. 8, 2018) (settled cease-and-desist order); In the Matter of Poloniex, LLC, Securities Exchange Act Release No. 92607 (Aug
.
31 See, e.g., DAO 21(a) Report at 17 (“The Platforms that traded DAO Tokens appear to have satisfied the criteria of Rule 3b-16(a) and do not appear to have been excluded from Rule 3b-16(b).”); In the Matter of Zachary Coburn, Securities Exchange Act Release No. 84553 (Nov. 8, 2018) (settled cease-and-desist order); In the Matter of Poloniex, LLC, Securities Exchange Act Release No. 92607 (Aug. 9, 2021) (settled cease-and-desist order).
32 See President's Executive Order on Ensuring Responsible Development of Digital Assets, dated Mar. 9, 2022, available at https://www.whitehouse.gov/briefing-room/presidential-actions/2022/03/09/executive-order-on-ensuring-responsible-development-of-digital-assets/.
33 17 CFR 242.300 through 242.304.
The Commission preliminarily believes that some amount of crypto asset securities trade on New Rule 3b-16(a) Systems, and that such systems may use DLT or be “DeFi” trading systems, as described by some commenters. Depending on facts and circumstances, systems that offer the use of non-firm trading interest and provide non-discretionary protocols to bring together buyers and sellers of crypto assets securities 34 can perform a market place function like that of an exchange—that is, they allow participants to discover prices, find liquidity, locate counterparties, and agree upon terms of a trade for securities. The exchange regulatory framework would provide market participants that use New Rule 3b-16(a) Systems for crypto asset securities with transparency, fair and orderly markets, and investor protections that apply to today's registered exchanges or ATSs. 35 These benefits, in turn, promote capital formation, competition, and market efficiencies
arties, and agree upon terms of a trade for securities. The exchange regulatory framework would provide market participants that use New Rule 3b-16(a) Systems for crypto asset securities with transparency, fair and orderly markets, and investor protections that apply to today's registered exchanges or ATSs. 35 These benefits, in turn, promote capital formation, competition, and market efficiencies. 36 An organization, association, or group of persons that constitutes, maintains, or provides a market place or facilities for bringing together purchasers and sellers of crypto asset securities or performs with respect to crypto asset securities the functions commonly performed by a stock exchange as that term is generally understood under the criteria of Exchange Act Rule 3b-16(a), as proposed to be amended, would be an exchange under section 3(a)(1) of the Exchange Act and would be required to register as a national securities exchange or comply with the conditions of Regulation ATS.
34 See Proposing Release at 15503.
35 See Regulation ATS Adopting Release at 70847.
36 See 15 U.S.C. 78c(f).
Some commenters question the application of the proposed amendments to Exchange Act Rule 3b-16 to assets that may not be securities. 37 In addition, commenters indicate that many crypto asset trading systems offer pairs trading, 38 which typically involves two crypto assets (which may or may not be securities) that can be exchanged directly for each other using their relative price (“trading pair”). 39 Trading pairs consist of both a base and quote asset; the base asset is the asset quoted in terms of the value of the other ( i.e., quote) asset in the trading pair. 40 Today, trading pairs can include a combination of securities and non-securities and frequently include so-called stablecoins, bitcoin, or ether as the base asset, quote asset, or both. 41 Users entering a trading pair on a system can exchange one crypto asset for another without exchanging the crypto asset for U.S
oted in terms of the value of the other ( i.e., quote) asset in the trading pair. 40 Today, trading pairs can include a combination of securities and non-securities and frequently include so-called stablecoins, bitcoin, or ether as the base asset, quote asset, or both. 41 Users entering a trading pair on a system can exchange one crypto asset for another without exchanging the crypto asset for U.S. dollars (or other fiat currency) by simultaneously selling one asset while buying another on the system without exchanging either crypto asset for U.S. dollars first.
37 See ADAM Letter II at 9 (stating that “it is premature of the SEC to include digital assets within the scope of the exchange regulatory framework until such time as there is a better understanding regarding the appropriate regulatory approach for such assets”); LeXpunK Letter at 2 n.4 (stating “where digital asset transactions do not involve securities, U.S. securities laws (and the instant proposed rulemaking) would be inapplicable” and that “in light of the lack of clarity with respect to the Commission's classification of digital assets and transactions involving digital assets, however, there remains a looming uncertainty as to whether the same would be regarded as securities and securities transactions, respectively”); a16z Letter at 15-16 (stating that the Proposing Release “does not mention `digital asset securities' or `investment contracts,' two of the terms the Commission uses to describe digital assets believed to be securities” and that the “omissions will further compound the uncertainty over whether the Proposal was meant to cover digital assets”).
38 See LeXpunK Letter at 4 and 4 n.19; Delphi Digital Letter at 7 (stating that, in the context of systems that use “technology in DeFi,” automated market makers (“AMMs”) use “liquidity pools,” which “represents assets in (and a market for) a single token pair” that are “ `locked' within smart contracts”)
her compound the uncertainty over whether the Proposal was meant to cover digital assets”).
38 See LeXpunK Letter at 4 and 4 n.19; Delphi Digital Letter at 7 (stating that, in the context of systems that use “technology in DeFi,” automated market makers (“AMMs”) use “liquidity pools,” which “represents assets in (and a market for) a single token pair” that are “ `locked' within smart contracts”).
39 See Fan Fang, Carmine Ventre, Michail Basios et al., Cryptocurrency Trading: A Comprehensive Survey, 8 Fin. Innovation 13 (2022), available at https://doi.org/10.1186/s40854-021-00321-6 (stating that in general, pairs trading involves two similar assets with a stable long-run relationship and slightly different spreads, and if the spread widens, investors short the high-priced crypto asset and buy the low-priced crypto asset).
40 See A Review of Cryptoasset Market Structure and Regulation in the United States, Feb. 2023, Program on International Financial Systems, available at https://www.pifsinternational.org/cryptoasset-market-structure-and-regulation-in-the-u-s/ (“PIFS Crypto Review”).
41 Crypto asset trading pairs offered by trading systems today also include other combinations ( e.g., crypto asset (security or non-security) for another crypto asset (security or non-security)). While some of the major crypto asset trading systems available in the U.S. allow trading in U.S. dollars, others only allow trading between different crypto assets and not fiat currencies. The main base asset used on certain of these other systems is Tether (USDT). See Igor Makarov & Antoinette Schoar, Trading and Arbitrage in Cryptocurrency Markets, 135 J. Fin. Econ. 293 (2020). See also PIFS Crypto Review at 10-11 (stating that most global bitcoin trading is conducted with stablecoins rather than fiat currency)
allow trading between different crypto assets and not fiat currencies. The main base asset used on certain of these other systems is Tether (USDT). See Igor Makarov & Antoinette Schoar, Trading and Arbitrage in Cryptocurrency Markets, 135 J. Fin. Econ. 293 (2020). See also PIFS Crypto Review at 10-11 (stating that most global bitcoin trading is conducted with stablecoins rather than fiat currency).
Section 3(a)(1) of the Exchange Act and Rule 3b-16 state that an exchange is any organization, association, or group of persons which constitutes, maintains, or provides a market place or facilities for bringing together purchasers and sellers of securities or for otherwise performing with respect to securities the functions commonly performed by a stock exchange as that term is generally understood. 42 An organization, association, or group of persons that meets the criteria of existing Exchange Act Rule 3b-16(a), and Rule 3b-16(a), as proposed to be amended, and makes available for trading a security and a non-security would meet the definition of “exchange” notwithstanding the fact that the entity traded non-securities. For its securities activities, the organization, association, or group of person must register as a national securities exchange or comply with the conditions of Regulation ATS. 43 Market places or facilities of, and the functions performed by, national securities exchanges and ATSs trade only securities quoted in and paid for in U.S. dollars.
42 See 15 U.S.C. 78c(a)(1).
43 Section 5 of the Exchange Act states that “[i]t shall be unlawful for any . .
n, or group of person must register as a national securities exchange or comply with the conditions of Regulation ATS. 43 Market places or facilities of, and the functions performed by, national securities exchanges and ATSs trade only securities quoted in and paid for in U.S. dollars.
42 See 15 U.S.C. 78c(a)(1).
43 Section 5 of the Exchange Act states that “[i]t shall be unlawful for any . . . exchange, directly or indirectly, to make use of the mails or any means or instrumentality of interstate commerce for the purpose of using any facility of an exchange within or subject to the jurisdiction of the United States to effect any transaction in a security, or to report any such transaction, unless such exchange (1) is registered as national securities exchange under [section 6 of the Exchange Act], or (2) is exempted from such registration . . . .” See 15 U.S.C. 78e.
The Commission is soliciting additional comment on Rule 3b-16, as proposed to be amended, and in
1. Should a New Rule 3b-16(a) System that trades crypto asset securities have the choice of registering as a national securities exchange or complying with the conditions of Regulation ATS? Why or why not?
2. Please describe any trading systems that currently offer the use of non-firm trading interest and provide non-discretionary protocols to bring together buyers and sellers of crypto asset securities, including a description of trading interest used, functionalities or protocols, requirements, limitations, types of market participants that use the systems, transaction volume, crypto asset securities offered for trading, and any other services offered by the system
f non-firm trading interest and provide non-discretionary protocols to bring together buyers and sellers of crypto asset securities, including a description of trading interest used, functionalities or protocols, requirements, limitations, types of market participants that use the systems, transaction volume, crypto asset securities offered for trading, and any other services offered by the system. Please provide any data, literature, or other information that you consider relevant to the Commission's analysis of New Rule 3b-16(a) Systems for crypto asset securities, including but not limited to, the types of systems, the amount of trading volume on such systems, the number of participants on such systems (as well as the participant types, such as institutional and retail), and the types of crypto asset securities they trade.
3. Do organizations, associations, or groups of persons that meet the criteria of New Rule 3b-16(a) Systems and trade crypto asset securities quote a security in an asset other than in U.S. dollars, such as a non-security crypto asset, and provide for the purchase or sale of that asset on the system or off-system? How do investors and trading systems use pairs trading involving non-security crypto assets and crypto asset securities? Are there significant differences between investors' use of pairs trading on centralized trading systems versus trading systems that commenters describe as “DeFi”? Please explain. For example, approximately how much trading volume for crypto asset securities is executed using trading pairs on various types of platforms discussed above? What percentage of trading in crypto asset securities, in terms of volume executed, is in exchange for U.S. dollars? Please provide any data, literature, or other information that you consider relevant to the Commission's analysis.
B. Exchange Activity Using DLT, Including “DeFi” Systems
1
or crypto asset securities is executed using trading pairs on various types of platforms discussed above? What percentage of trading in crypto asset securities, in terms of volume executed, is in exchange for U.S. dollars? Please provide any data, literature, or other information that you consider relevant to the Commission's analysis.
B. Exchange Activity Using DLT, Including “DeFi” Systems
1. Technology Neutral and Functional Test of the “Exchange” Definition
The Commission received comments regarding whether the proposed amendments to Exchange Act Rule 3b-16 were intended to apply to what commenters characterize as “DeFi,” and comments stating that the Proposed Rules could be interpreted to cover a broad range of technologies, including technologies used by so-called “DeFi” trading systems. 44 Some commenters state that so-called “DeFi” trading systems should be excluded from Exchange Act Rule 3b-16(a), as proposed to be amended. 45
44 See, e.g., ConsenSys Letter at 8-9 (requesting that any final rule make clear that “blockchain-based systems” would not be exchanges); a16z Letter at 1, 2, 28 (stating, among other things, that the Proposed Rules could be interpreted as applying to a broad array of technologies, including “DeFi systems and protocols”); Crypto Council Letter at 2, 4 (stating, in part, that the Proposed Rules could apply to the “crypto and decentralized finance markets”); LeXpunK Letter at 3 (stating, in part, its belief that many “DeFi protocols and applications” would meet the definition of a “communication protocol system” under the Proposed Rules); Global Digital Asset & Cryptocurrency Association, dated Apr. 18, 2022 (“GDCA Letter II”) at 11 (questioning whether “decentralized exchanges” would fall under the definition of “exchange”); Letter from Miller Whitehouse-Levine, Policy Director, DeFi Education Fund, dated Apr
“DeFi protocols and applications” would meet the definition of a “communication protocol system” under the Proposed Rules); Global Digital Asset & Cryptocurrency Association, dated Apr. 18, 2022 (“GDCA Letter II”) at 11 (questioning whether “decentralized exchanges” would fall under the definition of “exchange”); Letter from Miller Whitehouse-Levine, Policy Director, DeFi Education Fund, dated Apr. 18, 2022 (“DeFi Education Fund Letter”) at 3, 15 (stating, in part, that, without clarification, the Proposed Rules could be interpreted to regulate certain “DeFi protocols”); Letter from Dante Disparte, Chief Strategy Officer and Head of Global Policy, Circle internet Financial, LLC, dated Apr. 18, 2022 (“Circle Letter”) at 3; Letter from Michelle Bond, Chief Executive Officer, Association for Digital Asset Markets, dated Feb. 2, 2022 (“ADAM Letter I”) at 1-2 (stating that the Proposed Rules could expand Commission authority over “spot digital asset markets and peer-to-peer decentralized networks” in ways not discussed in the Proposing Release); Letter from Kimberly Unger, The Security Traders Association of New York, dated Feb. 3, 2022 (“STANY Letter”) at 2; Letter from Andrew Vollmer, Mercatus Center at George Mason University, dated Mar. 11, 2022 (“Vollmer Letter”) at 2. Two commenters also state their belief that there is a lack of clarity as to the application of the Proposed Rules to “decentralized finance” or “DeFi protocols” that raises administrative due process concerns for industry participants. See ConsenSys Letter at 18; DeFi Education Fund Letter at 19. The foregoing commenters describe systems that use DLT with varying definitions and terminology (some of which the commenters do not define). As discussed above, there is no generally agreed upon definition of “DeFi” or decentralization. See IOSCO Decentralized Finance Report at 1, 9. Nonetheless, as discussed below, the Proposed Rules, like the existing exchange framework, regulate exchange activity, and not the technology underlying such activity
LT with varying definitions and terminology (some of which the commenters do not define). As discussed above, there is no generally agreed upon definition of “DeFi” or decentralization. See IOSCO Decentralized Finance Report at 1, 9. Nonetheless, as discussed below, the Proposed Rules, like the existing exchange framework, regulate exchange activity, and not the technology underlying such activity.
45 See, e.g., a16z Letter at 3 (stating that “DeFi protocols eliminate the need for a central operator that could implement regulatory requirements applicable to traditional securities exchanges or broker-dealers” and therefore the Commission should “clarify that the [p]roposal does not apply to DeFi systems by explicitly excluding them”); LeXpunK Letter at 2 (stating that the Proposed Rules would improperly expand the Commission's authority to regulate “technologists with neither the resources nor the reasonable expectation of being so regulated, who `make available' peer-to-peer `communication protocols' used in DeFi”); ConsenSys Letter at 8-12 (stating its belief that the term “communication protocols” does not cover “blockchain-based systems”); Delphi Digital Letter at 6 (stating that, unless “decentralized-in-actuality software systems—including `automatic market-making' smart contract systems” are carved out of the term “communication protocols,” the Proposed Rules would impose “impossible compliance obligations on persons who may merely write open-source `communications protocol' code or publish information about the contents of communications systems which they do not control”); Blockchain Association Letter II at 3 (stating that application of the Proposed Rules to “decentralized exchange protocols through which digital assets may be traded, [and] operate[d] autonomously and automatically through smart contracts and the participation of their users” would exceed the Commission's statutory authority under the Exchange Act); Letter from Spence Purnell, Director of Technology Policy, Reason Foundation, dated Fe
(stating that application of the Proposed Rules to “decentralized exchange protocols through which digital assets may be traded, [and] operate[d] autonomously and automatically through smart contracts and the participation of their users” would exceed the Commission's statutory authority under the Exchange Act); Letter from Spence Purnell, Director of Technology Policy, Reason Foundation, dated Feb. 23, 2022 at 2 (stating that the Proposed Rules should not apply to “technologies such as decentralized finance and smart-contracts” because they were not explicitly considered in the Proposing Release); Letter from Bryant Eisenbach, dated Feb. 2, 2022 (“Eisenbach Letter”). See also Letter from Rep. Patrick McHenry, Ranking Member, and Rep. Bill Huizenga, Ranking Member Subcommittee on Investor Protection, Entrepreneurship and Capital Markets, House Committee on Financial Services, dated Apr. 18, 2022 (“McHenry/Huizenga Letter”) (expressing concern that the Proposed Rules “can be interpreted to expand the SEC's jurisdiction beyond its existing statutory authority to regulate market participants in the digital asset ecosystem, including in decentralized finance”).
When adopting Exchange Act Rule 3b-16, the Commission stated that the exchange framework is based on the functions performed by a trading system, not on its use of technology. 46 Notwithstanding how an entity may characterize itself or the technology it uses, a functional approach (taking into account the relevant facts and circumstances) will be applied when assessing whether the activities of a trading system meet the definition of an exchange. These principles continue to apply today under existing Rule 3b-16 and would equally apply under Rule 3b-16, as proposed to be amended
hstanding how an entity may characterize itself or the technology it uses, a functional approach (taking into account the relevant facts and circumstances) will be applied when assessing whether the activities of a trading system meet the definition of an exchange. These principles continue to apply today under existing Rule 3b-16 and would equally apply under Rule 3b-16, as proposed to be amended. 47 Accordingly, an organization, association, or group of persons that uses any form or forms of technology ( e.g., DLT, including technologies used by so-called “DeFi” trading systems, computers, networks, the internet, cloud, telephones, algorithms, a
46 See Regulation ATS Adopting Release at 70902.
47 See, e.g., DAO 21(a) Report (stating that “any entity or person engaging in the activities of an exchange, such as bringing together the orders for securities of multiple buyers and sellers using established non-discretionary methods under which such orders interact with each other and buyers and sellers entering such orders agree upon the terms of the trade, must register as a national securities exchange or operate pursuant to an exemption from such registration,” “the automation of certain functions through this technology, `smart contracts,' or computer code, does not remove conduct from the purview of the U.S. federal securities laws,” and that the requirements of the U.S. federal securities laws “apply to those who offer and sell securities in the United States, regardless whether the issuing entity is a traditional company or a decentralized autonomous organization, regardless whether those securities are purchased using U.S. dollars or virtual currencies, and regardless whether they are distributed in certificated form or through distributed ledger technology”).
2
eral securities laws “apply to those who offer and sell securities in the United States, regardless whether the issuing entity is a traditional company or a decentralized autonomous organization, regardless whether those securities are purchased using U.S. dollars or virtual currencies, and regardless whether they are distributed in certificated form or through distributed ledger technology”).
2. So-Called “DeFi” Systems and Exchange Act Rule 3b-16
Several commenters state their belief that the Proposed Rules could cause what they describe as “DeFi” trading systems to meet the criteria of Exchange Act Rule 3b-16(a), as proposed to be amended. 48 So-called “DeFi” trading systems can be used to allow investors to discover prices, find liquidity, locate counterparties, and agree upon terms of a trade for securities, including crypto asset securities, thereby performing market place activities or functions commonly performed by a stock exchange. Today, many systems, some of which are described as “DeFi” by commenters, bring together buyers and sellers of securities, including crypto asset securities, and could meet the existing criteria of Exchange Act Rule 3b-16(a). The Commission understands that so-called “DeFi” trading systems often rely on electronic messages that are exchanged between buyers and sellers so that they can agree upon the terms of a trade without negotiations. 49 If these electronic messages constitute a firm willingness to buy or sell a security, including a crypto asset security, the messages would meet the definition of orders under existing Rule 3b-16(c). 50 And if established, non-discretionary method(s) under which orders of multiple buyers and sellers interact with each other are provided, such as through the provision of certain smart contract functionality, the activities would be covered under existing Rule 3b-16(a)
ll a security, including a crypto asset security, the messages would meet the definition of orders under existing Rule 3b-16(c). 50 And if established, non-discretionary method(s) under which orders of multiple buyers and sellers interact with each other are provided, such as through the provision of certain smart contract functionality, the activities would be covered under existing Rule 3b-16(a). Accordingly, depending on the facts and circumstances, activities performed today using so-called “DeFi” trading systems could meet the criteria of existing Rule 3b-16 and thus constitute exchange activity. The proposed amendments to Rule 3b-16(a) would not, in any way, change whether such activities constitute exchange activity under section 3(a)(1) and Rule 3b-16(a).
48 See DeFi Education Fund Letter at 15; Circle Letter at 3; ADAM Letter I at 1-2; STANY Letter at 2; Vollmer Letter at 2; Crypto Council Letter at 2; LeXpunK Letter at 7-8.
49 For example, AMM is a mechanism designed to create liquidity for others seeking to effectuate trades. See President's Working Group on Financial Markets, Federal Deposit Insurance Corporation, and Office of the Comptroller of the Currency, Report on Stablecoins (Nov. 2021), available at https://home.treasury.gov/system/files/136/StableCoinReport_Nov1_508.pdf. Liquidity pools of so-called “DeFi” trading systems rely on AMM protocols which typically use preset mathematical equations ( e.g., x*y=k, where x and y represent the values of tokens in a liquidity pair and k is a constant) to ensure the ratio of assets in the liquidity pools remains balanced and determine prices based on trading volumes. See U.S. Department of the Treasury, Crypto-Assets: Implications for Consumers, Investors, and Businesses (Sept. 2022) (“Crypto-Assets Treasury Report”), available at https://home.treasury.gov/system/files/136/CryptoAsset_EO5.pdf. Some commenters argue that systems that use AMMs do not use trading interest as described in the Proposed Rules
s balanced and determine prices based on trading volumes. See U.S. Department of the Treasury, Crypto-Assets: Implications for Consumers, Investors, and Businesses (Sept. 2022) (“Crypto-Assets Treasury Report”), available at https://home.treasury.gov/system/files/136/CryptoAsset_EO5.pdf. Some commenters argue that systems that use AMMs do not use trading interest as described in the Proposed Rules. See LeXpunK Letter at 12-13; Delphi Digital Letter at 9-10. One commenter states that AMM users do not interact with each other but with a pool of liquidity resting in a smart contract. See LeXpunK Letter at 12-13. This commenter states that forms of non-firm trading interest—conditional orders and indications of interest—discussed in the Proposing Release, “do not align with AMMs provision of automated liquidity through the smart contract-based deterministic mechanisms,” where no party imposes such conditions or communicates such interest. See id. One commenter states that there are no “orders” on an AMM because, in contrast to a “centralized” platform which permits makers and takers to agree upon a price, an AMM sets the price. See Delphi Digital Letter at 9-10.
50 See 17 CFR 240.3b-16(c).
As discussed above, the Commission preliminarily believes that New Rule 3b-16(a) Systems, including some so-called “DeFi” systems, trade some amount of crypto asset securities, and would, under the proposed amendments to Exchange Act Rule 3b-16(a), be required to register as a national securities exchange or comply with the conditions of Regulation ATS.
3. Custodial Services Is Generally Not Relevant to Exchange Analysis
Some commenters state that because so-called “DeFi” trading systems do not custody assets, they should not be subject to exchange regulation. 51 One commenter states that trading conducted using “DeFi” trading systems does not involve users depositing assets with a central authority
mply with the conditions of Regulation ATS.
3. Custodial Services Is Generally Not Relevant to Exchange Analysis
Some commenters state that because so-called “DeFi” trading systems do not custody assets, they should not be subject to exchange regulation. 51 One commenter states that trading conducted using “DeFi” trading systems does not involve users depositing assets with a central authority. 52 Another commenter states that “custody” with reference to “DeFi” means self-custody, which the commenter states does not fit “the Commission's model, under which all exchanges are centralized.” 53 Neither existing Exchange Act Rule 3b-16 nor Rule 3b-16, as proposed to be amended, requires an organization, association, or group of persons to provide custodial services to be considered an exchange under section 3(a)(1) of the Exchange Act and Rule 3b-16 thereunder. 54 Thus, custodial services generally is not a relevant factor to the exchange analysis.
51 See a16z Letter at 8-9; GDCA Letter II at 11; DeFi Education Fund Letter at 6. See also LeXpunK Letter at 4 n.18 (stating that no “ `custody' or `transfer' actually occurs” in the context of a “smart contract-based platform”).
52 See a16z Letter at 8-9. The commenter cites a paper stating “one of the main advantages of decentralized exchanges over centralized exchanges is the ability for users to keep control of their private keys.” See id. at 8 n.41 (citing Igor Makarov & Antoinette Schoar, Cryptocurrencies and Decentralized Finance (DeFi) 23 (Brookings Paper on Econ. Activity, Conference Draft, 2022)).
53 See GDCA Letter II at 11. See also DeFi Education Fund Letter at 6 (stating “DeFi protocols” present “no financial risk for users from broker activity or custody”). One commenter also states that the Commission has provided no public guidance regarding how a digital asset communication protocol system could arrange for custody and settlement to the Commission's satisfaction, in order to operate as an exchange. See GDCA Letter II at 10
i Education Fund Letter at 6 (stating “DeFi protocols” present “no financial risk for users from broker activity or custody”). One commenter also states that the Commission has provided no public guidance regarding how a digital asset communication protocol system could arrange for custody and settlement to the Commission's satisfaction, in order to operate as an exchange. See GDCA Letter II at 10. Further, some commenters question how exchange regulation will apply to trading activities that use “DeFi” and do not involve an intermediary for trading or to custody securities. See supra note 52 and infra note 56.
54 The Customer Protection Rule requires a broker-dealer to promptly obtain and thereafter maintain physical possession or control of all fully-paid and excess margin securities it carries for the account of customers. See 17 CFR 240.15c3-3(b). In 2020, the Commission issued a statement describing its position that, for a period of five years, special purpose broker-dealers operating under the circumstances set forth in the statement will not be subject to a Commission enforcement action on the basis that the broker-dealer deems itself to have obtained and maintained physical possession or control of customer fully-paid and excess margin crypto asset securities for purposes of 17 CFR 240.15c3-3(b)(1) (“Rule 15c3-3(b)(1)”) under the Exchange Act. See Commission Statement on Custody of Digital Asset Securities by Special Purpose Broker-Dealers. To date, no person has been approved to act as a special purpose broker-dealer custodying crypto asset securities.
4. Group of Persons as the Exchange
Some commenters ask that the Commission explain which actor or group of actors would be responsible for compliance and how so-called “DeFi” trading systems should comply with exchange regulatory requirements. 55 Some commenters express concerns that the proposed amendments to Exchange Act Rule 3b-16(a) would inappropriately apply to systems that purport not to involve intermediaries
the Exchange
Some commenters ask that the Commission explain which actor or group of actors would be responsible for compliance and how so-called “DeFi” trading systems should comply with exchange regulatory requirements. 55 Some commenters express concerns that the proposed amendments to Exchange Act Rule 3b-16(a) would inappropriately apply to systems that purport not to involve intermediaries. 56 One commenter states that providers of rule sets on how messages should be formed, stored, and relayed on a network are not like “intermediaries of the traditional financial system” because “all they are doing is 57 In addition, some commenters state that “DeFi” trading systems may be unable to comply with exchange regulatory requirements because they lack a central operator. 58 Some commenters interpret Exchange Act Rule 3b-16(a), as proposed to be amended, to mean that each entity that performs any exchange function would need to register as a national securities exchange or comply with the conditions of Regulation ATS. 59 For example, some commenters state that, under the proposed amendments to Exchange Act Rule 3b-16(a), exchange regulation could extend to persons including open source developers who contribute code to the software repositories where software for so-called “DeFi” trading systems is first published, persons who republish and share this information, and persons who connect to the peer-to-peer networks on which “DeFi” activities takes place. 60 One commenter states that the group of persons involved in a “DeFi” trading system—including developers, AMMs, and miners—could all comprise essential components of the market infrastructure. 61 This commenter further states that the fact that these roles might be “decentralized” does not change that they would be considered a group of persons who constitutes, maintains, or provides facilities for bringing together purchasers and sellers of securities. 62
55 See Letter from Paul Grewal, Chief Legal Officer, Coinbase Global, Inc., dated Apr
ial components of the market infrastructure. 61 This commenter further states that the fact that these roles might be “decentralized” does not change that they would be considered a group of persons who constitutes, maintains, or provides facilities for bringing together purchasers and sellers of securities. 62
55 See Letter from Paul Grewal, Chief Legal Officer, Coinbase Global, Inc., dated Apr. 18, 2022 (“Coinbase Letter”) at 7; a16z Letter at 3; Blockchain Association Letter II at 8.
56 See a16z Letter at 10; ConsenSys Letter at 8; DeFi Education Fund Letter at 3, 11; Blockchain Association Letter II at 3, 5; CoinList Letter at 2; Eisenbach Letter at 2. For example, one commenter states that what it calls “decentralized” systems allow anyone to participate rather than rely on gatekeepers. See ConsenSys Letter at 8.
57 See Letter from Coin Center, dated Apr. 14, 2022 (“Coin Center Letter”) at 13. Another commenter states that developers of “DeFi protocols” would not qualify as a “group of persons” because they “merely make tools available for parties to communicate.” See DeFi Education Fund Letter at 15.
58 See, e.g., a16z Letter at 3; Coin Center Letter at 12; CoinList Letter at 2; GDCA Letter II at 11; Blockchain Association/DeFi Education Fund Letter at 5.
59 See, e.g., Letter from Robert Toomey, Managing Director and Associate General Counsel, Securities Industry and Financial Markets Association, dated June 13, 2022 (“SIFMA Letter II”) at 8.
60 See Coin Center Letter at 25. See also Delphi Digital Letter at 9 (stating that participants could “number in the hundreds or thousands and be distributed all over the world”).
61 See Letter from James F. Tierney, Assistant Professor of Law, University of Nebraska College of Law, dated June 13, 2022 (“Tierney Letter”) at 2 (stating that these participants in “blockchain and other DeFi applications” all “might play analogous roles to in-house counsel, market makers, and back-office clearance roles in a traditional exchange setup”).
62 See id
uted all over the world”).
61 See Letter from James F. Tierney, Assistant Professor of Law, University of Nebraska College of Law, dated June 13, 2022 (“Tierney Letter”) at 2 (stating that these participants in “blockchain and other DeFi applications” all “might play analogous roles to in-house counsel, market makers, and back-office clearance roles in a traditional exchange setup”).
62 See id.
The existence of smart contracts on a blockchain does not materialize in the absence of human activity or a machine (or code) controlled or deployed by humans. The Commission understands that, typically, including for so-called “DeFi” trading systems, a single organization constitutes, maintains, or provides the market place or facilities for bringing together buyers and sellers of securities or otherwise performs with respect to securities the functions commonly performed by a stock exchange under section 3(a)(1) and Exchange Act Rule 3b-16 thereunder. 63
63 See IOSCO Decentralization Finance Report at 8 n.13 (stating that “claims about decentralization for many projects may not hold up to scrutiny of the technical reality of what can be changed in the system, who can be involved in the decisions, and who actually is involved”).
While it is common today for a single organization to provide a market place or facilities to bring together buyers and sellers of securities and meet the definition of an exchange, an exchange can also exist where a market place or facilities are provided by a group of persons, rather than a single organization
in the system, who can be involved in the decisions, and who actually is involved”).
While it is common today for a single organization to provide a market place or facilities to bring together buyers and sellers of securities and meet the definition of an exchange, an exchange can also exist where a market place or facilities are provided by a group of persons, rather than a single organization. 64 Under section 3(a)(1), and Exchange Act Rule 3b-16(a), the term exchange “means any organization, association, or group of persons, whether incorporated or unincorporated, which constitutes, maintains, or provides a market place or facilities for bringing together buyers and sellers of securities or perform with respect to securities the functions commonly performed by a stock exchange.” 65 Thus, a group of persons, whether incorporated or unincorporated, can together constitute, maintain, or provide a market place or facilities or perform with respect to securities the functions commonly performed by a stock exchange. In determining which persons would be included in the group of persons that constitutes, maintains, or provides an exchange or performs with respect to securities the functions commonly performed by a stock exchange, important factors would generally include whether the persons act in concert in establishing, maintaining, or providing a market place or facilities for bringing together buyers and sellers of securities or in performing with respect to securities the functions commonly performed by a stock exchange, or exercise control, or share control, over aspects of such market place or facilities or the performance of functions commonly performed by a stock exchange
ns act in concert in establishing, maintaining, or providing a market place or facilities for bringing together buyers and sellers of securities or in performing with respect to securities the functions commonly performed by a stock exchange, or exercise control, or share control, over aspects of such market place or facilities or the performance of functions commonly performed by a stock exchange. In particular, when a group of persons exercises control, or shares control, over the organizational, financial, or operational aspects of a market place or facilities for bringing together buyers and sellers of securities, they are a group of persons that can be deemed to constitute, maintain, or provide the market place or facilities. 66
64 The term “person” means a natural person, company, government, or political subdivision, agency, or instrumentality of a government. 15 U.S.C. 78c(a)(9).
65 In a recent decision, the United States Court of Appeals for the District of Columbia Circuit held that the term “group of persons” “certainly includes closely connected corporate affiliates” and noted that “[w]hether two or more persons are or may be acting in concert is likely the key consideration” in determining whether two or more entities may constitute a “group of persons” for purposes of the statute. Intercontinental Exch., Inc. v. SEC, 23 F.4th 1013, 1024 (D.C. Cir. 2022). In addition, the court stated that it was “not suggest[ing] the term `group of persons' is synonymous with corporate affiliation” and that “one corporation that is affiliated with but not controlled by another may or may not, depending upon the circumstances, be considered a `group of persons' ” for the purposes of section 3(a)(1) of the Exchange Act. See id
, 23 F.4th 1013, 1024 (D.C. Cir. 2022). In addition, the court stated that it was “not suggest[ing] the term `group of persons' is synonymous with corporate affiliation” and that “one corporation that is affiliated with but not controlled by another may or may not, depending upon the circumstances, be considered a `group of persons' ” for the purposes of section 3(a)(1) of the Exchange Act. See id.
66 In the Proposing Release, the Commission explained that, depending on the activities of the persons involved with the market place or facilities, a group of persons, who may each perform a function of the market place that meets the criteria of Exchange Act Rule 3b-16, can together provide, constitute, or maintain a market place or facilities for bringing together buyers and sellers of securities and together meet the definition of exchange. See Proposing Release at 15506 n.109. See also Regulation ATS Adopting Release at 70891 (“. . . any subsidiary or affiliate of a registered exchange could not integrate, or otherwise link the alternative trading system with the exchange, including using the premises or property of such exchange for effecting or reporting a transaction, without being considered a `facility of the exchange.' ”). In determining whether affiliated persons would be a “group of persons” for the purposes of section 3(a)(1) of the Exchange Act and Rule 3b-16 thereunder, an important factor is whether the operations and management of the affiliated persons are separate
ng the premises or property of such exchange for effecting or reporting a transaction, without being considered a `facility of the exchange.' ”). In determining whether affiliated persons would be a “group of persons” for the purposes of section 3(a)(1) of the Exchange Act and Rule 3b-16 thereunder, an important factor is whether the operations and management of the affiliated persons are separate. For example, an affiliated entity of an exchange might not be considered a group of persons with that exchange if there is independent governance, management, and oversight between affiliated entities; prevention of strategic coordination or information sharing between the affiliated entities by way of information barriers and other procedures; separation of functions relating to technology, operations and infrastructure, sales and marketing, branding, and staffing; and avoidance of business links, such as routing, fees, billing, and membership.
Whether persons act in concert or exercise control, or share control, requires an analysis of the activities of each person and the totality of facts and circumstances. In assessing whether a person would be acting in concert with a group of persons, one factor to consider, depending on other facts and circumstances, would be the extent to which a person acts with an agreement (formal or informal) to constitute, maintain, or provide a market place or facilities for bringing together buyers and sellers of securities or to perform with respect to securities a function commonly performed by a stock exchange. For example, if one entity agrees with another entity to combine aspects of each other's market places or facilities ( e.g., order books, display functionalities, or matching engines) to bring together buyers and sellers of securities, both entities could be considered part of the group and thus an exchange
or to perform with respect to securities a function commonly performed by a stock exchange. For example, if one entity agrees with another entity to combine aspects of each other's market places or facilities ( e.g., order books, display functionalities, or matching engines) to bring together buyers and sellers of securities, both entities could be considered part of the group and thus an exchange.
Control could occur through several means, including, among other things, ownership interest, corporate organizational structure and management, significant financial interest, or the ability to determine or modify participant access, securities traded, operations or trading policies, or non-discretionary methods of the market place or facilities. For example, a person that can determine or modify, either individually or with others, the entering, storing, matching, or display of trading interest ( e.g., a matching engine, a smart contract) would be exercising control over the operations of the market place or facilities. In addition, a person that can determine or modify, or grant or limit access to, for example, either individually or with others, the market or other data about the securities and securities transactions available on the market place or facility, order types, order interaction procedures ( e.g., counterparty selection, segmentation), the priority or price at which trading interest will execute, or protocols for negotiation, would have the ability to determine trading policies or methods and exercise control over the market place or facilities.
The ability to exercise control over a market place or facilities is not limited solely to the operational control. 67 Also, a person that, for example, either individually or with others, can determine or modify, with respect to the market place or facilities, the securities made available for trading or the access requirements and conditions for participation would be exercising control
ities.
The ability to exercise control over a market place or facilities is not limited solely to the operational control. 67 Also, a person that, for example, either individually or with others, can determine or modify, with respect to the market place or facilities, the securities made available for trading or the access requirements and conditions for participation would be exercising control. In addition, a person could exercise control by determining who can, and in what amount, share in profits or revenues derived from the market place or facilities, or by having the ability to enter into legal or financial agreements or arrangements on behalf of or in the name of the market place or facilities. Depending on the facts and circumstances, significant holders of governance or other tokens, for example, could also be considered part of the group of persons and thus an exchange if they can control certain aspects of it. 68
67 See, e.g., Regulation ATS Adopting Release at 78052 (stating that a system that standardizes the material terms of instruments traded on the system will be considered to use established, non-discretionary methods).
68 This analysis would depend on facts and circumstances. Whether a token holder can exercise control over a market place or facilities and be considered part of a “group of persons” would depend, for example, on the number of total token holders, or, if a holder's votes are weighted proportionally to the size of their holdings of tokens, the size of their holdings, as well as what parameters the governance tokens are set to control ( e.g., fundamental operational decisions, strategic direction of the company, budgetary decisions, and ability to change the underlying code), among other things.
Generally, an entity that engages a service provider or vendor to operate a market place or facilities for bringing together buyers and sellers of securities directs, manages, and oversees the activities of the service provider or vendor
.g., fundamental operational decisions, strategic direction of the company, budgetary decisions, and ability to change the underlying code), among other things.
Generally, an entity that engages a service provider or vendor to operate a market place or facilities for bringing together buyers and sellers of securities directs, manages, and oversees the activities of the service provider or vendor. In this instance, the entity, not the service provider or vendor, controls the market place or facilities, and the entity is responsible for compliance with federal securities laws. In certain circumstances, however, a service provider or vendor could exercise control, or share control, over aspects of the market place or facilities along with the entity that procured the service provider or vendor. In that case, the service provider or vendor would be considered a person within a group of persons that constitutes, maintains, or provides the market place or facilities for bringing together buyers and sellers of securities. 69
69 See Proposing Release at 15548. This would not encompass purely administrative items, such as human resources support, or basic overhead items, such as phone services, electricity, and other utilities. In the Proposing Release, the Commission recognized that an ATS may engage an entity other than the broker-dealer operator to perform an operation or function of the ATS or a subscriber may be directed to use an entity to access a service of the ATS, such as order entry, disseminating market data, or display, for example. See Proposing Release at 15548. In such instances, the ATS must ensure that the entity performing the ATS function complies with Regulation ATS with respect to the ATS activities performed. See id
or to perform an operation or function of the ATS or a subscriber may be directed to use an entity to access a service of the ATS, such as order entry, disseminating market data, or display, for example. See Proposing Release at 15548. In such instances, the ATS must ensure that the entity performing the ATS function complies with Regulation ATS with respect to the ATS activities performed. See id.
The group of persons that constitutes, maintains, or provides a market place or facilities for bringing together buyers and sellers of securities or performs with respect to securities the functions commonly performed by a stock exchange, and is thus an exchange, would collectively have the responsibility for compliance with federal securities laws. A group of persons must consider how they will comply with the Exchange Act registration requirements given their activities, which can include, but are not limited to, designating a member of the group, 70 to register the group or forming an organization to register as an exchange or, to operate as an ATS, registering as a broker-dealer and becoming a member of Financial Industry Regulatory Authority (“FINRA”) to ensure compliance with the requirements of the Exchange Act, Commission rules, and FINRA rules. 71
70 The group of persons would be collectively responsible for ensuring that the designated member of the group fulfills its regulatory responsibilities.
71 An ATS that complies with Regulation ATS and registers as a broker-dealer would be required to, among other things, comply with the anti-money laundering and countering the financing of terrorism (AML/CFT) obligations under the Bank Secrecy Act. 31 CFR 1023.210; 31 CFR 1023.320. The Bank Secrecy Act is codified at 31 U.S.C. 5311-5314; 5316-5332 and 12 U.S.C. 1829b, 1951-1959
responsibilities.
71 An ATS that complies with Regulation ATS and registers as a broker-dealer would be required to, among other things, comply with the anti-money laundering and countering the financing of terrorism (AML/CFT) obligations under the Bank Secrecy Act. 31 CFR 1023.210; 31 CFR 1023.320. The Bank Secrecy Act is codified at 31 U.S.C. 5311-5314; 5316-5332 and 12 U.S.C. 1829b, 1951-1959. Additionally, sections 5(a) and 5(c) of the Securities Act of 1933 (“Securities Act”) generally prohibit any person, including broker-dealers, from selling a security unless a registration statement is in effect or has been filed with the Commission as to the offer and sale of such security. See 15 U.S.C. 77e(a) and (c). A New Rule 3b-16(a) System that operates as an ATS, which is a registered broker-dealer, could be subject to liability under section 5 of the Securities Act for facilitating the sale of a security by its customer on the ATS if the sale of such security is not registered or an exemption from the registration provisions does not apply. Section 4(a)(4) of the Securities Act provides an exemption for “brokers' transactions, executed upon customers' orders on any exchange or in the over-the-counter market but not the solicitation of such orders.” See 15 U.S.C. 77d(a)(4). To rely on this exemption, a broker-dealer is required to conduct a “reasonable inquiry” into the facts surrounding a proposed unregistered sale of securities before selling the securities to form reasonable grounds for believing that a selling customer's part of the transaction is exempt from section 5 of the Securities Act. The Commission has stated that broker-dealers “have a responsibility to be aware of the requirements necessary to establish an exemption from the registration requirements of the Securities Act and should be reasonably certain such an exemption is available.” In the Matter of World Trade Financial Corp., Securities Exchange Act Release No. 66114, 13 (Jan
xempt from section 5 of the Securities Act. The Commission has stated that broker-dealers “have a responsibility to be aware of the requirements necessary to establish an exemption from the registration requirements of the Securities Act and should be reasonably certain such an exemption is available.” In the Matter of World Trade Financial Corp., Securities Exchange Act Release No. 66114, 13 (Jan. 6, 2012) (quoting Stone Summers & Co., Securities Exchange Act Release No. 9839, 3 (Nov. 3, 1972)).
5. Group of Persons and So-Called “DeFi” Systems
One commenter states users of what it characterizes as “DeFi” protocols should not be considered part of a group of persons as they act independently of each other. 72 The commenter states that developers and users of “DeFi” protocols would not qualify as a “group of persons” because the developers have no ongoing relationship with either market participants or other financial providers and merely make tools available for parties to communicate, and users are acting independently of each other. 73 Another commenter describes that the “DeFi protocols” deploying AMM functionality rely on many distinct groups or participants, which may not be “affiliated or extrinsically coordinated” with one another. 74
72 See DeFi Education Fund Letter at 15.
73 See id.
74 See Delphi Digital Letter at 9 (describing that “[t]hey do not co-own assets or operate a single enterprise for profit, do not know each other's identities, and have diverse (and often competing) motivations”).
Trading on so-called “DeFi” systems can involve multiple actors. These actors can include, for example, the provider(s) of the DeFi application or user interface, developers of AMMs or other DLT code, decentralized autonomous organizations (“DAO”), 75 and issuers or holders of governance or other tokens
t, do not know each other's identities, and have diverse (and often competing) motivations”).
Trading on so-called “DeFi” systems can involve multiple actors. These actors can include, for example, the provider(s) of the DeFi application or user interface, developers of AMMs or other DLT code, decentralized autonomous organizations (“DAO”), 75 and issuers or holders of governance or other tokens. Often, a single organization constitutes, maintains, or provides a DLT-based market place or facilities for bringing together buyers and sellers of securities or performs with respect to securities the functions commonly performed by a stock exchange; however, a group of persons can likewise do so. As indicated above, one possible avenue for determining which persons comprise a group of persons can include whether such persons act in concert to establish, provide, or maintain a market place or facilities for securities or to perform with respect to securities the functions commonly performed by a stock exchange, or exercise control, or share control, over aspects of the market place or facilities or the performance of functions commonly performed by a stock exchange. 76 These actors can form a group of persons if they act in concert to perform, or exercise control or share control over, different functions of a market place or facilities for bringing together buyers and sellers of securities that, taken together, satisfy the elements of existing Exchange Act Rule 3b-16(a) or Rule 3b-16(a), as proposed to be amended.
75 Validators and miners verify transactions on the underlying blockchain and the function they perform is not only with respect to a particular trading system. Validators and miners use a consensus mechanism ( e.g., proof-of-stake or proof-of-work) to verify and add transactions to a distributed ledger in exchange for crypto assets. See Crypto-Assets Treasury Report at 11-12.
76 See supra note 66
Validators and miners verify transactions on the underlying blockchain and the function they perform is not only with respect to a particular trading system. Validators and miners use a consensus mechanism ( e.g., proof-of-stake or proof-of-work) to verify and add transactions to a distributed ledger in exchange for crypto assets. See Crypto-Assets Treasury Report at 11-12.
76 See supra note 66.
As discussed above, in assessing whether a person would be acting in concert with a group of persons, one factor to consider, depending on other facts and circumstances, would be the extent to which a person acts with an agreement (formal or informal) to perform a function of a market place or facilities for bringing together buyers and sellers of securities. 77 A software developer who, acting independently and separate from an organization, publishes or republishes code without any agreement (formal or informal) with any person for that code to be used for a function of a market place or facilities for bringing together buyers and sellers of securities may be less likely to be acting in concert to provide a market place or facilities for bringing together buyers and sellers. 78 This could be the case even if the software developer's code is subsequently adopted and implemented into a market place or facilities for securities by an unrelated person. Whether the activities of actors amount to a group of persons requires an analysis of the totality of facts and circumstances and the activities of each actor. If the activities of any combination of actors constitute, maintain, or provide, together, a market place or facilities for bringing together buyers and sellers for securities or perform with respect to securities a function commonly performed by a stock exchange, they could today be considered a group of persons and thus an exchange under section 3(a)(1) of the Exchange Act and Rule 3b-16 thereunder and therefore be required to register as an exchange under section 5 of the Exchange Act
market place or facilities for bringing together buyers and sellers for securities or perform with respect to securities a function commonly performed by a stock exchange, they could today be considered a group of persons and thus an exchange under section 3(a)(1) of the Exchange Act and Rule 3b-16 thereunder and therefore be required to register as an exchange under section 5 of the Exchange Act. 79
77 See supra section II.B.4.
78 See, e.g., LeXpunK Letter at 15 (requesting that the Commission clarify that persons who “write and publish smart contract code as a hobby or business, whether to an open-source repository otherwise, and may not otherwise be subject to the jurisdiction of the U.S.” are not intended to be captured by the Proposed Rules). If a software developer receives compensation for publishing, independently from an organization, code for a trading facility to match orders or a protocol for buyers and sellers to negotiate a trade, the software developer could be acting in concert with a group of persons to provide a market place or facilities for bringing together buyers and sellers.
79 See, e.g., Regulation ATS Adopting Release at 70852 (“[I]f an organization arranges for separate entities to provide different pieces of a trading system, which together meet the definition contained in paragraph (a) of Rule 3b-16, the organization responsible for arranging the collective efforts will be deemed to have established a trading facility.”). See also Proposing Release at 15506 (stating the proposed change to use the phrase “makes available” is intended to make clear that, in the event that a party other than the organization, association, or group of persons performs a function of the exchange, the function performed by that party would still be captured for purposes of determining the scope of the exchange under Exchange Act Rule 3b-16)
also Proposing Release at 15506 (stating the proposed change to use the phrase “makes available” is intended to make clear that, in the event that a party other than the organization, association, or group of persons performs a function of the exchange, the function performed by that party would still be captured for purposes of determining the scope of the exchange under Exchange Act Rule 3b-16). The Proposing Release also stated that, “[d]epending on the activities of the persons involved with the market place, a group of persons, who may each perform a part of the 3b-16 system, can together provide, constitute, or maintain a market place or facilities for bringing together purchasers and sellers of securities and together meet the definition of exchange. In such a case, the group of persons would have the regulatory responsibility for the exchange.” See id. at 15506 n.109. See also infra notes 101-103 and accompanying text.
One commenter states that attributing the function of constituting, maintaining, or providing an exchange to persons who initially created or deployed the system's code may not be practicable or advance the Commission's policy objectives because according to the commenter, the system, once deployed, typically cannot be significantly altered or controlled by any such persons. 80 A smart contract deployed to, and run on, a blockchain is typically accompanied by other functionality to bring together buyers and sellers of securities ( e.g., a user interface or website), and these functionalities can be provided and maintained by more than one party. If, for example, an organization deploys a smart contract that the organization cannot significantly alter or control but constitutes a market place for securities under existing Exchange Act Rule 3b-16 or Rule 3b-16, as proposed to be amended, then that organization would be an exchange and would be responsible for compliance with federal securities laws for that market place
more than one party. If, for example, an organization deploys a smart contract that the organization cannot significantly alter or control but constitutes a market place for securities under existing Exchange Act Rule 3b-16 or Rule 3b-16, as proposed to be amended, then that organization would be an exchange and would be responsible for compliance with federal securities laws for that market place. 81 Given that such a market place could be publicly available to bring together buyers and sellers of securities, requiring the organization to be responsible in this case would advance the Commission's policy objectives by ensuring the exchange complies with federal securities laws and regulations, including, among other things, the oversight, investor protection, and fair and orderly market principles applicable to registered exchanges and ATSs.
80 See Coinbase Letter at 6. Likewise, some commenters state that software developers cannot modify or control the code they have developed after it is launched. See Delphi Digital Letter at 8-9; Blockchain Association/DeFi Education Fund Letter at 5; DeFi Education Fund Letter at 11; Stinson Letter; Letter from Roman Scher, dated Apr. 18, 2022.
81 See also supra 78 and accompanying text (discussing “group of persons” involving a software developer acting independently and separate from an organization).
6. Feasibility of Compliance With Exchange Regulatory Requirements
Some commenters state that so-called “DeFi” trading systems may have difficulty complying with certain exchange regulatory requirements. 82 For example, one commenter states it is unclear that any party would have the necessary information to comply with Regulation ATS. 83 In addition, some commenters question how DeFi trading systems would comply with broker-dealer requirements. 84
82 See, e.g., a16z Letter at 3; CoinList Letter at 2; GDCA Letter II at 8, 10
ave difficulty complying with certain exchange regulatory requirements. 82 For example, one commenter states it is unclear that any party would have the necessary information to comply with Regulation ATS. 83 In addition, some commenters question how DeFi trading systems would comply with broker-dealer requirements. 84
82 See, e.g., a16z Letter at 3; CoinList Letter at 2; GDCA Letter II at 8, 10.
83 See a16z Letter at 15 (stating that there is no central operator of a DeFi exchange that could complete Form ATS or comply with periodic reporting requirements and that those who make available AMMs cannot identify, track the orders of, or report to the Commission information about users).
84 See, e.g., GDCA Letter II at 8; Blockchain Association Letter II at 8; Letter from Lilya Tessler, Founder and Co-Chair, Digital Asset Regulatory & Legal Alliance, Kristin Boggiano, Founder and Co-Chair, Digital Asset Regulatory & Legal Alliance, Lee Schneider, Co-Founder, Global Blockchain Convergence, Cathy Yoon, Co-Founder, Global Blockchain Convergence, Renata Szkoda, Chairwoman, Global Digital Asset & Cryptocurrency Association, dated Apr. 14, 2022 (“DARLA, GBC, and Global DCA Letter”) at 9.
The investor protection, fair and orderly markets, transparency, and oversight benefits of the federal securities laws are just as relevant to a system that uses DLT and meets the existing criteria of Exchange Act Rule 85
85 See DAO 21(a) Report (stating that “the automation of certain functions through [distributed ledger or blockchain] technology `smart contracts,' or computer code, does not remove conduct from the purview of the U.S. federal securities laws” and that the requirements of the U.S. federal securities laws “apply to those who offer and sell securities in the United States, regardless whether the issuing entity is a traditional company or a decentralized autonomous organization, regardless whether those securities are purchased using U.S
racts,' or computer code, does not remove conduct from the purview of the U.S. federal securities laws” and that the requirements of the U.S. federal securities laws “apply to those who offer and sell securities in the United States, regardless whether the issuing entity is a traditional company or a decentralized autonomous organization, regardless whether those securities are purchased using U.S. dollars or virtual currencies and regardless whether they are distributed in certificated form or through distributed ledger technology”).
One commenter states that “many Communication Protocol Systems are neither `brokers' nor `dealers' as defined by the Exchange Act because they do not effect securities transactions,” which the commenter equates to “order execution,” and “do not engage in the business of buying and selling securities.” 86 The commenter states accordingly that the option to qualify as an ATS is not available for Communication Protocol Systems under current law, as only a registered broker-dealer may qualify as an ATS. 87
86 See GDCA Letter II at 11-13.
87 See id.
Regulation ATS establishes a regulatory framework for ATSs. An ATS meets the definition of “exchange” under existing Exchange Act Rule 3b-16(a) and Exchange Act Rule 3b-16(a), as proposed to be amended, but is not required to register as a national securities exchange if the ATS complies with the conditions of Regulation ATS, which include registering as a broker-dealer. Section 3(a)(4)(A) of the Exchange Act defines “broker” as “any person engaged in the business of effecting transactions in securities for the accounts of others.” 88 The question of whether a person is a broker within the meaning of section 3(a)(4) turns on the facts and circumstances of the matter. Under section 3(a)(4)(A), the terms “engaged in the business” and “effecting transactions” are not defined by statute; however, effecting transactions in securities includes more than just executing trades or forwarding securities orders to a broker-dealer for execution
uestion of whether a person is a broker within the meaning of section 3(a)(4) turns on the facts and circumstances of the matter. Under section 3(a)(4)(A), the terms “engaged in the business” and “effecting transactions” are not defined by statute; however, effecting transactions in securities includes more than just executing trades or forwarding securities orders to a broker-dealer for execution. 89 In particular, the Commission stated that effecting securities transactions can include participating in the transactions through routing or matching orders, or facilitating the execution of a securities transaction. 90 In addition, courts have stated that a person may be found to be acting as a “broker” if the person participates in securities transactions “at key points in the chain of distribution.” 91 Accordingly, the Commission believes that a New Rule 3b-16(a) System that seeks to operate as an ATS could register as a broker-dealer.
88 15 U.S.C. 78c(a)(4)(A). Section 3(a)(5)(A) defines “dealer” as any person engaged in the business of buying and selling securities, with certain exceptions, for such person's own account through a broker or otherwise. 15 U.S.C. 78c(a)(5)(A).
89 See Securities Exchange Act Release No. 44291 (May 11, 2001), 66 FR 27760, 27772-73 (May 18, 2001) (stating that effecting securities transactions can include participating in the transactions through (1) identifying potential purchasers of securities; (2) screening potential participants in a transaction for creditworthiness; (3) soliciting securities transactions; (4) routing or matching orders, or facilitating the execution of a securities transaction; (5) handling customer funds and securities; and (6) preparing and sending transaction confirmations (other than on behalf of a broker-dealer that executes the trades)
purchasers of securities; (2) screening potential participants in a transaction for creditworthiness; (3) soliciting securities transactions; (4) routing or matching orders, or facilitating the execution of a securities transaction; (5) handling customer funds and securities; and (6) preparing and sending transaction confirmations (other than on behalf of a broker-dealer that executes the trades). Further, the Commission stated in the Regulation ATS Adopting Release that a trading system that falls within the Commission's interpretation of “exchange” in Rule 3b-16 will still be considered an “exchange” even if it matches two trades and routes them to another system or exchange for execution and that whether or not the actual execution of the order takes place on the system is not a determining factor of whether the system falls under Exchange Act Rule 3b-16. See Regulation ATS Adopting Release at 70852.
90 See Securities Exchange Act Release No. 44291 (May 11, 2001), 66 FR 27760, 27772-73 (May 18, 2001).
91 See Mass. Fin. Serv., Inc. v. Sec. Inv. Prot. Corp., 411 F. Supp. 411, 415 (D. Mass. 1976), aff'd 545 F.2d 754 (1st Cir. 1976). See also SEC v. Nat'l Exec. Planners, Ltd., 503 F. Supp. 1066, 1073 (M.D.N.C. 1980). Courts have also stated that in determining whether a person has acted as a broker, several factors are considered, including “whether the person: (1) actively solicited investors; (2) advised investors as to the merits of an investment; (3) acted with a `certain regularity of participation in securities transactions;' and (4) received commissions or transaction-based remuneration.” See, e.g., SEC v. U.S. Pension Trust Corp., 2010 WL 3894082, *20-21 (S.D. Fla. 2010).
Given that the Proposing Release applies to New Rule 3b-16(a) Systems that use DLT, the Commission seeks responses to the following questions:
4
of an investment; (3) acted with a `certain regularity of participation in securities transactions;' and (4) received commissions or transaction-based remuneration.” See, e.g., SEC v. U.S. Pension Trust Corp., 2010 WL 3894082, *20-21 (S.D. Fla. 2010).
Given that the Proposing Release applies to New Rule 3b-16(a) Systems that use DLT, the Commission seeks responses to the following questions:
4. Which, if any, activities performed on so-called “DeFi” trading systems meet the criteria of Rule 3b-16(a), as proposed to be amended? For example, does the use of AMMs alone bring together multiple buyers and sellers of securities through the use of non-firm trading interest? Please explain. Please identify any relevant data, literature, or other information that could assist the Commission in analyzing this issue.
5. Please give examples of New Rule 3b-16(a) Systems for crypto asset securities that use DLT or are so-called “DeFi” systems. Approximately how many such systems exist? Please identify the types of non-firm trading interest used and how participants use non-firm trading interest on such systems. Please explain what these systems trade (crypto asset securities or crypto assets) and the type of participants ( e.g., retail or institutional). How do participants on a New Rule 3b-16(a) System for crypto asset securities that use “DeFi” systems, as characterized by commenters, negotiate trades for crypto asset securities? Please identify any relevant data, literature, or other information that could assist the Commission in analyzing these issues.
6. Would an organization, association, or group of persons that is a New Rule 3b-16(a) System and uses DLT to trade crypto asset securities likely elect to register as a national securities exchange or comply with the conditions of Regulation ATS? Please explain.
7
s? Please identify any relevant data, literature, or other information that could assist the Commission in analyzing these issues.
6. Would an organization, association, or group of persons that is a New Rule 3b-16(a) System and uses DLT to trade crypto asset securities likely elect to register as a national securities exchange or comply with the conditions of Regulation ATS? Please explain.
7. What are common characteristics of New Rule 3b-16(a) Systems for crypto asset securities that use DLT? Further, what are common characteristics of New Rule 3b-16(a) Systems for crypto asset securities described as “DeFi” trading systems? Are there any characteristics that heighten the need for investor protection and market integrity under the exchange regulatory framework?
8. What are the various governance structures ( e.g., the role of governance token issuers or holders or of DAOs) of trading systems that use DLT and how can such structures administer regulatory programs or respond to regulatory oversight regarding activities on the system? What activities do governance token issuers or holders or DAOs undertake regarding the governance and operation of trading systems that use DLT? Is there any concentration in voting and if so, how does that arise? Are voting rights of governance tokens or DAOs capable of being assigned or delegated and, if so, how is that done? How are changes to trading systems that use DLT effected and how are changes proposed to holders of voting rights under governance tokens or DAOs? Under what circumstances should governance or other token issuers or holders or DAOs be responsible for an exchange's regulatory compliance?
9. As noted in the above requests for comment in this section, the
III. Proposed Amendments to Exchange Act Rule 3b-16 Generally
A
ng systems that use DLT effected and how are changes proposed to holders of voting rights under governance tokens or DAOs? Under what circumstances should governance or other token issuers or holders or DAOs be responsible for an exchange's regulatory compliance?
9. As noted in the above requests for comment in this section, the
III. Proposed Amendments to Exchange Act Rule 3b-16 Generally
A. Performs Functions Commonly Performed by a Stock Exchange
Some commenters state that the Proposing Release did not demonstrate that systems that offer the use of non-firm trading interest and provide non-discretionary protocols “perform[] with respect to securities the functions commonly performed by a stock exchange as that term is generally understood,” and assert that such a finding is required under the statutory definition of “exchange” under section 3(a)(1) of the Exchange Act. 92 In addition, some commenters state that systems that offer the use of non-firm trading interest and provide non-discretionary protocols to bring together buyers and sellers of securities do not perform functions commonly performed by a stock exchange, as that term is generally understood. 93
92 See, e.g., ConsenSys Letter at 14-15; DeFi Education Letter at 13; Coinbase Letter at 3 n.9. One of the commenters also states that in the Regulation ATS Adopting Release, the Commission assumed that to meet the statutory definition, the system must be “generally understood” to be performing stock exchange functions and “anchored” that rulemaking explicitly within the statutory definition. See Coinbase Letter at 3 n.10. In addition, a commenter opines that “[m]erely indicating a possible interest in buying or selling a security without mentioning the quantity or pricing terms that would otherwise characterize an order would allow the Commission to deem a platform an exchange despite it not `performing with respect to securities the functions commonly performed by a stock exchange.'” Blockchain Association Letter II at 4
tion, a commenter opines that “[m]erely indicating a possible interest in buying or selling a security without mentioning the quantity or pricing terms that would otherwise characterize an order would allow the Commission to deem a platform an exchange despite it not `performing with respect to securities the functions commonly performed by a stock exchange.'” Blockchain Association Letter II at 4.
93 See, e.g., Coinbase Letter at 3; ConsenSys Letter at 13-14; DARLA, GBC, and Global DCA Letter at 3-6; Letter from Gregory Babyak, Global Head of Regulatory Affairs and Gary Stone, Regulatory Analyst and Market Structure Strategist, Bloomberg L.P., dated Apr. 18, 2022 (“Bloomberg Letter I”) at 22.
The statutory definition of “exchange” is written in the disjunctive: “a market place or facilities for bringing together purchasers and sellers of securities or for otherwise performing with respect to securities the functions commonly performed by a stock exchange as that term is generally understood” (emphasis added). 94 Thus, if an organization, association, or group of persons constitutes, maintains, or provides a market place or facilities for bringing together purchasers and sellers of securities, it would be an “exchange”; it need not be demonstrated that the organization, association, or group of persons also performs functions commonly performed by a stock exchange as that term is generally understood. As discussed in the Proposing Release, systems today that offer the use of non-firm trading interest and provide non-discretionary protocols can constitute, maintain, or provide a market place or facilities for bringing together buyers and sellers of securities and meet the criteria of Exchange Act 3b-16 as proposed to be amended. 95
94 See 15 U.S.C. 78c(a)(1); Regulation ATS Adopting Release at 70900 n.544 (stating “the statutory definition of `exchange' is written in the disjunctive”)
nterest and provide non-discretionary protocols can constitute, maintain, or provide a market place or facilities for bringing together buyers and sellers of securities and meet the criteria of Exchange Act 3b-16 as proposed to be amended. 95
94 See 15 U.S.C. 78c(a)(1); Regulation ATS Adopting Release at 70900 n.544 (stating “the statutory definition of `exchange' is written in the disjunctive”). Section 3(a)(1) of the Exchange Act states that an “exchange” includes any organization, association, or group of persons that constitutes, maintains, or provides a market place or facilities for bringing together purchasers and sellers of securities or for otherwise performing with respect to securities the functions commonly performed by a stock exchange as that term is generally understood. Functions commonly performed by a stock exchange as that term is generally understood include, among other things, SRO functions and the listing of securities, by, for example, establishing or enforcing qualitative or quantitative listing standards. See Regulation ATS Adopting Release at 70880 (stating that “[r]egistered exchanges are able to establish listing standards, which may promote investor confidence in the quality of the securities traded on the exchange”).
95 See Proposing Release at section II.C.
B. Makes Available Non-Discretionary Methods
In the Proposing Release, the Commission proposed to amend Exchange Act Rule 3b-16(a) to provide that an organization, association, or group of persons would be considered to constitute, maintain, or provide an exchange if it: brings together buyers and sellers of securities using trading interest; and makes available established, non-discretionary methods (whether by providing a trading facility or communication protocols, or by setting rules) under which buyers and sellers can interact and agree to the terms of a trade
tion, or group of persons would be considered to constitute, maintain, or provide an exchange if it: brings together buyers and sellers of securities using trading interest; and makes available established, non-discretionary methods (whether by providing a trading facility or communication protocols, or by setting rules) under which buyers and sellers can interact and agree to the terms of a trade. The Commission proposed, among other changes, to replace the term “uses” with the term “makes available” in 17 CFR 240.3b-16(a)(2) (“Rule 3b-16(a)(2)”), 96 and to add “communication protocols” as an example of an established, non-discretionary method that an organization, association, or group of persons can provide to bring together buyers and sellers of securities. 97 The Commission received comment on the application of these proposed changes to all securities, including comments requesting the Commission to provide further consideration and opportunity for comments before adopting the proposed changes. 98 The Commission is now soliciting further comment on certain Proposed Rules.
96 See id. at 15506.
97 See id. at 15506-07.
98 See Bloomberg Letter I at 13-15; SIFMA Letter II at 7.
In the Proposing Release, the Commission discussed two reasons it proposed to replace “uses established, non-discretionary methods” with the phrase “makes available established, non-discretionary methods.” First, the Commission stated that the proposed change to use the term “makes available” rather than “uses” is designed to capture established, non-discretionary methods that an organization, association, or group of persons may provide, whether directly or indirectly, for buyers and sellers to interact and agree upon terms of a trade. 99 Unlike systems that “use” established non-discretionary methods to match buyers and sellers, communication protocols systems offer a different method for bringing together buyers and sellers by providing protocols that allow participants to interact, negotiate, and come to an agreement
y provide, whether directly or indirectly, for buyers and sellers to interact and agree upon terms of a trade. 99 Unlike systems that “use” established non-discretionary methods to match buyers and sellers, communication protocols systems offer a different method for bringing together buyers and sellers by providing protocols that allow participants to interact, negotiate, and come to an agreement. 100
99 See Proposing Release at 15506.
100 See id.
Second, the term “makes available” was intended to make clear that, in the event that a party other than the organization, association, or group of persons performs a function of the exchange, the function performed by that party would still be captured for purposes of determining the scope of the exchange under Exchange Act Rule 3b-16. 101 The Commission has previously stated that it will attribute the activities of a trading facility to a system if that facility is offered by the system directly or indirectly (such as where a system arranges for a third party or parties to offer the trading facility). 102 The Commission also recognized how a system may consist of various functionalities, mechanisms, or protocols that operate collectively to bring together the orders for securities of multiple buyers and sellers using non-discretionary methods under the criteria of Rule 3b-16(a), and how, in some circumstances, these various functionalities, mechanisms, or protocols may be offered or performed by an

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Source: Frix Law Library, https://www.frixlaw.com/law-library/statutes/FR_PRORULE_2023-08544. Check the current official text before relying on it. Not legal advice.