SEC Proposes Safe Harbor Scheme for Decentralized Exchanges

The US Securities and Exchange Commission (SEC) is moving forward with Project Crypto, aiming to promote blockchain technology in the American capital markets.

In April, the SEC's Trading and Markets Division clarified when user interfaces can operate without registering as a brokerage firm. In June, the SEC proposed repealing Rule 611 of the National Market System, which would eliminate an important barrier to the development of on-chain securities markets.

Recently, the SEC issued an 'innovation exemption' that excludes certain tokenized security trading venues (TSV) and flow providers from the definition of 'exchange' and 'broker-dealer', respectively. These moves indicate that the SEC recognizes the potential of blockchain in improving the financial system and acknowledges that on-chain markets should not be forced into inappropriate regulatory frameworks.

The SEC's actions are commendable, but they only address part of the regulatory uncertainty faced by on-chain markets. The innovation exemption provides a path for on-chain securities trading through intermediaries, but it does not address the need for clarity on when decentralized exchanges (DEX) and their front-end applications do not need to register as exchanges.

We propose that the SEC clarify when DEX developers and DEX App developers do not need to comply with exchange registration requirements. We suggest introducing a 'safe harbor' scheme that provides clear standards for determining which protocols and applications qualify as exempt from these requirements.