SEC Sets Narrow Conditions for Regulated DeFi

The recent failed vote on the CLARITY Act has been seen as a setback for cryptocurrency and decentralized finance (DeFi). However, the industry was never going to get its clarity from US Congress. The bill covered various aspects of DeFi compliance, including AML program requirements, protections for developers, and jurisdictional lines defining which agencies would regulate different types of cryptocurrencies.

The actual decisions that will govern DeFi access, sanctions screening, and pre-settlement risk checks are being written elsewhere. The SEC has already shown how it plans to regulate the industry through narrow, conditional rules one at a time. In August, the agency announced Regulation Crypto Assets, proposing new rules for how crypto projects can raise money by selling tokens.

The exemptions in this proposal are tightly capped: $5 million over four years for early projects, and $75 million a year for larger raises only if the issuer provides financial statements and ongoing reporting. Two days after the CLARITY cloture failed, the SEC followed up with the Innovation Exemption, clarifying how permissioned pools can legally offer tokenized equities.

This exemption is similarly constrained, with caps on how many stocks each venue can list and how much each can trade, as well as requiring venues to screen who can trade. It expires after five years. The industry should expect regulation to happen under a very narrow set of conditions as the SEC collects data on the effect regulated DeFi will have on existing markets.

Crypto shouldn't expect sweeping regulation to come quickly. The SEC's slow and steady progress on specific interpretations of existing laws is more likely to be the default. DeFi isn't structurally prepared for regulation, with no equivalent layer to enforce authorization checks natively. Centralized companies will run these checks instead if DeFi doesn't build that enforcement layer itself.