SEC intensifies scrutiny on DeFi, sparking concerns over innovation and competition

The U.S. Securities and Exchange Commission is taking a closer look at decentralized finance (DeFi), raising concerns about the potential stifling of innovation and competition within the rapidly evolving industry.

The United States SEC is increasing its focus on the cryptocurrency sector, with chairman Gary Gensler making it clear that DeFi will not be exempt. The SEC announced that it would reexamine plans to modify the definition of an exchange, which could encompass DeFi protocols such as decentralized exchanges.

In a rule initially proposed in the previous year, the SEC seeks to include language targeting the digital asset domain.

Gensler emphasized that many cryptocurrency trading platforms already fall under the existing definition of an exchange and are thus required to comply with securities laws. He asserted that investors in the crypto markets should receive the same protections as those in traditional markets.

However, not all regulators welcomed the idea. SEC commissioner Hester Peirce criticized the proposal as overly broad, claiming that it would hinder innovation and competition in the financial markets while protecting incumbents. She also argued that the plan’s ambiguity could undermine fundamental First Amendment protections.

DeFi aims to streamline financial transactions such as loans and interest earnings by making them faster, more accessible, and automated through decentralized apps. These apps enable the trading and borrowing of crypto assets without third-party intermediaries or the need to disclose personal information.

While DeFi has gained praise for the decentralization it offers users, it has also been criticized for its lack of security, with experimental platforms susceptible to hacks.

Decentralized exchanges (DEXs) such as Uniswap and Curve Finance are among the most popular decentralized apps. These platforms permit users to trade cryptocurrencies without revealing personal information.

Some users have expressed skepticism about the SEC’s ability to enforce its regulations outside the U.S., asserting that the agency cannot force compliance.

Critics within the crypto industry, such as Jason Allegrante, Compliance Officer at Fireblocks, have also voiced concerns that applying traditional exchange regulations to decentralized protocols might stifle innovation in the U.S. and drive businesses offshore.

The use of VPNs enables users to bypass location-based restrictions and access crypto apps even if they are banned in their country. Some DEXs have already taken action to prevent U.S.-based users from accessing their platforms.

The SEC has targeted prominent American cryptocurrency brands, including Coinbase and Kraken, intensifying its crackdown after the sudden bankruptcy of digital asset giant FTX in November.

Gensler has consistently maintained that most digital assets fall under the securities definition, and regulators have been scrutinizing the DeFi sector for some time. Last year, the Treasury Department sanctioned the “coin mixer” app Tornado Cash, used by North Korean hackers to allegedly launder funds.