Does DeFi lose some of its luster if regulators perceive it as a securities exchange? Or is it the U.S. that loses its luster in the increasingly global view of crypto?

That concern has been raised in the wake of recent commentary coming from the Securities and Exchange Commission, which has been looking closely at possible avenues of regulation for the crypto space, particularly around how an “exchange” is defined in the eyes of the law.

The VC giant Andreessen Horowitz had asked, in the wake of the SEC’s rule-making last year, to make it clear that the rule changes did not apply to DeFi.

“We believe that, if adopted, the unnecessarily broad language contained in the Proposal could be interpreted as applying to a broad array of technologies, including DeFi systems and protocols,” the company wrote.

The SEC, in a supplemental document submitted last month, emphasized that it said what it meant when it announced its plan to expand the definition of an exchange.

The commission emphasized that the rules would apply “if these electronic messages constitute a firm willingness to buy or sell a security, including a crypto asset security.”

There’s a strong case to strengthen regulations if the concern is consumer safety. The demise of the FTX exchange, and the reputational hit that comes with that, has put the crypto space back on its heels when it comes to pushback on stronger protections.

“As evident by numerous crypto scandals in the last year—most notably the collapse of the FTX crypto exchange—the industry hasn’t been able to lean into DeFi’s inherent advantages.”
– Umee’s Brent Xu wrote for Coindesk back in February.

Some observers, like Bloomberg’s Andy Mukherjee, saw opportunity in FTX’s demise to remove centralizing elements that are in opposition to the core concept behind decentralized finance.

If the SEC decides to push towards increased regulation, that innovation could happen elsewhere.

Could Exchanges Just … Leave?

The SEC’s approach to DeFi has been seen by some observers as old-school, and have little meaning in a world where borders matter less than ever.

If regulations put exchanges in regulatory jeopardy, it’s quite possible that they could depart to countries that are friendlier to their business models. Hugo Volz Oliveira, the secretary of the Portugal-based New Economy Institute, argued that while the SEC’s actions represent “a clear regulatory attack on the industry,” they ultimately will struggle to rein in the innovation happening in the field. “If any of these vectors is successful, it will certainly lead DeFi platforms and ecosystems to move abroad unless further regulation clarifies the overall situation. While this is particularly problematic for US organizations and individuals, it won’t affect crypto innovation around the world given that this workforce is highly mobile.” – Hugo Volz Oliveira, the secretary of the Portugal-based New Economy Institute

That level of mobility is one of the big advantages of decentralized finance, and there’s a strong case that this could legitimately happen.

In recent months, more centralized U.S.-based firms like Ripple and Coinbase started making waves about potentially lessening their presence in the United States in an effort to get around unfavorable an unfavorable regulatory environment.

That wouldn’t leave the SEC without regulatory options if a rogue player emerges, for example—it could work with outside governments to help rein in potential issues of fraud, or take steps to curb illegal activity that is affecting Americans. (After all, FTX was based in The Bahamas, and the SEC still stepped in.)

It, nonetheless, could discourage some major players in the crypto space from staying in the U.S. market.

“I think if a number of years go by where we don’t see regulatory clarity emerge in the US, we may have to consider investing more in other regions of the world,”
– Coinbase CEO Brian Armstrong recently said at a conference in London, according to Investopedia.

The SEC’s mindset reflects a desire to protect consumers—understandable, given headlines that constantly highlight the risks of investing in crypto.

It also highlights the tough stance on DeFi taken by SEC Chair Gary Gensler, exemplified by this recent comment: “These platforms are acting as if they have a choice to comply with our laws. They don’t.”

It’s a stance that could lead some DeFi players to sue the SEC over the perceived arbitrary approach to defining the terminology around exchanges.

But even if legal action doesn’t go the sector’s way, there is always plenty of room elsewhere. Volz Oliveira noted that the United Kingdom and European Union have each taken steps to better understand the needs of the emerging technology, and would be most likely to benefit if the U.S. hardened its regulatory stance on decentralized finance. “The US surely stands to lose its role as a key builder of future digital technologies and economies if it stays within this course of action” – Hugo Volz Oliveira