Coinbase Challenges SEC’s Proposal on DEX Regulation, Citing ‘Irrational’ Analysis and Threat to Innovation

Coinbase, the largest US-based cryptocurrency exchange, has responded to the Securities and Exchange Commission’s (SEC’s) proposal to broaden the legal definition of ‘exchange’ to include decentralised exchanges (DEXs). Coinbase strongly opposes the change and suggests its purpose may be to stifle the digital assets industry in the US.

In the exchange’s response letter Coinbase’s Chief Legal Officer, Paul Grewal, savaged the SEC’s proposed change. He called on the regulator to withdraw the proposal and start from scratch, preferably after it has done the necessary research to reach a basic understanding of how decentralised exchanges work and how regulation would impact them.

Related: Coinbase Posts US $1.45 Billion in Revenue as crypto.com Outshines in Trading Volume

What Is the Proposed Change?

The SEC is proposing an amendment to rule 3b-16 under the Exchange Act of 1934 that would make DEXs subject to the same regulatory requirements as traditional financial exchanges. The change was first proposed in January 2022 and was reopened for public comment in April of 2023. Many individuals and organisations have already commented on the proposed change including legislators, other crypto businesses and traditional exchanges.

Essentially, if this amendment was passed into law, it would mean decentralised exchanges would be required to register with the SEC as alternative trading systems—something that Grewal says is impossible given their decentralised nature.

Proposed Change Is Irrational and Lacks Critical Analysis, Says Grewal

In Coinbase’s response letter, Grewal emphasised that decentralised exchanges wouldn’t be able to comply with the regulator’s proposed change, saying:

Among other issues, DEXs cannot comply with registration and disclosure requirements designed for legacy financial exchanges managed by centralized companies.

Coinbase’s letter of response

The Coinbase CLO added that in the unlikely event that DEXs could comply with the proposed change it’s not clear how they could then continue to function effectively:

Even if DEXs could somehow comply with existing registration and disclosure rules, the Commission does not explain how SEC-registered DEXs could facilitate the trading of digital assets.

Coinbase’s letter of response

Grewal suggested that hobbling DEXs, and by extension the US digital assets industry, may actually be the intention of the change: “The Proposed Rule would have the effect (and perhaps even had the purpose) of terminating innovation in crypto markets in various ways, such as by saddling DEXs with anachronistic and impossible-to-satisfy requirements, by inexplicably banning side-by-side trading of digital assets and purported “crypto asset securities,” and by failing to conduct an adequate cost-benefit analysis of the Proposed Rule’s likely effects.”

On X / Twitter, Grewal went further, slamming the proposal as irrational and being a solution in search of a problem:

In short, the SEC’s proposal lacks critical analysis, rests on irrational assumptions, fails to show that there is any problem in need of regulation, and vastly overstates the proposal’s purported benefits.

Paul Grewal, Coinbase Chief Legal Officer

Related: SEC Takes Loss as Court Orders Ripple to Pay US$125 Million, XRP Explodes to Almost 30% for Brief Period

Grewal added that the SEC should rework the proposal to exclude DEXs, saying that in its current form it could prove devastating to both crypto investors and the US digital assets industry:

The SEC should decline to extend this proposed rule to DEXs. As is, it could have drastic consequences for the millions of Americans who engage with digital assets. Not to mention the harm it could bring to innovation in the growing DEX market.

Paul Grewal, Coinbase Chief Legal Officer