Venture Capital (VC) firm Andreessen Horowitz (a16z) and nonprofit research and advocacy organization DeFi Education Fund (DEF) have jointly submitted a key proposal to the Securities and Exchange Commission (SEC) to protect developers and innovation.
The VC firm and the DeFi advocacy group proposed a safe harbor from the broker registration requirements of the Securities Exchange Act of 1934 for trading interfaces that enable users to interact with blockchains and smart contract protocols, including those related to DeFi services and non-fungible token (NFT) marketplaces.
The letter aims to aid the Commission in creating clear rules for determining which Apps fall within the SEC’s jurisdiction, based on specific criteria and consistent with similar safe harbors recently proposed in federal market structure legislation.
“Only those Apps which do not engender the risks that the Exchange Act’s broker-dealer regulatory regime was designed to address should be eligible; in such cases, registration as a broker under the Exchange Act is unwarranted and inappropriate. Conversely, Apps that do pose traditional risks that broker regulations were designed to address should not be able to avail themselves of this safe harbor,” the proposal reads.
As the letter explained, apps must meet four objective criteria to qualify for the safe harbor. First, an app must be non-custodial, never taking control of users’ funds, and it must not exercise discretion over the execution of user transactions. Additionally, the app must not actively solicit or provide investment recommendations and may only passively display neutral market data or functionality.
Lastly, the underlying protocol must be decentralized, either interfacing with protocols that have eliminated operational control or have demonstrated “good faith intention” to decentralize. The proposal also highlighted a limited exception for early-stage protocols under a certain threshold.
According to the letter, this approach would offer three primary benefits, including establishing limits for the application of federal and securities laws to apps that fall within the scope of the proposed safe harbor and safeguarding DeFi developers from being subject to “retroactive application of federal securities laws.”
Additionally, the proposal aligns with the SEC’s historical practices concerning broker registration safe harbors and “is consistent with the historical lack of prohibition on persons engaging in private peer-to-peer securities transactions without the participation of a registered broker, as well as Commissioner Peirce’s recent dictum.”
We should not ask peers transacting with one another, where no intermediary exists, to collect and report information on each other. Doing so would deputize us to surveil our neighbors—a practice antithetical to a free society. Nor should we require an intermediary to step in the middle of peer-to-peer transactions.
The rule, originally proposed in November 2021 through the Infrastructure Investment and Jobs Act, aimed to close the “tax gap” by broadening the definition of “brokers” to include crypto exchanges and other intermediaries, while requiring DeFi platforms to report proceeds from digital asset transactions and detail user transaction information, including names and addresses.
