Cryptocurrency exchanges, be warned. There’s no out-innovating the regulatory reach of the U.S. Securities and Exchange Commission.
Clarifying an announcement yesterday that the SEC is in the middle of its first ever case against a cryptocurrency exchange running on the ethereum blockchain, the chief of the SEC’s newly created cyber unit, Robert Cohn, exclusively told Forbes that using any blockchain to create an exchange without central operations doesn’t remove the original creator’s responsibility.
As similar decentralized exchanges are being launched with increasing ease, and frequency, the warning shows how serious the SEC is about taming the cryptocurrency Wild West, and the semantics used to bolster it.
“The focus is not on the label you put on something or the technology you’re using,” says Cohen. “The focus is on the function, and what the platform is doing. Whether it’s decentralized or not, whether it’s on a smart contract or not, what matters is it’s an exchange.”
While traditional, centralized exchanges like Coinbase, or even Nasdaq, are run by individuals, this new breed of decentralized exchanges runs on self-executing code. Instead of serving as a middleman connecting buyers and sellers, these decentralized exchanges connect people directly using the code, also known as a smart contract.
But according to Cohen, the individuals behind that code remain responsible. It’s notable, that the SEC’s charges yesterday were not against the exchange, but the individual, Zachary Coburn, founder of the unlicensed decentralized EtherDelta token exchange. The exchange, which is still operational in spite of the SEC describing Coburn as being cooperative, has already helped users execute 3.6 million orders and took it’s most recent order at 3:07 pm ET on Friday, November 9.
In total, Coburn he agreed to pay a $300,000 disgorgement, $13,000 in prejudgment interest and a $75,000 penalty, though he didn’t admit to or deny the SEC findings. In its official statement, the SEC described Coburn as “cooperative.” Importantly, “almost all” of the trades conducted on the platform occurred after July 25, 2017, when the SEC published its conclusions on the seminal DAO investigation.
Similar to EtherDelta, The DAO, or Decentralized Autonomous Organization, was an elaborate collection of smart contracts executed on the ethereum blockchain. When the code in the smart contracts was made to execute in a way unintended by the original developers, $60 million was siphoned off into an unknown third-party’s account.
While the SEC didn’t fine The DAO creators, it did create the cyber unit still investigating EtherDelta. The cyber unit filed its first charges against a blockchain company in December 2017, for matters related to the issuance of an ICO. Then, in September 2018 charges were filed against a crypto asset fund manager and a crypto broker-dealer. But yesterday’s charges were the first against a crypto exchange and show the agency is escalating its efforts.
Since the catastrophic failure of The DAO, which so deeply split ethereum users that it resulted in the creation of an entirely new cryptocurrency called Ethereum Classic, the decentralized exchange business has become increasingly refined, and streamlined.
In May 2018 licensed cryptocurrency exchange Coinbase purchased Paradex, a decentralized exchange powered by 0x, a platform designed to streamline the creation of cryptocurrency exchanges without a single point of failure. In August 2017 0x raised $24 million in an initial coin offering (ICO) in which the public was able to purchase tokens used by the exchange.
Since then, a number of other decentralized exchanges have launched on the 0x platform, the most prominent of which is Radar Relay, which raised $10 million in traditional venture capital from Blockchain Capital and others. Similarly, decentralized asset manager Melonport is building an autonomous system scheduled to be fully deployed in February 2019.
While Cohen’s comments make it clear the SEC intends to assure that exchanges doing business in the United States are compliant, what is less clear is how the regulator might handle decentralized exchanges with less cooperative, or anonymous, creators.
By their very nature, blockchain-based exchanges are nearly impossible to shut down. While online access to centralized servers can revoked, a new wave of decentralized servers, domain providers and more is becoming increasingly popular. Soon, even traditional means of enforcement could become more difficult.