The Breakdown - The SEC Shoves New Market Maker Rule Through

Episode Date: February 8, 2024

NLW summarizes the new market maker rules, their implications for crypto, and the pushback they're getting not only from crypto but hedge funds and other tradfi institutions as well. Enjoying this content? SUBSCRIBE to the Podcast: https://pod.link/1438693620 Watch on YouTube: https://www.youtube.com/nathanielwhittemorecrypto Subscribe to the newsletter: https://breakdown.beehiiv.com/ Join the discussion: https://discord.gg/VrKRrfKCz8 Follow on Twitter: NLW: https://twitter.com/nlw Breakdown: https://twitter.com/BreakdownNLW

Welcome back to The Breakdown with me, NLW. It's a daily podcast on macro, Bitcoin, and the Big Picture Power Shifts remaking our world. What's going on, guys? It is Wednesday, February 7th, and today we have a short but dense episode for you. Before we get into that, however, if you are enjoying the breakdown, please go subscribe to it, give it a rating, give it a review, or if you want to dive deeper into the conversation, come join us on the Breakers Discord. You can find a link in the show notes or go to bit.ly slash breakdown pod. All right, friends, so as I said, it is a little bit dense today, and in fact, we are getting a little bit wonky, but I think it is important. So the main topic we are talking about today is that the SEC has adopted a new rule which

would force large crypto market makers to come in and register. The rule seeks to clarify the definition of a securities dealer by extending what it means to provide liquidity to markets as part of a regular business. In its originally proposed format, the 194-page rule only had one mention of crypto, tucked away in a footnote. In its final form, the 247-page rule deals with a wide range of irregular market makers who will now be required to register largely in traditional securities markets. The point is to capture any market participant of sufficient size, including many algorithmic trading firms and hedge funds.

The finalized rule clearly covers liquidity providers in crypto markets, but fails to fully explain how it would apply to large defy participants. There is an exception for firms and individuals with less than 50 million deployed in capital markets. So it is important to keep in mind that we are talking about the large section of crypto firms that would have new reporting requirements. Now, this rule is separate to propose changes to the definition of an exchange, which, as we've discussed before, threatens to require dexes to register and might even cover some forms of text-based over-the-counter markets. In framing the need for these new rules, Gary Gensler said that markets have evolved over the past decade, to the point that many firms are acting as de facto market makers

without registering with the SEC. This gap means they don't have the same reporting and record-keeping requirements as more traditional securities dealers. Gensler said, these measures to me are just common sense. Congress did not intend for registration and regulatory requirements to apply to some dealers and not to others. Absent, unexemption, or exception, if anyone trades in a manner consistent with de facto market making, it must be registered as a dealer. That is consistent with Congress's intent, but also sort of competitively makes it fair and level. Now, even though Gensler thinks its common sense, a wide range of crypto policy bodies criticize the rule, largely for its lack of clarity. The SEC appears to have treated crypto firms as if they can come in and register

without any modifications to the existing reporting standards. Yes, it is that all over again. The Defy Education Fund calls the rulemaking misguided and unworkable. They said that, quote, while the SEC acknowledged receiving comments discussing Defi, including our concerns, the SEC not only failed to confront the substance of our concerns, but also failed altogether to articulate any discernible path to compliance for Defy Market Participants. Imposing obligations on entities in the DeFi ecosystem that cannot be complied with is wrong, impractical, and hostile to innovation. Cody Carbone, Vice President of Policy for the Chamber of Digital Commerce,

called this rulemaking, quote, another example of the SEC's continued hostility towards the digital asset industry. He went on, We're asking additional market participants to register as dealers, abandoning decades of precedent to apply impossible rules on digital asset market participants. The SEC did not want the digital asset industry's perspective on this rule, despite its impact, as the 200-page proposed rule only mentions digital assets in a footnote. Now, it appears that the SEC did not even conduct economic analysis

on how this rule would impact crypto markets. Commissioner Hester Perse provided her usual dissent alongside Commissioner Marcueda. During the commissioner's meeting, Perce attempted to get to the bottom of exactly how this rule would impact Defi participants by questioning SEC staff. She tried to ask whether automated market makers

like Uniswap would need to register and how they would go about doing that. The staff answered, we have to be careful about terms, the people versus means, the people are using the technology to deal. Unimpressed with this unclear, or one might even call it total word salad answer, Perce asked a more direct question, whether the people who write the AMM code would need to

register. Staff responded to that? Depends on facts and circumstances. If you write software and you are also using the software to deal crypto securities, then you are in. Getting to her point, Perce asked how many Defi participants staff anticipated would be captured by this rule. They responded, it's a market that's not transparent or compliant so we don't have data. Perce seemed to think the number could be large, replying, I mean, I think one of the reasons they're not compliant is because they can't figure out what our rules are and they can't even figure out when we think something is a security.

This will be a huge implementation challenge for us. Marissa Tashman-Koppel, the head of legal for the blockchain association, summed up the issue with this vagueness tweeting, so I guess being, quote, engaged in a regular pattern of providing liquidity to other market participants as part of a regular business is basically just vibes and circumstances. Cool, cool, cool. Now, in her written descent, Perce identified the biggest problem with this rule, and indeed,

the SEC's approach to regulating crypto. She wrote, Not surprisingly, the rule reflects little thought regarding its practical application in the crypto markets. The rule covers providers of liquidity and crypto asset securities. Not only do the tired questions about when a crypto asset is a security remain, but the rule raises new questions about how the rule will apply in the context of automated market makers.

For example, given that an AMM is a software protocol, who will have to register? In light of the difficulties that other would-be crypto registrants have encountered with the SEC and FINRA, will those persons even be able to register? Rather than engage seriously with these questions, the Commission hints that, quote, certain persons engaging in crypto asset security transactions may be operating as dealers already. Wintermute CEO of Gany Gaveoy really got down to the point on these impossible to comply with rules, tweeting, Americans are not welcome in Defi. Sorry, I'm not making the rules, but the SEC certainly does.

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Learn more at crackin.com slash the breakdown. Disclaimer, not investment advice. Crypto trading involves risk of loss. Cryptocurrency services are provided to U.S. and U.S. territory customers by Payward Ventures Inc. PVI, DBA, Crakin. Now, it seems likely that most of the large crypto market makers have already decamped from the U.S., but this rulemaking could push the last of them offshore. It's not even particularly clear that foreign firms would be outside of the SEC's jurisdiction

here. The regulator could argue that many U.S. investors access particular DFI Pools, giving them an enforcement prerogative. The final rules will come into effect 60 days after being published in the Federal Register with a one-year grace period to meet registration requirements. The only thing that could stop it now are intervention from Congress and lawsuits. Now, the Republican House Financial Services Committee tweeted, The SEC's final rule expanding the dealer definition is overly broad

and risks harming market dynamics, particularly within the digital asset ecosystem. The lack of clarity and consideration for implementation challenges exacerbates these issues, leaving market participants uncertain about their regulatory obligations, and potentially disrupting markets. The SEC should reconsider its final rule to ensure market stability and efficiency while fostering innovation. Now, crypto trading firms were only a tiny portion of the companies that would be impacted by these new rules. One of the larger groups that would have new reporting requirements

is hedge funds that regularly trade U.S. Treasuries, gaining better data on how the U.S. Treasury market trades seems to be one of the big reasons behind the rulemaking. However, additional data for the SEC will come at the cost of greater compliance costs and scrutiny on these firms. Private trading firms have lobbied against these rules since they were first introduced in 2022. Industry groups even went so far as calling the requirements an existential threat to certain trading strategies. Regarding the treasury market, the SEC maintained that the rules were necessary because trading firms make up such a large part of trading volume. The regulator said these rules would ensure that similar activities are regulated in a similar manner. So when it comes to what we need to do, I think

it's best summed up by Jake Trevinsky, the chief legal officer at Variant Fund, who tweeted, file more lawsuits. Now, staying in Wonkville for one more story, Treasury Secretary Janet Yellen was called before Congress on Tuesday to discuss the latest Financial Stability Oversight Council report. House Financial Services Committee Chairman Patrick McHenry opened the hearing by leveling a familiar accusation. Under the current leadership, he said, we've seen FSOC expand its regulatory reach to fit the administration's political priorities. Unfortunately, FSOC appears to be part of the same troubling trend as Biden's other financial regulators. When you're distracted by shiny partisan objects, you take your eye off the ball. Now, FSOC is made up of the heads of multiple financial regulators

including the Treasury, the Fed, the SEC, and the CFTC. Its mandate is narrow to identify and mitigate financial stability risks before they become a problem. McHenry noted that at the beginning of last year, F Sox report featured a long section on the crypto collapse, but failed to recognize the looming bank failures that would hit in March. Now, this hearing focused on pending crypto legislation around stable coins and market structure. Yellen said, there are many areas with respect to digital assets where we do have clear regulatory authority, but we've identified some gaps. It would be very useful for Congress to fill those gaps. She claimed that structural risks from crypto are largely about high volatility and the possibility to trigger bank runs on crypto-friendly banks.

Yellen claimed that stablecoins pose risks to the financial system which have the potential to become significant over time. She weighed in on the current sticking point for stable coin legislation, whether state authorities are sufficient regulators for stable coin issuers. Representing the position of FSOC on the issue, Yellen said, it's critical for there to be a federal regulatory floor that would apply to all states and that a federal regulator should have the ability to decide if a stable coin issuer should be barred from issuing such an asset. Now, the hearing also ranged from SEC overreach to the status of Bitcoin and Ethereum as commodity tokens. Yellen offered very little by way of definitive opinions. However, she did confirm the view

that the CFTC has no rulemaking authority over spot markets, a regulatory gap that FSOC thinks should be closed. The main takeaway was that Yellen is eager to see appropriate crypto legislation passed during this Congress, although it appears that Yellen doesn't view the bills currently on offer as entirely appropriate. This is really a more of the same kind of story. Democrats and Republicans have been at loggerheads on these issues for a long time now and just don't seem to be getting any closer or really finding any reason to have any sort of compromise. Call me cynical, but in an election year, I don't think anything is happening in 2024. Now, lastly today, micro-strategy are back in the market but at a significantly reduced size.

January's purchase was for a measly 850 Bitcoin for around 37.2 million. That pales in comparison to the last two months of buying, which each saw over half a billion dollars worth. Then again, maybe that's why we saw a little bit of a reduced size. Micro Strategy now owns 190,000 Bitcoin at an average price of 31,168. The total stack is worth about $8.1 billion for a 37% gain on paper. It also represents around 1% of all Bitcoin in circulation. Now, this slowdown in buying could indicate that free cash is almost completely deployed. Throughout December, Micro Strategy sold 1 million newly issued shares, raising $610 million. That figure is a close match to December.

Bitcoin purchase. And according to its Q4 earnings report, the company had just 46.8 million in cash remaining on its balance sheet to end the year. Seems like Mr. Saylor might have decided to bet most of it on Orange. Anyways, guys, like I said, a little bit shorter today, but an information dense one. We'll be back tomorrow, hopefully not having to talk about the SEC. But for now, I want to say one more big thank you to today's sponsor, Cracken. Go to Cracken.com and see what crypto can be. Until next time, be safe and take care of each other. Peace.