Consensys Software Inc. (“Consensys”) writes to comment on the amendments proposed in the above-captioned rulemaking, and particularly to provide our perspective on what appears to be a broad assertion of regulatory authority over blockchain technology. As the leading programmable blockchain software company helping to build the digital economy of tomorrow, we have a strong interest in the blockchain regulatory environment. We thus had serious concerns when the SEC originally unveiled these amendments regarding the definition of“exchange,” starting with the fact that the amendments seemed potentially applicable to blockchain-based systems despite the Proposing Release never mentioning cryptocurrency,blockchain technology, or their applications in its 200-plus pages. We appreciate that theCommission has now issued a Reopening Release that eliminates this ambiguity, but we are troubled to see that the Release erroneously concludes that the amendments—and the underlying rule—are applicable to blockchain-based systems, while also committing other serious errors. We write again to highlight these critical legal and factual errors.

In submitting this letter, we expand on the concerns we expressed during the initial comment period. Our earlier letter, which we attach as an exhibit, details the exciting potential of blockchain technology, Consensys’s work in the blockchain sphere, and the numerous shortcomings of the Commission’s proposal. But apart from taking a more explicit position on the amendments’ application to blockchain technology, the Reopening Release fails to correct these shortcomings and indeed goes further down the wrong track.

We discuss our concerns in three parts with the sincere hope that the Commission will reconsider its current proposal and engage earnestly with the blockchain community to arrive at a sensible regulatory framework. First, we reiterate the ways in which the proposed amendments are fundamentally flawed, highlighting shortcomings that the Reopening Release does not correct. Second, we explain why the new Release underscores and indeed exacerbates these shortcomings. Finally, we discuss how the Release’s attempt to provide blockchain-specific analysis only serves to introduce new errors into the SEC’s proposal.

Together, these flaws mean that the proposed amendments cannot be lawfully adopted in their current form. As we explain below, the SEC’s analysis simply cannot be squared with the Exchange Act of 1934, existing exchange regulations, or an accurate understanding of blockchain technology or the ecosystem as it exists today and is likely to evolve over time. The proposed amendments are not only flawed as a legal matter, though; they would have tremendous practical consequences for a transformative and fast-growing sector of the economy. The amendments would subject blockchain-based systems to regulatory burdens for which compliance is not only difficult, but also often impossible, and thus throw the broader blockchain ecosystem in the United States into paralyzing regulatory uncertainty. Indeed, the Releases themselves are already fostering substantial uncertainty, as the ecosystem tries to determine whether the Commission intends to follow through on its sweeping claims of authority, and, if so, whether those claims are legally sound. Existing entities are increasingly considering whether to relocate outside the United States or shut down entirely, while the uncertainty deters new entrants into the market, stifling growth and innovation.

We respectfully request that the Commission withdraw the proposed amendments— either generally or at least as applied to blockchain-based systems. Such caution would be particularly appropriate because, as the Commission is undoubtedly aware, Congress is currently crafting comprehensive legislation for regulating blockchain technology and has been considering various legislative proposals concerning a regulatory framework for several years. The high likelihood that legislation will be passed in due course means that the SEC will soon need to adopt implementing regulations under a new legal framework. Given the fundamental questions about the Commission’s authority to regulate in this space at all—including questions being asked by members of the Commission itself—we respectfully submit that the Commission should proceed with care and prudence.


I. The Reopening Release Fails to Correct Key Legal Deficiencies in the Proposed Amendments.

During the initial comment period, Consensys and other commenters identified a host of shortcomings with the proposed amendments. The SEC is no longer silent on the amendments’ application to blockchain technology, which is certainly an improvement to the extent the intent of the amendments has always been to apply to blockchain, as the Reopening Release essentially admits. But the Release fails to meaningfully correct other deficiencies. In the interest of brevity, we do not restate the full analysis in our earlier letter, but we reiterate that—as currently formulated—the proposed amendments cannot be squared with the ’34 Act, the Administrative Procedure Act, or the U.S. Constitution.

First, the proposed amendments seek to expand the regulatory definition of “exchange” beyond what the ’34 Act can bear. The Act defines “exchange” as “any organization, association, or group of persons, … which constitutes, maintains, or provides a market place or facilities for bringing together purchasers and sellers of securities or for otherwise performing with respect to securities the functions commonly performed by a stock exchange.”

As we explained in our earlier letter, this statutory definition is concerned only with intermediary systems that bring together the orders of actual buyers and sellers. And the statutory history reflects that Congress sought to regulate exchanges only insofar as they were centralized entities that possess—as a result of their centralization—a uniquely important role in setting market prices and otherwise affecting market conditions. Yet the SEC is now proposing a regulatory redefinition of 17 C.F.R. § 240.3b-16(a) that would treat as exchanges systems that merely reach potential buyers and sellers, allowing them to find and negotiate transactions with each other. And it seeks to apply this regulation to blockchain-based systems despite their predominantly decentralized nature—a structure that does not implicate any of the market-setting concerns underlying the ’34 Act. The proposed amendments thus violate the basic rule that an agency may not adopt a regulatory definition inconsistent with the statute it is interpreting.

Second, the proposed amendments are impermissibly motivated by “factors which Congress has not intended [the SEC] to consider.”

When the Commission initially announced the amendments, it made clear that, while their stated purpose was to expand the regulatory definition of “exchange,” the amendments would not increase the number of registered exchanges. Rather, the amendments would serve to induce new broker-dealer registrations by providing so-called “New Rule 3b-16(a) Systems” an easier off-ramp through the Regulation ATS exemption. The issue with this, of course, is that the ’34 Act defined the terms “broker” and “dealer” as categories distinct from “exchange,” and the Commission (like all agencies) is bound by that congressional choice. It cannot promulgate a regulation interpreting one statutory provision as a backdoor means of expanding other provisions beyond their text.

Third, the proposed amendments are unconstitutionally vague. The amendments sow confusion about the intended scope of “exchange” by replacing the current rule’s clear parameters with ones that are nebulous and poorly defined. For example:

● They provide no way for market participants to know whether their actions contribute to the efforts of potential buyers and sellers to transact, or to contemplate a possible future transaction.

● They do not specify the level of causation necessary for a group to be “making available” an established, non-discretionary method for trading.

● They do not specify the level of scienter required for someone to become a part of a “group of persons” that is making such methods available.

● They do not explain the extent to which they apply to platforms and participants that reside in part, substantially, or even entirely in foreign jurisdictions.

● They do not even explain what constitutes a “communication protocol” in the first place.

With these and other questions unresolved, the proposed amendments are riddled with “terms so vague that men of common intelligence must necessarily guess at [their] meaning." This problem leaves everyone who guesses wrong—ranging from companies like Consensys to the individual software developers and users who rely on our offerings in their work and personal affairs, and who generally are not sophisticated securities-law experts—to face hefty penalties after the fact. That sort of retroactive punishment on the basis of hopelessly vague rules is precisely what the Due Process Clause forbids.

Fourth, the cost-benefit analysis underlying the proposed amendments is woefully deficient. Agencies may not promulgate regulations “based on arbitrary and capricious cost-benefit analyses.” A regulation is “highly capricious” if it purports to solve a problem that does not actually exist, yet in announcing the amendments, the Proposing Release failed to identify any evidence of real-world harm necessitating the amendments or to provide even a non-conclusory justification for why they would be beneficial. Likewise, a regulation is irrational if the agency fails to give due consideration to the accompanying costs and how they weigh against any benefits. Here, the Release’s failure to conduct any meaningful benefits analysis underscores the irrationality of proceeding with a rule that the Commission admits would impose (at least) several million dollars in costs annually; for which it fails to estimate, even just qualitatively, the value of any countervailing benefits; and as to which it neglects to explain how the amendments satisfy cost-benefit analysis. Moreover, the Release takes an improper catch-all approach that fails to distinguish between very different categories of blockchain participants and technologies, while also failing to provide any meaningful analysis of the costs and benefits to efficiency and capital formation—criteria that Congress has specifically directed the Commission to weigh in every rulemaking.

Finally, the proposed amendments would infringe on protected speech in violation of the First Amendment. Under the amendments, whether a system qualifies as an “exchange” turns on the content of the speech it facilitates. Systems that help people communicate about their interest in buying or selling securities would count as exchanges, while systems that facilitate communication about other topics would not. But the Constitution almost always forbids the government from “target[ing] speech based on its communicative content.” For such content-based targeting to be permissible, the SEC must show that it is advancing sufficiently important ends and doing so through sufficiently tailored means.

The Proposing Release did not even acknowledge that the amendments implicate the First Amendment, much less explain how they would survive any level of First Amendment scrutiny. And as currently formulated, the amendments would fail such scrutiny, given the Commission’s failure to explain the need for its proposal or to establish clear boundaries for the scope of its redefinition and thus demonstrate that the amendments are carefully tailored to securing important interests.

II. The Reopening Release Reinforces and Exacerbates the Problems of the Original Proposal.

We are disappointed that the Reopening Release has not reconsidered the broader analysis offered in the Proposing Release, as that sweeping analysis cannot be squared with the SEC’s authorizing statute, its constitutional obligations, or basic principles of administrative law. Instead, the Reopening Release appears to double down on these fundamental flaws.

A. The Reopening Release Overreads the Term “Exchange” in the ’34 Act.

To start, the Reopening Release is similarly insistent on expanding the term “exchange” beyond what the ’34 Act can bear. In addition to the problems described in Part I, the Reopening Release fails to properly consider either what an exchange does under the ’34 Act, or who may be considered part of an exchange.

  1. The ’34 Act is clear about the functions necessary for an exchange to exist. It asks whether a group “constitutes, maintains, or provides a marketplace or facilities for bringing together purchasers and sellers of securities or for otherwise performing with respect to securities the functions commonly performed by a stock exchange.” During the original comment period, Consensys and other commenters explained that New Rule 3b-16(a) Systems do not qualify because they do not “perform[] with respect to securities the functions commonly performed by a stock exchange.”

    The Reopening Release tacitly admits the premise of the point: rather than explain how New Rule 3b-16(a) Systems do perform functions commonly performed by stock exchanges, it professes only that the SEC is not required to show that they do. The Release reads section 3(a)(1) of the ’34 Act to operate in the disjunctive: a group qualifies as an exchange if its market place or facilities (1) “bring[] together purchasers and sellers of securities” or (2) “perform[] … the functions commonly performed by a stock exchange.” And it asserts that New Rule 3b-16(a) Systems satisfy option (1).

    This interpretation fundamentally distorts the statute. Section 3(a)(1) does not say that a facility is an exchange if it does “A” or “B”—as a disjunctive requirement would. It instead explains that, to qualify as an exchange, a facility must do “A” or “otherwise” “B.” And it is a “cardinal principle of statutory construction” that statutory provisions should be read, wherever possible, to “give effect … to every clause and word of [the] statute.” The word “otherwise” is a critical statutory term that the Commission simply ignores.

    Read properly, the statute creates a single path to becoming an exchange, not two separate ones. The word “otherwise” specifies that the second clause is not some distinct mode of qualifying as an exchange. It is, rather, a residual clause that fills any gaps in the specific examples section 3(a)(1) enumerates.

    The word “otherwise” means “[i]n another way” or “[b]y another means,” and thus conveys that the “A” and “B” clauses must be read in conjunction. In particular, “otherwise” “operates as a catchall: the specific items that precede it are meant to be subsumed by what comes after the ‘or otherwise.’” So, in the context of section 3(a)(1), the inclusion of “otherwise” means that the statute is concerned with “market place[s] or facilities for bringing together purchasers and sellers of securities” only insofar as they are performing “functions commonly performed by a stock exchange.”

    New Rule 3b-16(a) Systems do not perform functions commonly performed by stock exchanges, as the Reopening Release all but admits. They thus do not “bring[] together purchasers and sellers of securities” within the meaning of section 3(a)(1), and so are not exchanges under the ’34 Act.

    This basic statutory limit not only precludes the proposed rule but also underscores why the Reopening Release’s broader effort to apply existing exchange requirements to blockchain-based systems exceeds the Commission’s statutory authority. In clarifying that the SEC interprets the proposed amendments to reach the blockchain, the Release declares that the existing regulation already applies to many blockchain systems. That is a remarkably broad assertion to casually make in a rulemaking, and it is one that both requires more extensive justification and underscores the capriciousness of the Release’s rulemaking approach. But more than that, it is also wrong as a matter of law.

    Most blockchain-based systems are partially or entirely decentralized and thus do not perform the functions of a stock exchange as that concept was understood at the time of the ’34 Act. For example, “automated market makers”—which the Reopening Release contemplates could be part of an exchange—operate through decentralized processes. But as discussed above and as explained at length in our earlier comment, the original understanding of “exchange” extended only to centralized entities due to their market-setting capabilities. The ’34 Act is governed by the “ordinary meaning at the time Congress enacted” it, and thus precludes any belated attempt by the SEC to expand its authority. Thus, any rulemaking that is faithful to the statute would exclude decentralized systems, including those on the blockchain.

  2. In addition to mangling what constitutes an exchange, the Reopening Release misunderstands who may be part of an exchange. The term “exchange” means any “organization,” “association,” or “group of persons” that “constitutes, maintains, or provides a market place or facilities” for the purposes discussed above. Typically, identifying the pertinent “organization,” “association,” or “group of persons” is simple; traditional exchanges generally have clear organizational structures. But blockchain protocols and the networks on which they operate often do not, and the Release has no satisfactory answer for how to discern the “group of persons” responsible for a blockchain-based system. Rather than provide a clear definition or standard, it advances a few “important factors” of indeterminate weight.

    According to the Release, “important factors” in determining whether a person is part of the relevant “group of persons” that can constitute an “exchange” “would generally include whether the persons act in concert in establishing, maintaining, or providing” the necessary marketplace or facilities, or whether they “exercise control, or share control, over aspects of such marketplace or facilities or the performance of functions commonly performed by a stock exchange.”

    These factors raise countless questions as one digs deeper into what all this actually means for anyone participating in the blockchain ecosystem. For example, the Release states that a group of persons might share a working agreement, but that would be just “one factor to consider, depending on other facts and circumstances." But the Release leaves hopelessly unclear what else it considers relevant, or how important an actual agreement is to the group analysis. Can persons unwittingly engage in concerted activity sufficient to constitute a “group of persons,” absent an established meeting of the minds? The scant discussion leaves one to guess.

    As for control, the Release gives a few examples of when control over market place or exchange functions is alone sufficient to create responsibility over an “exchange.” But what level of control is actually sufficient is left unsaid. In particular, the Release does not explain the threshold of “significant” token ownership at which blockchain users suddenly obtain sufficient control over the system to assume regulatory responsibilities. Nor does it address the circumstances when a service provider or third-party vendor begins exercising enough control to become responsible—alongside its clients—for registering the “exchange.” Absent clarification about these and other questions, regulated parties will not have fair notice of their obligations under the law.

    But even setting aside the fundamental ambiguities in the listed “factors,” it is clear that they sweep too broadly. Under the text of section 3(a)(1), “[w]hether two or more persons may be acting in concert” is the crucial prerequisite for membership in a qualifying “group of persons”—not just one of several factors. And “acting in concert” requires making a conscious choice—i.e., entering an agreement to join together in furtherance of a common objective.

    This requirement follows from the text of section 3(a)(1). The statutory phrase “group of persons” that constitutes, maintains, or provides “a market place or facilities” clearly connotes a bona fide group of persons that has agreed to come together to form, maintain, or provide an exchange. And even if that were not clear from the statutory text, due process principles require reading this provision narrowly, to ensure that it is “sufficient[ly] definite[] that ordinary people can understand” their regulatory obligations and to limit the risk that the SEC could enforce those obligations in “arbitrary” or “discriminatory” ways. The statute thus precludes including within an exchange persons who are not exercising their purported control in concert with others.

    The Reopening Release’s contrary interpretation is particularly troubling as applied to blockchain-based systems. While it does acknowledge, albeit vaguely, some limits on what constitutes a “group” in general, it fails to give sufficient weight to independence in the blockchain context. Rather than meaningfully address that issue, the Release glosses over concerns previously raised by commenters about how persons or users involved with “‘DeFi’ protocols . . . act independently of each other.” It instead suggests that all manner of disparate actors—including “validators,” “miners,” and “holders of governance or other tokens”—could be deemed part of an exchange. Given that these wide-ranging actors are invariably and entirely independent from each other, in terms of both functions and incentives, among other things, the Release’s standard for blockchain-based systems—and blockchain-based systems alone— appears to be that persons can be lumped together in a “group” whenever they engage in “related” activities. Not only would that sweeping test conflict with the ’34 Act for the reasons detailed above, but it also would lead to a perverse result where blockchain users who are working at cross-purposes—like validators competing with each other to earn a limited number of block rewards—could nonetheless be deemed part of a unified group that shares regulatory responsibilities.

    Importantly, the Reopening Release also fails to grapple with the fact that—particularly in the blockchain context—a “group of persons” operating a so-called exchange will often if not always include persons based outside the United States. That matters because the ’34 Act generally does not apply extraterritorial. Yet beyond acknowledging that “some amount of activity in the market for crypto assets discussed in this Reopening Release is conducted outside the U.S.,” the Release offers no analysis of how the SEC intends for its proposed amendments to affect groups that include international actors. This is a serious issue that greatly impacts blockchain participants around the world, and the Reopening Release is unquestionably deficient for failing to meaningfully deal with it at all.

    These complex issues of extraterritoriality further underscore the need for caution in expanding the scope of “exchange.” And more than that, they require a fuller explanation from the SEC about how these rules will operate in the context of blockchain protocols and the global, permissionless computer networks on which they operate, followed by an opportunity for comment from the public, which has not yet had even a “first opportunity … to offer comments” on this important issue.

    In short, the Reopening Release adheres to and extends positions that are irreconcilable with the ’34 Act and that exceed the Commission’s “statutory jurisdiction, authority, or limitations.” The analysis underlying these positions likewise conflicts with the APA and its prohibition on arbitrary and capricious agency action. Should the Commission insist on moving forward with the proposed amendments, it must thus substantially narrow them to stay within the bounds of what the statute will permit and the evidence will support. And because such a substantial overhaul would require revisions that take the final rule far afield from the current proposal, the SEC must further allow for public comment on any revised proposal.

B. The Reopening Release Underscores the Improper Aims of the Proposed Amendments.

To the extent the Proposing Release left any doubt about the purpose of the proposed amendments, the Reopening Release confirms that the SEC is using the amendments as a backdoor to expand the applicability of broker-dealer registration requirements. The new Release is predicated on the assumption that no New Rule 3b-16(a) Systems will actually register as exchanges, and that they will instead register as broker-dealers under the Regulation ATS option. Most tellingly, although a primary purpose of the Reopening Release is to flesh out the SEC’s economic analysis of the proposed amendments49—amendments written to expand the regulatory definition of exchange—the Release does not add any analysis about the costs or benefits of exchange registration in its pages and pages of supplemental analysis. It, too, addresses only the purported costs and benefits of broker-dealer registration and compliance with Regulation ATS requirements. But as discussed above, Congress intentionally defined “exchanges” and “broker-dealers” as separate statutory categories, and the Commission may not regulate around Congress’s choice. If the Commission believes the regulatory definition of “broker-dealer” or the scope of Regulation ATS to be inadequate, it should amend those rules—to the extent it can do so consistent with the ’34 Act.

Moreover, the proposed amendments would inevitably chill the development and continuation of New Rule 3b-16(a) Systems and of blockchain-based systems more generally. While we, as a U.S.-based technology provider that employs nearly 900 people, hope that the SEC does not intend this result, we can see how others could infer otherwise, particularly against the backdrop of SEC leadership’s public hostility towards the blockchain ecosystem. Just last week, for example, Chairman Gensler asserted that “we don’t need more digital currency.” So too, the Release brusquely dismisses commenters’ concerns, including ours, that blockchain-based systems may not be able to comply with exchange regulatory requirements in general, and with the broker-dealer and Regulation ATS requirements in particular. The Release likewise makes clear the SEC’s indifference to the fact that the proposed amendments may deter innovation and drive market participants either to move outside the United States or to shut down entirely. And finally, given that the proposed amendments are replete with vague interpretations, requirements, and standards, they only increase regulatory confusion.

This confusion is further compounded by the SEC’s apparent use of the Reopening Release as a vehicle to make highly contestable pronouncements about the scope of its current regulation—namely, how the current definition of “exchange” in Commission regulations already applies to blockchain protocols. This almost off-handed pronouncement raises fundamental questions for stakeholders as to whether and how they are already regulated, or just at risk of future regulation, or somewhere in between. As Commissioner Peirce aptly put it, the result is a proposal that “embrace[s] stagnation, … urge[s] expatriation, and welcome[s] extinction of new technology.” The Commission should make clear that this is not its goal by< withdrawing its proposal and including appropriate safeguards in any revised effort.

We would like to believe that broadly chilling blockchain innovation is not actually the Commission’s goal, because that is clearly not a legally permissible basis for the proposed amendments. Agencies may not adopt regulations for pretextual or predetermined reasons. Nor, as discussed above, may an agency consider “factors which Congress has not intended it to consider." And the ’34 Act Congress—which enacted section 3(a)(1) to create guardrails around the operation of centralized systems—could not have intended for the SEC to elaborate on that provision for the purpose of targeting primarily decentralized entities, many of which have a greater footprint overseas than in the U.S. Thus, if the Commission believes that certain blockchain-based systems, as currently constituted, should not be permitted to operate, then the proper course is to propose that change directly rather than marshaling the exchange rules as a conduit for doing so.

C. The Reopening Release Exacerbates the Vagueness of the Original Proposal.

The Proposing Release was impermissibly vague, and the Reopening Release only makes the problem worse. As the new Release acknowledges, numerous commenters previously warned that the boundaries of the proposed amendments were too uncertain. The Reopening Release gestures at addressing this problem, such as by proposing the possibility of revising the proposed amendments to cover “negotiation protocols” instead of “communication protocols.” But that marginal change would only nibble at the edges. To craft a proposal that is not impermissibly vague, the SEC must revisit all of its proposed changes, and provide actual definitions (or at least concrete examples) of the new terms it seeks to adopt so that commenters like Consensys can understand what they mean in practice. The Reopening Release does not do any of this. Even as to “negotiation protocols,” it cannot point to specific examples of what kinds of systems it has in mind. Instead, the Release merely repeats that the proposed amendments’ application will depend on “facts and circumstances”—a phrase it uses fully a dozen times.

But the Release’s discussion of possible “facts and circumstances” only heightens the uncertainty about how broadly the proposed amendments will apply. First, the Release repeatedly makes clear the SEC’s view that questions of application will turn on facts and circumstances in the plural. For example, as discussed above, it describes the existence of an underlying agreement as “one factor to consider, depending on other facts and circumstances,“in assessing whether a person would be acting in concert with a group of persons.” But hereand elsewhere, it provides no hint as to how this factor should be weighed alongside the other facts and circumstances. In what circumstances does the SEC think individuals can act in concert without having agreed to do so? Can concerted action ever be absent even if there is an underlying agreement? The Release does not say.

Likewise, the Release refuses to identify circumstances that definitively fall outside the proposed amendments’ scope, leaving commenters guessing as to where the outer perimeter of these amendments is to be found. For example, even as to a software developer who publishes or republishes code on his own independent volition—i.e., a developer who obviously is not establishing an exchange—the most the Release can say is that the developer “may be less likely” to face registration obligations if the code is subsequently repurposed for use by a supposed exchange. This is a critical point to a company like Consensys, which among other things develops free, open-source software for a wide variety of purposes. The Release leaves completely unclear to us the circumstances in which our software development might inadvertently venture from “less likely” (which is no real comfort to begin with) to “more likely” to face registration obligations. Any good-faith attempt to stay on the right side of the proposed amendments in this regard would be nothing more than a stab in the dark.

And it is even more disconcerting that the Release does not deny that the various entities commenters fear “might be inadvertently captured by the definition”—such as social-networking sites, messaging applications, and smart-contracting platforms—could, in fact, fall within the scope of the proposed amendments.64 Instead, the Release attempts to pass the task of resolving the proposal’s ambiguities onto commenters, making myriad requests for comment about the proper scope of the rule. For example, the Release asks whether the phrase “directly or indirectly”—which it is seeking to add to Rule 3b-16(a)—should be interpreted to have limiting principles and, if so, what they should be. These questions further confirm that the language in the proposed amendments is open-ended and ambiguous rather than self-defining and clear.

To the extent the SEC leaves gaps like these unresolved in any final rule, it would be unlawful for a host of reasons. Such ambiguity is impermissibly arbitrary because it allows the Commission to apply the amendments without meaningful constraint.It also deprives regulated parties of fair notice because the proposed amendments are “not sufficiently clear to warn [regulated parties] what is expected of [them].”And, just as troublesome, the proposed amendments would unduly burden market participants who are not regulated parties by making them understandably fearful that they might be. Moreover, if and when the SEC offers much-needed regulatory clarity through definitions and examples, it must also provide a specific opportunity for public comment on that new analysis, which like other substantial changes should be “tested by exposure to diverse public comment.”

D. The Reopening Release’s Economic Analysis Is Deeply Flawed.

The Reopening Release’s deficiencies also persist in its economic analysis. The Commission devotes much of the Release to supplementing the analysis of costs and benefits in the Proposing Release. Yet the new Release only repeats and even worsens the flaws in that original analysis.

  1. To start, the Reopening Release still makes no effort to show that the benefits of the proposed amendments outweigh their costs—a basic prerequisite to rational agency action.70 Instead, the Release appears to suggest that the SEC may impose rules without regard to the proportionality of their consequences, reassuring commenters at one point that “the Commission believes that the[] costs [of the proposed amendments] are not impossible to pay.” But the relevant question is whether a proposal would do “more good than harm,” and an agency thus may not promulgate rules whose costs “far outweigh any benefits.” And given that the Release is simply silent on this proportionality question, it is reasonable to infer that either the Commission cannot actually foresee the consequences of its proposal, or it has concluded that such an assessment would not support the amendments.

    Indeed, even if the Commission had wanted to provide a rough weighing analysis, the breadth and ambiguity of the amendments would make doing so impossible. Under the current Release, it is entirely unclear what range of participants may or may not be swept up in this proposed regime. We see this uncertainty in considering the amendments’ application to Consensys’s own products. For instance, Consensys offers MetaMask, a client-side, unhosted wallet software program that permits users to maintain secure and exclusive access to their funds, read blockchain data, and send transactions on their own behalf, including ones that leverage the computational logic of DeFi smart contract protocols; Infura, a blockchain node service that processes billions of user and developer queries a day, as people read and write to the blockchain; and Diligence, a smart contract security auditing service often used by DeFi projects to test and improve their code. These programs, and similar ones offered by others located around the world, all perform critical functions in the peer-to-peer blockchain space, but the Release leaves unclear the extent to which these programs—and affiliated developers or users—may be implicated by an amended Rule 3b-16(a). And the Release certainly makes no attempt to weigh the costs, benefits, or proportional value of ensnaring these programs.

  2. Even if the Reopening Release could justify the proposed amendments by reference to benefits alone, the benefits it identifies are illusory. The new Release, like the Proposing Release, does not identify even a single real-world example of why the proposed amendments are necessary—for instance, it offers no evidence that anyone has been harmed by the absence of the regulations it seeks to impose. The Reopening Release instead offers only a conclusory analysis of the proposal’s purported benefits: it makes the unsupported assertion, for example, that the expansion of regulatory oversight is necessarily beneficial. But the SEC may not promulgate a regulation to address a problem that does not in fact exist and then cite the proposed regulation’s enhanced application to that non-existent problem as a basis for its legality.

    Moreover, to the extent the proposed amendments may generate any meager benefits, the Reopening Release fails to consider how those benefits will vary depending on the nature of the regulated entity. It elides the fact that blockchain-based systems operate very differently from their “TradFi” counterparts, and that the blockchain ecosystem is itself divided between “CeFi” and “DeFi” systems, with only the latter being organized around principles of decentralization. These differences mean that the cost-benefit analysis must be category-specific. For example, the Release touts one benefit of the proposed amendments as their enhancement of investor protection. But the need for such traditional protections in that regard is meaningfully reduced in the DeFi context and varies among different protocols, given the strong investor protections underlying blockchain technology and the variability in how smart contract protocols are composed and function. DeFi platforms are generally noncustodial (i.e., the platforms never take possession of users’ funds) and atomic (i.e., the platforms facilitate transactions address-to- address, without risk of error, as address owners either see their transaction processed or simply retain the assets they started with). But some may have different characteristics and functionality. These distinctions matter to a cost-benefit analysis, and on their face, the Release’s summary assertion that the benefits of its proposed amendments will be similar for both blockchain-based and more traditional systems makes little sense. Agencies may not ignore potentially dispositive factual distinctions.

  3. In any event, the Reopening Release also needs to consider costs, and its consideration here fares no better. By recognizing that blockchain-based systems generally—and particularly decentralized systems, such as those that use smart contracts—are likelier to face higher costs than other New Rule 3b-16(a) Systems, the Release tacitly acknowledges that the cost side of the cost-benefit equation is particularly important here.80 But the Release makes no attempt to provide a specific estimate, instead admitting that the SEC has no understanding of just how high the costs might rise for either category.

    Indeed, to the extent the Reopening Release does discuss costs, it underestimates the likely harms in important ways. For one thing, the Release substantially undercounts the number of entities that will be affected by the proposed amendments. It estimates that there are between 35 and 46 New Rule 3b-16(a) Systems, between 15 and 20 of which trade digital assets. But based on Consensys’s experience in the blockchain industry, both of those estimates are far too low, and neither estimate even attempts to account for the many new entrants likely to join that fast-growing ecosystem in the coming months and years. By way of comparison, one blockchain research and data firm, which is widely relied on in the space, has reported that there are hundreds of protocols that function as “Decentralized Exchanges,” and hundreds more “lending protocols”—all of which must now wonder whether they now fall under the Commission’s new interpretation of its authority, under either the existing Rule 3b-16(a) or the proposed amendments.

    Beyond this underestimation of the size of costs, the Reopening Release takes a too-cramped view of the range of relevant costs. For example, the Release largely ignores the following important costs:

    ● The costs of slowing innovation. The Release admits that adoption of the proposed amendments could well cause “market participants [to] decrease and slow down the development of new products and technologies,” push systems away from operating through decentralized mechanisms, raise barriers to entry in the blockchain space, and even drive some entities out of the blockchain market. But it makes no systematic attempt to estimate the costs of reduced innovation, despite the disproportionate rate of economic growth and innovation taking place until now in the blockchain ecosystem, which all accrues to the benefit of consumers, retailers, and the public more broadly. Nor does it consider the fact that this stifling of innovation may affirmatively disadvantage the United States by driving innovation overseas.

    ● The costs of regulatory uncertainty. As this letter makes clear, the regulatory uncertainty wrought by the proposed amendments is substantial. Actors in the blockchain sphere must struggle to decipher whether they fall within the new Rule 3b- 16(a), whether they can come into compliance, and what (if anything) they can do if not. Yet the Reopening Release acknowledges the fact of regulatory uncertainty only in passing, with no attempt to measure the extent to which such uncertainty will harm these potentially regulated parties and the broader economy.

    ● The outsized costs the proposed amendments would impose on smaller or less sophisticated market participants. While even established companies like Consensys will be substantially burdened by the proposed amendments, these burdens are magnified for the ordinary individuals who participate in the blockchain ecosystem—such as validators, DAO members, and liquidity providers—who may now be facing demanding regulatory obligations.88 It is hard to see how less-sophisticated participants could feasibly comply with the regulatory regime to guard against personal liability, either individually or with other members of a so-called “group of persons” that would invariably include others who are pseudonymous and located in far-flung places around the world. Yet the Reopening Release makes no effort to meaningfully assess these costs either.

    Moreover, as discussed above, the Release ignores the actual costs of exchange registration, considering only the costs of broker-dealer and ATS registration. But even if it is right that entities are likely to avail themselves of the Regulation ATS exception if available, the SEC may not reasonably expand the regulatory definition of “exchange” without contemplating the costs of actually registering as an exchange, especially when commenters have warned the SEC that many New Rule 3b-16(a) systems would not be eligible for the ATS exception. This analysis is particularly necessary because the Release recognizes that the burdens of exchange registration and ATS registration are not interchangeable: the costs of the former are “generally significantly higher.” So the Release’s analysis of the proposed amendments’ costs—like its assessment of benefits—contains “serious flaw[s]” that render it “unreasonable.”

  4. In sum, the cost-benefit analysis in the Reopening Release is untenable because it “inconsistently and opportunistically frame[s] the costs and benefits of the [proposed] rule,“neglect[s] to support [the SEC’s] predictive judgments,” and ignores “substantial problems.”These flaws are particularly acute because they extend to matters the SEC is statutorily required to consider. Specifically, the SEC must always consider whether a rulemaking “will promote efficiency, competition, and capital formation.” But the Reopening Release offers only equivocal and barebones assertions on these grounds, stating that the amendments “could” promote efficiency, competition, and capital formation, while also acknowledging various costs. For any new regulatory burden to be rational, the APA requires more substantiation of benefits than this, and demands that the SEC actually make a predictive judgment about a new rule’s effects. It is simply not a legally tenable position that the amendments are too far reaching, flexible, and complex to make such a predictive judgment. And the Commission’s reluctance to make a meaningful prediction suggests that—as to efficiency, competition, and capital formation, as more generally—the current record compels a finding that the proposed amendments on balance do more harm than good.

    Indeed, the Reopening Release provides every reason to think that the proposed amendments will have seriously negative consequences for each of efficiency, competition, and capital formation. The amendments almost certainly would reduce price efficiency by reducing the availability of innovative tools that make digital-asset transactions and other activities on the blockchain ecosystem more price-efficient. The SEC itself has recognized that the proposed amendments may well reduce competition by driving blockchain-based entities offshore or forcing them to shut down entirely. Likewise, the innovation-stifling and regulatory uncertainty discussed above inevitably will reduce new capital formation, as investors otherwise interested in backing further development of blockchain-based and other New Rule 3b-16(a) Systems increasingly decline to do so because these regulatory hurdles are impossible to clear.

    In short, the proposed amendments fail to properly weigh costs and benefits to ensure that the benefits outweigh costs—either generally or as to efficiency, competition, and capital formation in particular. And to the extent the costs and benefits can be identified, the sizable costs of the proposed amendments appear to outweigh their minimal-to-nonexistent benefits. Given all this, it is unclear why the Commission is insistent on pushing forward with its proposal. In doing so, the Commission ignores reasonable alternatives readily available to it— indeed, perhaps the only reasonable course of action: it can simply retain the current and well- adapted Rule 3b-16(a), and stop trying to extend the Rule to blockchain-based and other previously uncovered entities, as Commissioner Peirce has recognized. That choice marks yet another reason why the Reopening Release cannot pass muster.

E. The Reopening Release Still Fails to Grapple with the Proposed Amendments’ Encroachment on the First Amendment

Finally, the Reopening Release still does not acknowledge that the proposed amendments run headlong into the First Amendment. Its suggestion that the SEC might replace the term “communication protocol” in the amended Rule 3b-16(a) with “negotiation protocol” would not eliminate this problem, as the Release is not proposing to narrow the substantive scope of what that term covers, and it still has not identified any concrete interests that could render the amendments of compelling or even substantial importance.

If anything, the new Release only worsens the First Amendment violation. By expressly suggesting that software developers may be liable under the amendments, including those who develop software for non-business, purely expressive, and very often explicitly political reasons, the Release gives rise to a clear chilling effect, given the long-established fact that computer code is speech.And more generally, the Release exacerbates the First Amendment problem by fostering uncertainty about the scope of the amendments’ reach—for instance, whether they apply to certain persons upon electing to participate in a DAO vote—making the amendments even less narrowly drawn. Given that the SEC must show a close fit between means and ends under any level of First Amendment scrutiny, the Release underscores the incompatibility of the Commission’s proposed changes with the First Amendment.

III. The Reopening Release’s Analysis of the Proposed Amendments’ Application to Blockchain-Based Systems Rests on Fundamental Misunderstandings of Blockchain.

In addition to repeating the errors of the Proposing Release, the Reopening Release introduces entirely new errors in its blockchain-specific supplemental analysis. These errors raise serious questions about the extent to which the SEC understands nascent and fast evolving blockchain technology, and underscore why any amendments to Rule 3b-16(a) should not reach blockchain-based systems—either generally or, at the very least, for the foreseeable future.

A. The Reopening Release Depends on Flawed Assumptions About the Extent to Which Digital Assets are Securities.

The SEC’s attempt to regulate blockchain-based systems under Rule 3b-16(a) depends on the threshold premise that, as Chairman Gensler has pronounced in public fora, nearly all of the digital assets used and traded on such systems are securities. After all, the SEC’s jurisdiction spans only the sphere of securities regulation, and both the statutory and regulatory definitions of exchange—including under the proposed amendments—are concerned solely with facilities that help facilitate securities transactions. Blockchain-based systems thus fall within the Rule’s ambit only if the assets whose exchange they help facilitate are actually securities under federal law.

The Reopening Release makes clear that the SEC is proceeding from this assumption, but it offers no meaningful analysis of why the SEC believes that many or most digital assets are securities. For example, the SEC asserts, without explanation, that the probability of digital assets being securities is sufficiently high that “it is unlikely that systems trading a large number of different crypto assets are not trading any crypto assets that are securities,” such that the SEC finds it reasonable to assume that most such systems likely fall within the current Rule 3b-16(a) and are already liable under the current Rule. And one of the SEC’s own commissioners has interpreted the Reopening Release as an apparent “paper exercise” to finalize the Commission’s pre-determined view that “nearly all crypto assets are securities and are subject to the

Commission’s jurisdiction.” But an agency may not engage in such pro forma maneuvering; it must instead proceed through the rulemaking process with an open mind and “provide[] a reasoned explanation for [its] policy assumptions and conclusions.” Any final rule will be arbitrary and capricious unless the SEC provides a considered antecedent explanation for its assertion of jurisdiction to regulate blockchain-based systems.

Any final rule will also be arbitrary and capricious if the agency is relying on incorrect assumptions. Here, there is good reason to think the Reopening Release substantially overestimates the extent to which digital assets are securities. Whether a digital asset is a security turns on whether it is an investment contract, and many, if not most, digital assets function purely as assets rather than as binding contracts for an investment scheme. Most simply, the term “investment contract” requires a binding obligation (a “contract”). But for virtually every digital asset traded on the secondary market via the sorts of systems implicated by the exchange regulations, there are no implied or written contracts. The developers who initially created these secondarily traded tokens have no obligations to those exchanging them in secondary markets. And there is thus no “investment contract” or underlying security.

Moreover, that threshold point is far from the only thing that distinguishes the vast majority of digital assets from federal securities. For example, many digital assets function as utility tokens—allowing for use on a platform, rather than accrual as an investment—and so generally cannot be investment contracts. Other tokens, like the most widely accessible and used tokens, were created and are indeed technologically essential because their networks do not process transactions unless a transaction sender pays a fee in that native token. Likewise, many tokens accrue value primarily from the vagaries of market forces rather than any particular managerial efforts from the developers or promoters of the token, which likewise prevents them from being considered investment contracts. There is much more that could be said about the distinctions between digital-asset tokens and investment contracts, but for present purposes it is

sufficient to say that a lawful justification of SEC regulation of blockchain-based systems would require rigorous analysis of why that regulation does not sweep beyond bona fide securities.

Given the complexity of assessing the regulatory status of digital assets, the SEC should at minimum table any application of Rule 3b-16(a) to blockchain-based systems—both under the current Rule and through the proposed amendments—until these antecedent jurisdictional questions are settled. And as discussed above, particular caution is needed because Congress— the appropriate body for resolving major questions of law—is working on legislation clarifying the jurisdictional status of digital assets. But careful resolution of this issue will require the SEC at some point to initiate a separate rulemaking on the matter, given the magnitude and salience of the underlying issues, not to mention the tremendous confusion the SEC has fostered on this issue in recent years. Only then can the SEC give this issue—including the many follow-on questions that it implicates—the necessary attention, priority, and public input.

B. The Reopening Release Contains Serious Misconceptions About Blockchain Technology and the Blockchain Industry.

The proposed amendments are further premature because the blockchain-specific analysis in the Reopening Release reveals little comprehension of how blockchain technology and the blockchain ecosystem actually work. The Release admits that the SEC has limited insight into how blockchain-based systems operate. Perhaps unsurprisingly, then, the result of the Commission’s guesswork leaves much to be desired. The Release contains significant errors about blockchain, as reflected in the foregoing discussion about the SEC’s undercounting of protocols, and the functional and geographic diversity of participants potentially affected by these amendments. And as detailed below, the errors do not end there. Effective regulation requires that the regulator understand what it is regulating.

Most importantly, the Reopening Release offers a deficient analysis of the ability of decentralized blockchain-based systems to comply with the SEC’s envisioned registration requirements. Although it acknowledges that the requirements’ burdens may force some New Rule 3b-16(a) Systems to exit the market, the Release insists that all blockchain-based systems would be able to comply with the requirements if they wish to do so, regardless of their technological nuances. But this assertion utterly ignores how “DeFi” platforms actually operate, shrugging off commenters’ identifications of systems that could not possibly come into compliance, in no small part due to the pseudonymity and tremendous geographic dispersion of platform participants and the low barriers of entry and exit on these platforms. Here too, the Release’s reliance on incorrect assumptions would render any final rule arbitrary and capricious.

For one thing, the Reopening Release fails to recognize that many decentralized systems are not controlled by any “organization, association, or group of persons” and so cannot qualify as exchanges under the ’34 Act. Under section 3(a)(1), it is not enough that there be a market place or facility that performs the functions of an exchange; the provision is triggered only by the ongoing existence of an “organization, association, or group of persons . . . which constitutes,maintains, or provides” the market place or facility—i.e., present tense. Because decentralized protocols often run autonomously after being created by developers who relinquish control over their creations, many protocols are not being constituted, maintained, or provided by any person or group of people.

Rather than acknowledging that such autonomously operating systems are not exchanges, the Release attempts to ensnare tangentially related persons into possible “groups of persons” that could be ascribed regulatory responsibility for these faux-exchanges. It suggests that software developers could bear indefinite legal responsibility for the protocols they create, notwithstanding their current lack of operating control and regardless of the intent with which the protocol was designed. This extension both contravenes the ’34 Act’s present-tense wording and would be arbitrary and capricious regardless. The SEC may not impose retroactive liability on developers who have relinquished control over their creations without specifically considering “whether to make [its] new policy prospective or retroactive.” And more generally, this aspect of the Release—like its broader analysis—is unsupportable as a matter of weighing costs and benefits. If adopted, it would have outsized costs, as the Commission’s effective rejection of the concept of decentralization would deter growth and innovation while increasing regulatory uncertainty, all for little-to-no evident benefit.

Nor can the SEC adopt its alternative suggestion that other persons, such as miners,validators, and token holders in a decentralized autonomous organization, could all bear regulatory responsibility. Including such minor market participants in an exchange group defies the ’34 Act’s scope for the reasons explained above, and it also would have the perverse effect of foisting legal risk on the least sophisticated market participants, who have no realistic means of complying with complex regulatory requirements.

Moreover, the Reopening Release’s proposal to assign regulatory responsibility to miners and validators reflects a basic misunderstanding of what those individuals can do. The Release premises its rosy view of market participants’ ability to comply with its regulations on the assumption that even immutable smart contracts are not really immutable: miners or validators can always “effect a change to a blockchain through, for example, a fork that would impact interactions with the immutable smart contract.” Setting aside that many if not most miners and validators are not located in the United States, and even assuming such forking is always possible, forking serves only to create a new blockchain; it does not shut down the previous system. For example, the Release cites the example of a past Ethereum fork, but its own cited source explains that the result is that “[t]here are now two versions of the Ethereum blockchain growing in tandem.” This analysis offers no clarity as to whether miners, validators, or other individuals would still be responsible for the original system. But given that the SEC generally enforces securities-law requirements on a strict-liability basis, not even following the SEC’s current opinions about compliance would provide a complete safe harbor later.

Nor are the Release’s misunderstandings limited to the direct question of compliance. For example, it asserts that “the majority of [blockchain] platforms typically require crypto assets and fiat currency to be provided to the platform in advance of any trading activity.” But this assertion ignores the norm in DeFi systems, which, as discussed above, generally do not take custody of users’ funds or otherwise require a prior deposit. Likewise, the Release identifies as one downside of blockchain-based systems that “messages to be appended to a blockchain often end up in a queue that is publicly viewable, which then exposes the marketplace to information leakage.” But this view reflects an outdated understanding of the blockchain ecosystem, overlooking innovations that greatly mitigate the information-leakage issue.

These examples are not exhaustive of the Release’s technical errors, but they exemplify how the SEC’s place on the learning curve has hampered the accurate assessment of costs, benefits, and other considerations in the Reopening Release. In short, when an agency does not even understand the contours of an issue, it has no way to fulfill its obligation to assess all “important aspects” of the issue. The Commission thus has much work to do before it can engage in any kind of reasoned regulation, which includes reengaging with the blockchain ecosystem that has been understandably reluctant to further educate the Staff about cutting-edge technological developments given the frequency with which good-faith interaction has been leveraged solely for enforcement purposes.


Given the range of shortcomings in the proposed amendments and the Reopening Release, we respectfully urge the Commission to withdraw its proposal in full. For the reasons discussed in this letter and in our earlier comment, the Commission cannot lawfully promulgate the amendments as currently formulated. And given the absence of any demonstrable harm caused by the scope of the current Rule 3b-16(a), the SEC need not take any action beyond withdrawing the proposed amendments. If it believes that revisions to the Rule remain necessary, though, it must at least issue a new proposal with substantial alterations, subject to further public comment.

Finally, however the Commission proceeds, it should carve blockchain-based systems out of the Rule. For the reasons discussed, such systems fall outside a proper understanding of “exchange” in the ’34 Act and so cannot be regulated under it. And SEC regulation in the broader blockchain context is further inappropriate given (1) the unresolved antecedent questions about the extent to which the SEC has jurisdiction at all over blockchain-based systems, and (2) the SEC’s limited understanding of blockchain technology and the dynamics of the blockchain ecosystem. Particularly given Congress’s ongoing efforts to enact a comprehensive regulatory framework in this area, which will include specific provisions pertaining to the proper role of the securities laws and the SEC, the Commission should not upend this large and growing economic sector with hasty and ill-conceived regulations that depend on a conclusory assertion of jurisdiction.

Respectfully Submitted,



William C. Hughes