To bring DeFi into mainstream U.S. markets, the relief must reach registered broker-dealers, ATSs, and exchanges.

By B. Salman Banaei

On September 17, the SEC issued its Innovation Exemption. The order lets Tokenized Securities Venues (TSVs) run permissioned automated market makers (AMMs) for certain tokenized U.S. stocks without registering as exchanges. It also relieves liquidity providers in those pools from dealer registration. Chairman Paul Atkins has called it a bridge toward durable rulemaking. That is the right way to read it.

The order is a real step. It accepts that market structures built in crypto can have a place in regulated U.S. markets. But a bridge needs a far bank. As I told the House Financial Services Committee in March, the goal should not be to run onchain markets through temporary exemptions. It should be to give compliant onchain venues a durable route into the regulated system.

The most consequential gap is who may use these tools. The exemption reaches new, unregistered venues. It does not let registered broker-dealers, ATSs, and national securities exchanges use DeFi protocols and AMMs on the same terms. That is the change that would move DeFi into the mainstream. Four principles frame the point.

Innovation

The order moves the ball. By itself, it will not bring DeFi into mainstream markets.

Mike Cagney puts the frame well. The exemption, he writes, is “a sandbox, not a market.” It “is not a competition for flow; it is infrastructure legitimization.” Legitimization matters. But a sandbox open only to new entrants leaves the regulated core untouched.

The European Union’s DLT Pilot Regime is a cautionary case. As one post-mortem found, “a widespread belief that the pilot regime was slated to end after three years” “disincentivised participation.” A sunset without a committed path to permanence tends to produce experiments, not markets.

Shapiro highlights the same point: “A venue that the mere expiry of the Order can end in 2031 is hard to finance.” He would have the Commission commit that the relief stays in effect until a final rule replaces it. That is a sound interim measure.

The better path is to let the regulated core adopt the same technology. In March I urged the Commission to “move concurrently toward full ATS registration for ATSs that use DeFi protocols.” The same logic applies to broker-dealers and exchanges. Gabriel Shapiro makes a parallel point on the dealer side. The order’s statement that liquidity provision alone is trader activity, he argues, “should be made general and durable,” and carried into dealer rulemaking rather than confined to TSV pools. He is right. Relief that turns on a venue’s registration status, rather than on the activity itself, will not scale.

So the first fix is scope. Extend the AMM and liquidity provider relief to registered venues. Let a registered ATS or exchange operate an AMM. Provide clarity that supplying pool liquidity is not dealer activity. Innovation should not require leaving the regulated perimeter.

Capital formation

Here the order falls short. Its permissioned, capped design limits the feature that makes public blockchains valuable for capital formation. That feature is global reach.

Public networks let a compliant token reach any qualified investor anywhere. Permissioned networks do not. As I testified, “permissioned systems offer little direct capital formation benefit,” because a closed network restricts participation to pre-approved counterparties. The opportunity is larger than that. “It is imperative that tokenized securities operate under a regulatory framework that enables broad, global distribution of tokenized securities through DeFi markets accessible to global investors. This will ensure that U.S. tokenized securities become more readily available for foreign investors, enhancing capital formation opportunities for U.S. businesses.”

The stakes are strategic. As I told the Committee, the question “is whether American capital markets infrastructure and American regulatory frameworks will channel that demand or whether foreign competitors with different geopolitical objectives will capture it.” DeFi protocols are a tool to link global investors to U.S. businesses. An exemption that keeps that tool inside a small, permissioned sandbox forfeits the advantage.

Shapiro adds a useful expansion. The framework, he argues, should reach issuer-tokenized shares of private companies (including and especially those that leverage SEC crowdfunding rules), a category that “is a better fit for the Order’s architecture than the listed stocks for which the Order was written.” Private issuance is where onchain distribution can widen access the most. The order should grow in that direction.

Investor protection

The order’s investor-protection design has a specific weak point. It is best execution.

Registered broker-dealers owe customers reasonable diligence to obtain the most favorable terms. A TSV reached through a covered user interface carries no equivalent duty. TSVs also sit outside the National Market System rules that help ensure fair prices. That gap has consequences.

Cagney describes the mechanism. In a standard pool, “prices move with the pool’s inventory rather than the national best bid and offer (NBBO), so arbitrageurs harvest the difference from liquidity providers.” The AMM, he notes, “competes only when the NBBO is live, which is the one environment where it structurally loses.” Without a price reference, a TSV pool can become a reservoir of stale liquidity. It can also become a source of toxic fills for the investors who trade against it.

There are fixes. A TSV can use a pricing oracle to set a collar that aligns executions with NBBO levels. Registered venues already carry best-execution and surveillance duties. That is another reason to bring AMMs inside registered venues, where investor protections travel with the technology. Weak execution quality is not only an investor problem. It is a durability problem.

Durability

An exemption can be undone. A rule is harder to reverse. This is the order’s central vulnerability.

In March I framed durability as a first principle. Regulatory change should “provide lasting legal certainty, not time-limited exemptions.” A five-year window with volume caps does the opposite. It “may prevent operators from achieving the scale and legal certainty necessary to attract institutional investment.” It “may provide false comfort to tokenization entrepreneurs and incumbent businesses alike that the future of tokenized securities will operate outside of legacy regulatory protections.” Full registration under Regulation ATS, by contrast, “provides durable legal certainty that enables long-term investment in compliance infrastructure.”

There is legal risk too. As I noted to the Committee, a recent decision “calls into question whether the SEC can rely on exemptive authority or no-action relief to create a new regulatory regime for tokenized securities” of this significance. See CBOE Futures Exch. v. SEC, 77 F.4th 971 (D.C. Cir. 2023). The weaker the investor protections, the easier it is for a future Commission to reverse or supersede the relief. 

Combatting illicit finance

The order controls illicit finance at the gate. It conditions relief on permissioned participants and identity verification. That design limits who can hold a tokenized security. It also carries forward the weakness of the current regime. As I told the Committee, BSA compliance in securities markets depends today on broker-dealer KYC screening, yet "mapping KYC-derived personally identifiable information to illicit activity is far more difficult than onchain transaction monitoring."

Congress has already endorsed a better model for stablecoins. The GENIUS Act requires issuers to build transaction monitoring and freeze-and-seize capabilities into the asset itself. Treasury, in consultation with the SEC, should set BSA expectations for tokenized securities "that mirror those for payment stablecoins." Compliance then travels with the token rather than with a permissioned gate. That approach preserves the global reach this technology exists to provide, and it does not trade capital formation for compliance.

The enforcement case is strong. "Freeze-and-seize" token functionality is, as I testified, "a very potent law enforcement tool." The data bear that out. Onchain "seizure rates approach 12%, far exceeding rates in traditional finance." The credible risk of seizure deters misconduct in a way that identity checks at onboarding cannot. That is a same-or-better outcome, achieved while creating unprecedented capital formation opportunities unlocked by the use of public blockchains to connect global investors and American businesses.

From exemption to registration

The policy goal we advocate at Plume is consistent. Regulate the risk, not the technology. A tokenized security is still a security. The goals of investor protection, market integrity, capital formation, and combatting illicit finance do not change when a trade moves onchain. But meeting those goals should not require blockchain markets to copy legacy plumbing. And it should not incentivize innovators to operate outside the regulated system.

The Innovation Exemption opens the door. The next step is to widen it. Modernize Regulation ATS so DeFi-based venues can register and compete. Replace the exemption with a durable rule before the window closes. Combat illicit finance more effectively than KYC through onchain analytics tools and freeze-and-seize technology through new AML rules for onchain finance. These and other initiatives we advocate are how a first step becomes a market.

The author is General Counsel of Plume Network. The views expressed are his own.