On Thursday (8 November 2018), the U.S. Securities and Exchange Commission (SEC) announced that it had settled charges against Zachary Coburn, the founder of decentralized exchange EtherDelta. What is significant about this enforcement action is that it is the first one ever based on “findings that such a platform operated as an unregistered national securities exchange.”

A Little Primer on the Relevant U.S. Securities Laws

In general, if a crypto exchange wants to deal with non-currency cryptoassets, i.e. securities in the eyes of the SEC, and it is offering (or promoting) its services to U.S. persons, it needs to be registered and regulated by the SEC under the Securites Exchange Act of 1934. Here is how the SEC explained this in a public statement titled “Statement on Potentially Unlawful Online Platforms for Trading Digital Assets” on 7 March 2018:

“If a platform offers trading of digital assets that are securities and operates as an “exchange,” as defined by the federal securities laws, then the platform must register with the SEC as a national securities exchange or be exempt from registration… To get the protections offered by the federal securities laws and SEC oversight when trading digital assets that are securities, investors should use a platform or entity registered with the SEC, such as a national securities exchange, alternative trading system (“ATS”), or broker-dealer.”

Since it is not very difficult to get registered by the SEC as a national securities exchange (an example is the New York Stock Exchange), the only other way to offer a trading platform that allows buy/selling of securities is register that platform as an Alternative Trading System (ATS). What is an ATS? This is the SEC’s definition:

“An ATS is a trading system that meets the definition of ‘exchange’ under federal securities laws but is not required to register as a national securities exchange if the ATS operates under the exemption provided under Exchange Act Rule 3a1-1(a). To operate under this exemption, an ATS must comply with the requirements set forth in Rules 300-303 of Regulation ATS.”

One of the main requirements for complying with Regulation ATS is registering as a broker-dealer. Under Section 3(a)(4)(A) and Section 3(a)(5)(A) and the Security Exchange Act 1934 respectively, a broker is “any person engaged in the business of effecting transactions in securities for the account of others” and a dealer is “any person engaged in the business of buying and selling securities for his own account, through a broker or otherwise.”

Also, according to the SEC’s “Guide to Broker-Dealer Registration”, in most cases, broker-dealer registration also requires the applicant to join a “self-regulatory organization” (SRO), such as Financial Industry Regulatory Authority (FINRA). 

And that is why on 6 June 2018, Coinbase, announced (as covered by CryptoGlobe) that it had taken a major step on the path to becoming the first SEC-registered/regulated crypto exchange through its acquisition of Venovate Marketplace Inc, Keystone Capital Corp, and Digital Wealth LLC. Venovate Marketplace had the type of SEC registration that is not too common and one which is especially important to have for any crypto exchange that wants to deal with securities: an ATS license.

The SEC’s Case Against EtherDelta

EtherDelta is a decentralized crypto exchange that provides a secondary market for Ethereum (ERC-20) tokens, such as Augur (REP) and 0x (ZRX). According to CryptoCompare Research's October 2018 Exchange Review, “the total average 24h-volume produced by the top 5 decentralized exchanges on CryptoCompare totals just under 2.4 million USD,” which “constitutes just 0.4% of total exchange volume.” 

The SEC's order found that Coburn was running “an unregistered national securities exchange” (since EtherDelta had no ATS license).

The SEC’s press release states that EtherDelta “provided a marketplace for bringing together buyers and sellers for digital asset securities through the combined use of an order book, a website that displayed orders, and a ‘smart contract’ run on the Ethereum blockchain,” and that its “smart contract was coded to validate the order messages, confirm the terms and conditions of orders, execute paired orders, and direct the distributed ledger to be updated to reflect a trade.”

It further claims that over an 18-month period, “EtherDelta’s users executed more than 3.6 million orders for ERC20 tokens, including tokens that are securities under the federal securities laws.” What made things worse was that almost “all of the orders placed through EtherDelta’s platform were traded after the Commission issued its 2017 DAO Report, which concluded that certain digital assets, such as DAO tokens, were securities and that platforms that offered trading of these digital asset securities would be subject to the SEC’s requirement that exchanges register or operate pursuant to an exemption.”

Stephanie Avakian, Co-Director of the SEC’s Enforcement Division, said:

“EtherDelta had both the user interface and underlying functionality of an online national securities exchange and was required to register with the SEC or qualify for an exemption.”

Steven Peikin, Co-Director of the SEC’s Enforcement Division, stated:

“We are witnessing a time of significant innovation in the securities markets with the use and application of distributed ledger technology. But to protect investors, this innovation necessitates the SEC's thoughtful oversight of digital markets and enforcement of existing laws.”

The SEC points out that it had “previously brought enforcement actions relating to unregistered broker-dealers and unregistered ICOs, including some of the tokens traded on EtherDelta.”

The EtherDelta founder, without any admission or denial of guilt, apparently, “consented to the order and agreed to pay $300,000 in disgorgement plus $13,000 in prejudgment interest and a $75,000 penalty.” The SEC says that had he not cooperated, the penalty imposed on Coburn could have been greater.

What the Crypto-Twitter Community Thinks About the SEC’s Action Against EtherDelta’s Founder?

Meltem Demirors, the Chief Strategy Officer at CoinShares:

Anthony Pompliano, Founder and Partner at Morgan Creek Digital:

Drew Hinkes, the General Counsel, Chief Legal Officer, and Co-Founder of Athena Blockchain (Also: Adjunct Professor at NYU School of Law):

Marco Santori, President and Chief Legal Officer at Blockchain (Also: Fintech Advisor to the IMF):

Jake Chervinsky, prominent American lawyer working at the Washington-based law firm Kobre & Kim:


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