On November 8, the SEC issued a settled order against Zachary Coburn, the creator of the smart contract that powers the EtherDelta decentralized exchange. In the settled order, the Commission found that Coburn’s EtherDelta smart contract, which enabled trading of Ether against any other ERC20 token, and the EtherDelta website through which buyers and sellers of ERC20 tokens met, operated as an unregistered “exchange” in violation of Section 5 of the Exchange Act. Without admitting or denying the findings, Coburn consented to the order and agreed to pay $300,000 in disgorgement plus $13,000 in prejudgment interest and a $75,000 penalty. The Commission’s order notes that Coburn’s cooperation was a consideration in not imposing a greater penalty.
This is the first case involving a so-called “decentralized exchange.” Unlike some of the most well-known cryptocurrency platforms like Coinbase and Gemini, which generally operate as custodians, EtherDelta never maintained accounts for its users’ funds. Instead, parties could transact directly with each other using the EtherDelta smart contract. Though the EtherDelta smart contract by itself is merely code that runs on the Ethereum blockchain, the Commission found that the activities taken by its creator to bring together buyers and sellers to transact through the smart contract constituted an “exchange” as defined under Section 3(a)(1) of the Exchange Act and Rule 3b-16 thereunder. In particular, Coburn’s website had features similar to many online securities trading platforms. The website displayed EtherDelta’s order book and transaction information, and provided graphical tools to assist users in understanding and analyzing the data. Users could enter limit orders to buy or limit orders to sell. The website also maintained a curated list of “official [token] listings” which had undergone due diligence by Corburn, even though the EtherDelta smart contract by its terms would effect a transaction with any ERC20 token. The EtherDelta smart contract charged a fee of 0.3% of the transaction trade value to a person transacting against a posted limit order (“taker”). The fee was paid to Coburn as the owner of the “fee account” specified in the EtherDelta smart contract.
The settled order does not directly affect the operation of well-known custodial cryptocurrency platforms, but it clarifies the legal status of decentralized exchanges in the eyes of the SEC, and it raises some significant questions for operators of various types of cryptocurrency platforms.
A few observations.
- The SEC differentiates transactions between activity pre-DAO Report and post-DAO Report. In this case, 92% occurred post-DAO Report. This suggests that the SEC is still continuing to distinguish between conduct that took place before and after its 21(a) Report, its first major statement that digital assets could be securities.
- There are no allegations of fraud or customer harm or market abuse. This case is strictly about operating an unregistered exchange.
- Perhaps the most glaring omission in the order is that it does not indicate how many or which of the 3.6 million trades effected on the platform during the period of the alleged violation (from July 12, 2016 to December 15, 2017) involved a security. On one hand, it is understandable that an order against an unregistered exchange is not the proper context for such guidance. A statement by the Commission that a particular digital asset is a security would have a pronounced effect on the asset, and would, in accordance with fundamental principles of due process, necessitate an opportunity for the issuer of such asset to address the SEC’s findings. On the other hand, the order raises the possibility that any type of platform handling any ERC20 token could be subject to this same type of proceeding. In that way, the order could have a pronounced effect on all types of cryptocurrency platforms, creating uncertainly even for those that do not turn out to be handling any types of tokens that the SEC may ultimately find to be a security.
 See Steptoe’s previous discussions on the DAO Report here and here.