SEC rule rollback could unlock tokenized U.S. stock trading in DeFi

In a significant move that could reshape trading dynamics in the U.S. equity markets, the U.S. Securities and Exchange Commission (SEC) has proposed eliminating two foundational rules from Regulation National Market System (NMS), igniting discussions around tokenized stocks and decentralized finance (DeFi) trading.

On June 11, the SEC announced its intention to eliminate Rules 611 and 610(e) from Regulation NMS, which have governed the equity markets for almost two decades.

Specifically, Rule 611 prevents trade-throughs on national market system stocks, meaning a trading venue cannot execute a stock trade at a less favorable price than what is available on another venue. Meanwhile, Rule 610(e) addresses locked and crossed quotations, mandating that trading centers avoid quoting prices that equal or exceed the national best bid or offer.

The proposed change would also eliminate corresponding definitions in Rule 600 and implement other related adjustments. The public will have 60 days to comment following the proposal’s publication in the Federal Register.

SEC Chairman Atkins Discusses Cost Reduction

SEC Chairman Paul Atkins emphasized that this initiative intends to streamline the equity market structure after years under Rule 611. He stated that the rule may have inadvertently restricted market growth.

“After two decades of Rule 611, it is high time that the Commission review its unintended consequences that have hindered — rather than enhanced — the long-term growth of our markets,” stated Atkins. “This proposal is intended to simplify market structure and reduce costs for market participants, encouraging competition, innovation, and the natural evolution of our equity markets.”

It is important to note that the proposal does not authorize tokenized stock trading on its own; instead, it initiates a rulemaking process that allows market participants to voice their opinions before any final decisions are made.

Analysts Highlight Advantages for Tokenized Stocks

Analysts from Galaxy Digital see the SEC’s proposal as a potential turning point for tokenized U.S. equities within DeFi. Alex Thorn pointed out that automated market makers (AMMs) have difficulty adhering to Rule 611 because they execute trades through liquidity pools and bonding curves, making it challenging to comply with the rule’s requirements.

“An AMM cannot comply with 611 by construction. It executes against a bonding curve at whatever the pool price is, with slippage, at block-time granularity,” Thorn remarked.

The challenge lies in that DeFi liquidity pools cannot check every stock exchange quote live before each transaction and cannot route orders across markets like traditional systems do. Moreover, Rule 610(e) poses additional challenges as AMM prices change with trading flows, which can lead tokenized equity pools to inadvertently lock or cross displayed quotes in standard markets.

Other Regulatory Hurdles for Tokenized Equities

If the SEC moves forward with rescinding these rules, analysts suggest that the best execution duties at the broker level may assume greater importance. Under FINRA Rule 5310, brokers must secure the best available terms for client orders, which could align more effectively with tokenized markets compared to traditional price protection rules.

Despite the potential easing of regulations, tokenized stocks will still face additional barriers, including requirements for exchange registration, Alternative Trading System (ATS) conformity, clearing and settlement processes, along with addressing investor rights.

The SEC has previously indicated that it is researching an innovation exemption that may permit tokenized public stocks to be traded on blockchain platforms. If implemented, such an exemption might require tokenized shares to carry the same rights as conventional shares, including entitlements to dividends and voting rights.

Furthermore, SEC Commissioner Hester Peirce has cautioned that any exemptions are likely to be narrowly focused, mostly applying to digital replicas of existing public equities, rather than synthetic tokens lacking shareholder rights.

This SEC proposal adds a notable chapter to the ongoing transformation of market structures. Although it may alleviate some obstacles, the eventual outcomes will hinge on public feedback and further regulatory actions.