Citadel targets DeFi! Calls for SEC regulation of tokenized stocks, crypto community in uproar

Market maker Citadel Securities sent a letter to the U.S. Securities and Exchange Commission (SEC) on Tuesday, recommending tighter regulation of decentralized finance (DeFi). Citadel argued that DeFi platforms offering tokenized U.S. stocks should be subject to securities laws and should not be granted exemptions. Citadel claims that DeFi trading platforms are likely to fall under the definitions of “exchange” or “broker-dealer,” sparking strong opposition from the crypto community.

Citadel’s Core Argument: Technology Neutrality Does Not Mean Regulatory Exemption

(Source: SEC)

This letter from Citadel Securities was a response to the SEC’s request for input on how to regulate tokenized stocks. Citadel’s core argument is based on the principle of “technology neutrality,” asserting that all securities trading platforms, regardless of the technology used, should be subject to the same regulatory standards. Traditional securities exchanges are required to register, undergo oversight, and comply with strict investor protection rules; if DeFi platforms provide the same services, they should bear the same obligations.

Citadel pointed out: “Granting broad exemptions to facilitate trading of tokenized stocks via DeFi protocols would create two separate regulatory regimes for the same security. This would be entirely contrary to the ‘technology-neutral’ approach adopted by the Securities Exchange Act.” This argument is logically persuasive—if a stock is strictly regulated on traditional exchanges but exempted on DeFi platforms, it indeed creates space for regulatory arbitrage.

However, the crypto community argues that this line of reasoning confuses the fundamental difference between platforms and intermediaries. Traditional exchanges are centralized entities controlling user funds and trade execution, thus requiring oversight to prevent abuse of power. DeFi protocols, on the other hand, are open-source code that anyone can inspect and verify, with no single entity controlling user funds. From this perspective, DeFi is more akin to a technical tool than a financial intermediary.

In July, Citadel also sent a letter to the SEC’s crypto working group, stating that tokenized securities “must achieve success by bringing true innovation and efficiency to market participants, not by exploiting regulatory arbitrage.” This wording implies that Citadel views current DeFi tokenized stock projects as primarily exploiting regulatory loopholes rather than delivering real value innovation.

Citadel’s Three Core Demands

Principle of Technology Neutrality: The same security should be subject to the same regulatory standards regardless of the trading platform.

Expanded Definition of Exchange: If DeFi platforms offer securities trading, they should be considered exchanges or broker-dealers.

No Regulatory Exemption: Developers, smart contract programmers, and wallet providers should not receive exemptions.

If adopted by the SEC, these demands would fundamentally impact the entire DeFi industry. Many DeFi protocol developers have chosen decentralized governance precisely to avoid becoming regulatory subjects. If the SEC treats the protocol itself as a registerable exchange, these projects could be forced to shut down or move to more lenient jurisdictions.

Crypto Community’s Angry Backlash: Exposing Conflicts of Interest

Citadel’s letter has sparked strong opposition from the cryptocurrency community and organizations advocating for blockchain innovation. Jake Chervinsky, lawyer and board member of the Blockchain Association, mocked on social media Thursday: “Who would have thought Citadel would oppose innovations that could eliminate predatory, rent-seeking intermediaries from the financial system? Oh right, everyone in crypto.” This sharp sarcasm directly targets Citadel’s conflict of interest.

Citadel Securities is one of the world’s largest securities market makers, earning billions of dollars in profit annually from trading. DeFi platforms, through automated market maker (AMM) mechanisms, allow anyone to provide liquidity and earn trading fees, fundamentally threatening the business model of traditional market makers like Citadel. From this viewpoint, Citadel’s push for DeFi regulation appears more like protecting its vested interests than investor protection.

Uniswap founder Hayden Adams added: “It’s understandable—the king of shady trading financial market makers doesn’t like open-source peer-to-peer technology that lowers the barrier to liquidity creation.” Adams’ comment directly challenges Citadel’s motives. As the largest decentralized exchange, Uniswap’s AMM mechanism has processed trillions of dollars in trading volume, proving the viability of DeFi in liquidity creation.

Traditional market makers like Citadel profit from bid-ask spreads and payment for order flow. DeFi AMMs redistribute these profits to liquidity providers, essentially democratizing market making from professional institutions to ordinary users. This business model disruption is the fundamental reason Citadel feels threatened.

Kristin Smith, CEO of the crypto advocacy group Blockchain Association, said: “Regulating software developers as if they were financial intermediaries will erode U.S. competitiveness, push innovation offshore, and do nothing to protect investors.” She added: “We urge the SEC to reject this overly broad and unrealistic approach and instead focus regulatory attention on true intermediaries who stand between users and their assets.”

This response highlights the fundamental distinction between software developers and financial intermediaries. Developing an open-source DeFi protocol is like creating open-source word processing software—the developer provides the tool but does not control how users employ it. Holding software developers responsible for user actions would create unworkable regulatory burdens and stifle innovation.

SIFMA and the Formation of the Traditional Finance Alliance

The Securities Industry and Financial Markets Association (SIFMA), an industry trade group, issued a similar statement Wednesday, supporting innovation but insisting that tokenized securities must be subject to the same basic protections as traditional financial investors. SIFMA represents mainstream Wall Street financial institutions, including investment banks, brokers, and asset management companies. Their alignment with Citadel shows traditional finance is forming a united front against DeFi.

SIFMA’s report noted that recent crypto market turmoil, including October’s flash crash, “reminds us of the reasons for the long-standing securities regulatory framework designed to maintain market quality and protect investors.” This argument seeks to blame crypto market volatility on insufficient regulation and suggests that only traditional regulatory frameworks can protect investors.

This statement echoes the position SIFMA took in July, rejecting any SEC exemption for blockchain and DeFi platforms issuing tokenized assets. In November, the World Federation of Exchanges, representing major exchanges, also urged the SEC to abandon plans to grant “innovation exemptions” to crypto companies seeking to issue tokenized stocks.

The formation of this traditional finance alliance is no accident. Tokenized securities represent DeFi’s direct entry into the core domain of traditional finance. When DeFi platforms only traded crypto-native tokens, traditional finance could tolerate them as a different market. But when DeFi starts offering tokenized versions of traditional stocks like Apple and Tesla, it directly threatens the core business of exchanges and market makers.

Three Main Members of the Traditional Finance Anti-DeFi Alliance

Citadel Securities: The world’s largest market maker, concerned that AMM mechanisms will take away market making business.

SIFMA: Securities industry association representing the interests of investment banks and brokers.

World Federation of Exchanges: Represents traditional exchanges such as NYSE and Nasdaq.

The common demand of this alliance is to bring DeFi under the same regulatory framework as traditional finance. However, the crypto community views this as an attempt by vested interests to stifle innovation. The fundamental divide is whether regulation should be based on function (same function, same regulation) or on technical architecture (different rules for centralized and decentralized entities).

The Regulatory Dilemma and Future of DeFi Tokenized Stocks

At the core of this debate is how to classify DeFi tokenized stocks. From Citadel’s perspective, a tokenized Apple share and a traditional Apple share are economically identical, both representing ownership in Apple, and thus should comply with the same securities laws. From the DeFi perspective, tokenized stocks are a new asset class: while they track traditional stock prices, their trading, settlement, and custody mechanisms are entirely different and should not be shoehorned into old regulatory frameworks.

The SEC faces the challenge of balancing investor protection with fostering innovation. Overregulation could push DeFi innovation overseas, weakening the U.S. competitive edge in blockchain. But full exemption could create regulatory arbitrage and investor protection gaps. Reports indicate that tokenized money market funds have surged to $9 billion, showing that this market is growing rapidly and regulatory decisions will have increasing impact.

The Bank for International Settlements warns that tokenization brings new risks, including smart contract vulnerabilities, cross-chain bridge security, and regulatory fragmentation. These technological risks do not exist in traditional securities and require new regulatory approaches. Simply requiring DeFi to comply with rules designed for centralized exchanges may not effectively manage these novel risks.