Digital trading facilities that seek to trade SEC-registered securities will need to improve their operations as well as possibly take on additional regulatory requirement compared to existing self-regulatory organizations, according to the U.S. market regulator.

“The proliferation of new technologies and trading platforms belie the fact that many digital asset trading platforms still suffer from poor execution quality, wash trading, and other manipulative practices,” said Brett Redfearn, director of the Division of Trading and Market at the SEC during the regulator’s recent Fintech Summit in Washington, D.C.

Not wanting to emphasize “the dark side” of the nascent market, he noted that the Commission desires to foster innovation but balance it with investor protection.

Many digital trading facilities operators may think that if they move matching and trading for their platform and onto a public blockchain that they would not fall under the SEC’s exchange regulatory framework.

“This, however, would be incorrect,” said Redfearn. “It would disregard the Commission’s well-established framework for regulating exchanges. An entity facilitating the trading of securities should consider the totality of the activities and functionalities used to bring together the orders of buyers and sellers to determine if it meets the definition of an exchange.”

The Division of Markets and Trading and the Division of Enforcement clarified that the regulator considers whether an entity is an exchange by the activity occurring between the buyer and sellers and not the technology or terminology used by the trading platform’s operator in a joint-staff statement that the divisions issued in November 2018.

Redfearn also floated the idea that digital exchange operators might need to provide some fashion of investor protection for their disintermediated market.

“The protections created by the regulation of broker-dealers and investment advisors under Federal securities laws are largely absent when such intermediaries do not play a role of digital asset markets,” he said. “The question is then whether there should be greater responsibilities on the primary intermediary, the trading platform, to ensure that investors have the level of information required to make meaningful choices while trading in digital assets.”

While digital exchanges have incorporated functions that typically rested with broker-dealers, custodians, prime brokers, and “information/research providers,” the SEC needs to ensure that the proper investor protections are in place for each function, Richard Johnson, principal, market structure and technology at Greenwich Associates, told Markets Media.

“The SEC has been hinting for a while that exchanges need to register under the Exchange Act,” he added. “But when you are talking about informational responsibilities, it seems to speak more to investment advisor regulations.”