July 22, 2025 – Citadel Securities, the notorious market maker, has called on the U.S. Securities and Exchange Commission (SEC) to adopt a cautious and structured approach to regulating tokenized securities, emphasizing the need for transparency and investor protection.
In a letter to the SEC’s Crypto Task Force, the firm warned that rushed exemptions for tokenized securities could lead to investor confusion, market fragmentation, and unfair advantages for certain platforms.
However, Citadel’s advocacy for transparency is steeped in irony, given its history of regulatory scrutiny and distrust among retail investors for alleged market manipulation practices.
In its letter, Citadel Securities expressed concerns about the SEC’s potential move to grant exemptions for tokenized securities—digital representations of traditional assets like stocks or bonds issued on blockchain networks.
The firm argues that such exemptions, particularly for large players like Coinbase, could create regulatory arbitrage, allowing some firms to bypass rules that traditional market participants must follow.
Stephen Berger, a Citadel executive, wrote, “While we strongly support technological innovations designed to address market inefficiencies, seeking to exploit regulatory arbitrage for ‘look-a-like’ securities is not innovation.”
The firm advocates for a formal rulemaking process with public input to ensure clarity, fairness, and market integrity.
Citadel’s concerns echo those of the Securities Industry and Financial Markets Association (SIFMA), which recently cautioned against exemptions that could disrupt capital markets.
Both entities argue that tokenized securities, if not properly regulated, could siphon liquidity from traditional equity markets and harm the initial public offering (IPO) market by offering private companies alternative fundraising routes.
Citadel specifically highlighted risks such as investor confusion, reduced transparency, and restricted access for institutional investors like pensions and banks, which may face barriers to crypto exposure due to internal policies.
The firm’s recommendations include mandatory disclosures on tokenization structures, clear regulations for trading platforms, robust custody and transfer rules, and jurisdictional clarity for cross-border operations.
These measures, Citadel argues, would balance innovation with investor protection while preventing market fragmentation.
However, the use of blockchain would actually deter hedge funds and short selling firms from illegal market manipulation tactics.
How Blockchain Improves Markets for Retail Investors
Blockchain technology has the potential to enhance financial markets for retail investors by increasing transparency, improving efficiency, and reducing opportunities for certain types of market manipulation, such as naked short selling.
- Transparency and Immutability:
- Mechanism: Blockchain is a decentralized, tamper-resistant ledger where all transactions are recorded in real time, visible to all participants, and cannot be altered retroactively. Each transaction is cryptographically verified and stored across multiple nodes, ensuring a single source of truth.
- Benefit for Retail Investors: This transparency allows retail investors to verify the ownership, transfer, and settlement of securities in real time, reducing reliance on opaque intermediaries like brokers or clearinghouses. For example, tokenized securities (digital representations of stocks or bonds on a blockchain) provide a clear audit trail, making it easier to detect discrepancies or manipulative activities.
- Faster Settlement Times:
- Mechanism: Traditional markets operate on a T+2 settlement cycle (trade date plus two days), creating a window where trades are not finalized, which can be exploited. Blockchain enables near-instantaneous settlement (T+0 or T+1) by automating and streamlining the process through smart contracts—self-executing agreements coded on the blockchain.
- Benefit for Retail Investors: Faster settlement reduces counterparty risk (the risk that one party fails to deliver), ensuring retail investors receive their assets promptly. It also minimizes the time window for manipulative practices that exploit settlement delays.
- Fractional Ownership and Accessibility:
- Mechanism: Blockchain allows assets to be tokenized into smaller units, enabling fractional ownership. Smart contracts facilitate 24/7 trading on decentralized platforms, bypassing traditional market hours.
- Benefit for Retail Investors: Fractional ownership lowers the cost of entry, allowing retail investors to own portions of high-value assets like real estate or blue-chip stocks. 24/7 trading provides flexibility, leveling the playing field with institutional investors who often dominate traditional market hours.
- Decentralized Governance:
- Mechanism: Blockchain platforms often operate without a single controlling entity, using consensus mechanisms (e.g., proof-of-stake) to validate transactions. This reduces the influence of centralized intermediaries like market makers or clearinghouses.
- Benefit for Retail Investors: Decentralization limits the ability of powerful players to manipulate markets behind closed doors, as all actions are recorded publicly. Retail investors gain confidence that trades are executed fairly without hidden agendas.
Eliminating Naked Short Selling and Other Market Manipulation Tactics
- Naked Short Selling:
- What It Is: Naked short selling occurs when a trader sells shares they do not own or have not borrowed, creating “synthetic” shares that artificially inflate supply and depress prices. This practice is illegal in many jurisdictions but persists due to enforcement challenges in traditional systems.
- How Blockchain Eliminates It:
- Immutable Ownership Records: Blockchain records every share’s ownership and transfer in real time. Before a sale can occur, the blockchain verifies that the seller holds the asset or has borrowed it, preventing the creation of synthetic shares. Smart contracts can enforce this by requiring proof of ownership or borrow agreements.
- Real-Time Settlement: By settling trades instantly, blockchain eliminates the T+2 window where naked short sales can occur without immediate detection. If a seller fails to deliver shares, the transaction is rejected by the blockchain’s consensus mechanism.
- Example: A tokenized stock on a blockchain like Ethereum would require the seller’s wallet to hold the corresponding tokens. If the tokens are absent, the smart contract would block the sale, making naked short selling impossible.
- Spoofing and Layering:
- What It Is: Spoofing involves placing large buy or sell orders to create a false impression of demand or supply, then canceling them to manipulate prices. Layering is a similar tactic involving multiple fake orders.
- How Blockchain Mitigates It:
- Transparent Order Books: Blockchain-based trading platforms record all orders publicly and immutably. Spoofed orders would be visible to all participants, making it harder to manipulate perceptions without detection.
- Cost of Manipulation: Placing fake orders on a blockchain incurs transaction fees (e.g., gas fees on Ethereum), discouraging spoofing. Additionally, smart contracts can enforce rules requiring orders to be backed by actual funds or assets, reducing fraudulent activity.
- Example: A decentralized exchange (DEX) like Uniswap uses transparent order books and automated market makers, making spoofing less effective as all actions are visible and costly.
- Front-Running and Insider Trading:
- What It Is: Front-running occurs when intermediaries (e.g., brokers) trade ahead of client orders to profit from price movements. Insider trading involves using non-public information to gain an unfair advantage.
- How Blockchain Mitigates It:
- Decentralized Execution: On blockchain-based platforms, trades are executed via smart contracts without intermediaries, eliminating the opportunity for brokers to front-run. For example, a retail investor’s trade on a DEX is processed directly on the blockchain, bypassing traditional brokers.
- Public Transaction Data: All trades are recorded transparently, making it easier to detect suspicious patterns that suggest insider trading. Regulators can analyze blockchain data to identify trades linked to non-public information.
- Example: Ethereum’s public ledger allows anyone to audit transactions, making it harder for insiders to hide manipulative trades.
- Pump-and-Dump Schemes:
- What It Is: Manipulators artificially inflate an asset’s price through coordinated buying or misinformation, then sell at the peak, leaving retail investors with losses.
- How Blockchain Mitigates It:
- Traceability: Blockchain’s audit trail makes it easier to trace coordinated buying patterns to specific wallets, aiding regulators in identifying culprits.
- Smart Contract Safeguards: Platforms can implement rules to flag or limit rapid, suspicious trading activity. For instance, a smart contract could cap trade volumes during sudden price spikes to prevent manipulation.
- Example: DeFi platforms like Aave use governance tokens and community oversight to monitor and mitigate manipulative behaviors.
The Irony of Citadel’s Transparency Push
Citadel’s call for transparency and fair markets is notable given its controversial history, which has fueled distrust among regulators and retail investors.
In 2023, the SEC charged Citadel Securities with violating Regulation SHO by incorrectly marking millions of sale orders over a five-year period, mislabeling short sales as long sales and vice versa.
This coding error led to inaccurate data being provided to regulators, undermining efforts to police abusive short-selling practices.
Citadel agreed to a $7 million penalty and a cease-and-desist order without admitting or denying the findings.
Retail investors have long accused Citadel of market manipulation, particularly through practices like naked short selling and trading synthetic shares.
Posts on X reflect this sentiment, with users alleging that Citadel’s actions have disadvantaged retail traders while generating billions in profits.
One user claimed, “They never closed their short positions ever and use naked short sales to trade synthetic shares, thus screwing retail investors.”
Citadel’s aggressive tactics have also drawn criticism.
In 2022, the firm sought a restraining order against a former employee who joined a crypto startup, alleging he possessed confidential information.
The employee’s legal team argued that Citadel’s claims were baseless, as the information was unrelated to the startup’s operations.
Additionally, Ledger Insights reported that Citadel pressured them to alter a non-controversial article about EDX Markets, a crypto trading platform co-founded by Citadel, despite the article being factually accurate.
These incidents suggest a pattern of assertive behavior that contrasts with Citadel’s current advocacy for transparency.
The Broader Context of Tokenization
Tokenized securities, which leverage blockchain for faster settlements, fractional ownership, and 24/7 trading, are gaining traction.
Platforms like Coinbase and Robinhood see them as a way to democratize access to assets, but Citadel warns that without proper oversight, they could destabilize markets.
The firm points to complex tokenization structures, such as offshore money market funds or Republic’s “Mirror Tokens,” which may introduce risks to investors and market liquidity.
The SEC, under Chairman Paul Atkins, is exploring ways to modernize securities rules to accommodate tokenization. Atkins has signaled a shift from the enforcement-heavy approach of his predecessor, Gary Gensler, toward fostering innovation.
This includes considering exemptions to encourage tokenized securities, a move Citadel and SIFMA argue should be approached cautiously through formal rulemaking.
Recent legislative developments, such as the U.S. House’s passage of a stablecoin bill signed into law by President Trump, reflect growing regulatory clarity in the crypto space.
The bill mandates dollar-for-dollar reserves for stablecoin issuers, aiming to enhance market legitimacy.
However, critics like Senator Elizabeth Warren argue it falls short on consumer protections.
Citadel’s intervention underscores the tension between innovation and regulation in the evolving world of tokenized securities.
While its recommendations for structured rulemaking and transparency have merit, the firm’s checkered past raises questions about its motives.
Is Citadel genuinely concerned about market integrity, or is it seeking to protect its dominant position in traditional markets?
The answer likely leans towards the firm seeking to protect its position as it navigates a landscape where blockchain could disrupt its business model.
As the SEC weighs its next steps, the debate over tokenized securities will shape the future of capital markets.
But I’m curious to know what you think — leave your thoughts below.
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