Many cryptocurrency exchanges now make proud statements about their regulated status, but does “regulated” really mean what investors think? Martin CW Walker and Winnie Mosioma review 16 leading exchanges to find out.

The exchange of cryptocurrencies has long been the subject of controversy, especially in relation to the numerous cases of hacking and problems related to combating money laundering. However, the regulatory focus is slowly shifting to its core activity, trading. In March 2021, the Commodity Futures Trading Commission (CFCT) issued a fee for submitting and processing orders (including a $ 6.5 million settlement) for the cryptocurrency exchange Coinbase for “reckless, false, misleading, or inaccurate reporting as well des Waschhandel ”in their GDAX platform. Other leading cryptocurrency exchanges that have been screened for their trading practices include Bitfinex and Binance.

Traditional platforms for trading stocks, forex, derivatives, commodities and other more conventional financial assets are strictly regulated, regardless of whether they are officially classified as exchanges or alternative trading systems (ATS). While an ATS is not a pure exchange, it must follow the regulations that apply to exchanges or broker-dealers, depending on a number of criteria (different depending on jurisdiction), such as: B. the trading volume and the market share. Regardless of the classification, traditional trading platforms must adhere to strict rules to protect investors and avoid destabilizing the financial system. In particular, rules that require a high degree of transparency and the guarantee of operational resilience.

A fundamental mistake in Satoshi Nakamoto’s infrastructure design for the original cryptocurrency Bitcoin was the lack of an obvious way to connect it to the existing financial infrastructure. especially to facilitate the exchange of Bitcoin for conventional currencies such as dollars, pounds and euros. A loophole that did not exist in the predecessors of Bitcoin’s digital currency, e-gold and the Liberty Reserve dollar. Both had networks of independent exchanges from the start and both were closed following legal and criminal prosecution. It took 18 months from Bitcoin’s launch to the creation of the first independent exchange, bitcoinmarket.com, where Bitcoin could be traded for dollars. Unlike Liberty Reserve or E-Gold, Bitcoin (as a currency rather than a platform) was not tied to any real asset. This meant that cryptocurrency exchanges not only had to exchange cryptocurrency and conventional currency for a fee, but also had to facilitate trading between multiple parties to determine prices like an exchange.

Given the fundamental role of cryptocurrency exchanges across the crypto ecosystem and the increasing interdependence between crypto and conventional funding, it is important to understand not just whether cryptocurrency exchanges are regulated, but how they are regulated. To understand the current picture of regulation, we conducted a qualitative review of 16 leading exchanges (see Table 1), including the seven that contribute prices to the CME bitcoin reference rate, which measures the daily cost of a bitcoin in US dollars and is used to calculate the prices of Bitcoin futures on the Chicago Mercantile Exchange, an activity regulated by the Commodity Futures Trading Commission (CFCT).

The review revealed a patchwork of regulation and, in some cases, its complete absence. The leading exchanges, which were determined based on the ranking found at Cryptocompare.com from March 2021, include: Coinbase, Binance, Zwillinge, Bitstempel, Kraken, itBit, Luno, Cex.io, Liquid, LMAX Digital, Bitfinex, eToroX, Bitflyer , Currency.com, Bittrex, OKCoin. Determining the regulatory status of these platforms often proved difficult given their complex corporate structures. Of the 16 leading platforms examined, only four were subject to significant trading regulation.

itBit, a US-based exchange with an estimated daily trading volume of nearly $ 12 million (one of the smaller exchanges), is arguably the safest, with DFS oversight and registration as a bank. This means that the exchange is subject to the provisions of the US Bank Secrecy Act (BSA), the US Patriot Act and the General Regulations of the Banking Board. eToroX and LMAX Digital operate as multilateral trading systems and are under the supervision of the Federal Regulatory Authority and the UK Financial Supervisory Authority (FCA). However, the main reason for this monitoring was more conventional activity in forex and stocks than in cryptocurrencies. The Belarus-based exchange Currency.com is subject to extensive controls over transaction reporting, monitoring of suspicious activity, AML requirements and even fair advertising rules on par with Belarus-based stock exchanges. However, Belarus is not exactly a leading financial center.

Seven of the remaining exchanges operate as licensed Money Service Businesses (MSBs) or equivalent – including the ubiquitous Coinbase. This means that they must register with the Financial Crimes Enforcement Network (FinCEN) in the US and / or with the Financial Conduct Authority (FCA) under the Payment Services Regulations 2017 in the UK. This does not mean that their trading activities are regulated.

At the other end of the spectrum, three of the top exchanges don’t appear to be under any government control. Liechtenstein-based company Bittrex, Singapore Luno and Bitfinex based in the British Virgin Islands are unregulated companies and are not licensed by any major international organization. This is despite the fact that Bitfinex suffered a hack in 2016 that resulted in the loss of around $ 72 million in Bitcoin. The event led to an order being placed by the US Commodity Futures Trading Commission (CFTC), which, in particular, was unable to force Bitfinex to take positive action.

While registering exchanges can provide some convenience for investors, regulators generally focus on anti-money laundering (AML) and due diligence measures – not trading. In the UK, cryptocurrencies are only regulated for money laundering purposes, and there is no broader framework for the activities of exchange platforms unless they cross the line with other areas of regulated financial activity.

Many of these exchanges proudly advertise their possession of a Distributed Ledger Technology license from the Gibraltar Financial Services Commission. This is advertised by Cex.io as a sign of legitimacy and seriousness, but in practice there seems to be very little in terms of ongoing review once approval has been granted.

Given the lack of significant government oversight of actual trading activity, it is likely no surprise that many cryptocurrency exchanges engage in questionable activity, such as trading activities. B. Leverage for their customers and laundry retailers, all against the background of inexplicable system failures in times of market instability. Reasons for regulatory intervention in the conventional world. Few practice any form of anti-market abuse mitigation, while some have even been accused of trading against their customers, which economist Nouriel Roubini compared to a casino dealer betting against a player whose cards they saw.

Today, cryptocurrencies are an important asset class with a nominal value of 1.77 trillion US dollars (as of March 2021). Investments are made by publicly traded companies like Tesla and MicroStrategy, and large financial institutions are more willing to offer cryptocurrency-related services. However, the regulatory framework within which it exists is very worrying. In general, cryptocurrencies lack people who are really responsible for core processes like property transfers, trade validation and creation of cryptocurrencies. A concern that can ultimately only be resolved through acceptance of the situation or through complete bans. However, the almost complete lack of regulation of highly centralized cryptocurrency exchanges is likely to be an easier loophole to fill. Regulated companies that rely on “stock exchanges” prices to account for or calculate the value of futures contracts are clearly exposed to significant risk. At least until cryptocurrency exchanges are subject to the same supervision as other financial markets.

Table 1. Regulation of leading crypto exchanges

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Remarks:

  • This article reflects the views of its authors, not the position of LSE Business Review or the London School of Economics.
  • Featured image by Pierre Borthiry on Unsplash
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