When crypto exchanges decentralise | Financial Times

Earlier this month, the Justice Department filed criminal charges against the founders of the Seychelles-based crypto exchange BitMEX.

The Commodity Futures Trading Commission has filed civil lawsuits against the founders and five other companies behind BitMEX for failing to register with the agency and failing to comply with AML procedures. The founders were also accused of having operated an internal trading desk in conflict situations.

Readers may remember BitMEX CEO Arthur Hayes who had a fiery debate with economist Nouriel Roubini. Dubbed “the Taipei Tangle,” Roubini accused the company of a number of controversial allegations, including that the exchange was openly targeting “degenerate gamblers” and brazen disregard for accredited investor and KYC / AML rules by she operated from the light. Touch the Seychelles jurisdiction.

Representatives from HDR Global Trading Limited, a BitMEX affiliate, responded that the company plans to defend itself vigorously, calling the charges persistent.

Nevertheless, it looks, at least for now, as if Roubini’s perspective has the advantage over the BitMEX perspective.

As the case progresses, another important aspect of the story may come into play: How the case affects the development of decentralized crypto exchanges.

BitMEX was one of the last major exchanges (at least with significant liquidity) where traders could trade almost entirely anonymously. As recently as the beginning of this year, a user only had to open an email and 2-factor verification tool to open a BitMEX account.

In theory, this meant that anyone filing business in and out of BitMEX from countries that applied KYC and AML rules would be illegally served by BitMEX.

Sources close to BitMEX told FT Alphaville last year that the company believes users with IP addresses from controversial jurisdictions, particularly America, would continue to comply.

FT Alphaville believes the controversial markets remain a major source of revenue, especially in terms of fees, and the company has made a strong suggestion to users that using VPNs would bypass their systems.

Recent US promotions (which can be read in full here and here) thus result in a death penalty for the crypto exchange model, which anonymously serves customers in KYC / AML mandatory jurisdictions (i.e. most of the world).

This is important because it means that customer-facing crypto services in countries like the US will be fully incorporated into the regulatory web of the core system, ensuring that there is little advantage in using crypto data over traditional financial services

Never ready to give up, however, this has shifted the focus of the crypto community to the creation and dissemination of so-called decentralized exchanges. The problem is that the industry is still not ready to acknowledge the fact that a decentralized exchange is a contradiction and therefore not a substitute for operations like BitMEX.

However, that doesn’t mean they won’t try.

In the eyes of the industry, matching software, which can be downloaded and used to match counterparties, is more of a tool than a service. Accordingly, the same requirements for the disclosure of financial data, KYC and AML do not apply, not least because there is no central body that regulates or mediates the amounts of money that flow through a system.

It is undeniable that there are some advantages to using such software over reliance on traditional off-grid exchanges. Most important among them is eliminating the risk that a third party exchange like BitMEX would use a proprietary trading desk – with superior information on customer flows – to trade against their own users.

As the CFTC Complaint notes, this was a point of contention regarding BitMEX:

BitMEX acts as a counterparty for certain transactions on its platform, e.g. B. via the internal market-making desk or via the BitMEX liquidation engine, which can take the position of a customer under certain circumstances.


BitMEX has not been able to establish rules to minimize conflicts of interest. This is evident because Hayes, Delo, Reed and numerous other BitMEX employees trade on the platform and BitMEX’s internal market making desk has been one of the largest traders on the platform at times.

Such conflicts remain possible with all centralized exchanges, dark pools, and market-making operations. Without proper supervision, there is always the risk, if not the temptation, of acting against your own customers. As is the temptation to engage in conflicting market-making operations. The core financial system itself is not immune to this problem, but the risk is all the greater when the exchange is also the manager and controller of trust funds and operates offshore.

A decentralized system theoretically eliminates this problem. The downside of this reality, however, is that there is no guaranteed liquidity and no protection against counterparties flaking or worse in any such system. There are just no guarantees at all. While reputation assessment can be helpful, over time it becomes a standalone issue as it becomes utterly impossible to independently review all counterparties to any significant extent or pace. All of this affects liquidity and increases the theoretical discount that must be applied to any cryptocurrency that cannot be withdrawn in the area of ​​the regulated system.

In the long run, customers (even fraudulent ones) will realize that all the structure really does is outsource the task of KYC and AML screening directly to users. If crypto users are smart they will realize that it will never be as cost effective as institutions that do KYC on behalf of users.

At this point, everyone involved should do a good job of investigating why there have always been things like pirate code and honor among thieves. Trust is not optional. If you want to take advantage of a scaled system, you need institutional trust to get it across. This applies to black market transactions as well as to completed transactions.

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