It seems there has
been nothing but bad news for cryptocurrency exchanges
Amid the price collapse, a number of high-profile incidents
have cast further doubt on the stability of the market. Most
notably, the death of Gerry Cotton, chief executive of Canadian
exchange QuadrigaCX, which allegedly resulted in $145 million
of investors’ money being frozen in inaccessible
cold wallets. Conspiracy theories have naturally
This isn’t the only case to concern potential
investors. In 2014 Mt. Gox, one of the first bitcoin exchanges,
shut down its operations and filed for bankruptcy. At the time,
the exchange handled 70% of all bitcoin transactions, and
investors are still unclear as to the state of their
The plethora of hacks on exchanges around the world has had a
big impact on prices, contributing to bitcoin’s
collapse. Its price is now down from $19,700 in December 2017
to $2,867 at the time of writing. In September 2018, Japanese
exchange Zaif was infiltrated by hackers who stole almost $60
million worth of cryptocurrency.
These high-profile incidents have led many to believe that new
cryptocurrency-specific regulation is required. It is said that
doing so would help protect retail investors, as well as drive
out some of the less scrupulous market players.
"Regulation defining minimum standards of risk management
framework would address cyber risks and information security,"
said a vice president at a regtech firm. "Doing so is important
to mitigate operational risks and enhance customer
Coinbase CEO says crypto-specific regulation is
What is regulators’ current
Cryptocurrency exchanges are a digital marketplace where users
can trade digital cryptocurrencies.
One of the major difficulties for regulators is defining
precisely what cryptocurrencies are, and the technology
associated with the market. There is disagreement as to whether
they should be named cryptocurrencies or cryptoassets, for
instance. The distinction will affect whether these are
regulated as a currency or an asset.
Regulators were initially reticent to regulate
cryptocurrencies, given fears that such a move would legitimise
a market they were sceptical of. Yet across the globe, many are
now putting in place frameworks that will offer clear rules for
The UK, for example, is in the process of establishing a
cryptocurrency framework which is expected to
mirror Switzerland’s approach. The Financial
Conduct Authority (FCA) published guidance in January 2019,
dividing tokens into three separate categories: exchange
tokens, not within FCA remit; security tokens, regulated as
financial instruments; and utility tokens, which would normally
France is also in the process of creating its own framework.
French foreign minister Bruno Le Maire said in March 2018 that
he wanted his country to become the capital of ICOs. New
regulation is expected imminently, which will force exchanges
that conduct fiat to cryptocurrency trades to complete a
registration form with the Autorité des
"A growing number of jurisdictions are recognising
cryptocurrencies as something they can use to promote
their own financial centre," said the regtech vice president.
"They can attract new exchanges by providing a clear regulatory
Many exchanges had previously avoided fiat to cryptocurrency
trades, as it would mean complying with anti-money laundering
(AML) regulation. Yet to improve user convenience, more
exchanges are beginning to offer these kinds of trades, even if
it does mean they are subject to AML rules. This is part of an
increasing trend towards more actively compliant cryptocurrency
separate rules for crypto could be the
What changes are being made?
Exchanges have begun to put more emphasis on improving their
security after a series of high-profile hacks on platforms. The
security demands from users have risen because of an increased
awareness of risks in the market. In order to be successful,
exchanges need to offer a certain level of trust, and are now
beginning to realise this and take active steps to address the
According to Sarah Lewis, counsel at Cleary Gottlieb, to
establish trust with market participants exchanges are seeking
to differentiate themselves by taking into account the position
of regulators. "They are acknowledging that the regulatory
position may be uncertain in some jurisdictions, but also that
it is evolving," she said.
There is a risk that too much regulation could disincentivise
exchanges from operating in a certain jurisdiction, and even
stifle the developing industry. While opinion from governments
on cryptocurrencies or cryptoassets is mixed at best, almost
all are in support of blockchain. Lawmakers will not want to
inhibit the industry and disrupt distributed ledger technology
in their country.
New York’s Bitlicence, which businesses need
before they can deal in virtual currencies, drove a number of
companies out of the state. As of January this year, only 14
licences have been granted to companies. The framework has
received widespread criticism for being too
"Due to regulatory uncertainty, some crypto exchanges have
taken advantage of regulatory arbitrage, and based themselves
out of jurisdictions with looser regulatory oversight," Lewis
said. For example, many exchanges are based in Estonia, home to
arguably the biggest money laundering scandal in
In order to address concerns that bitcoin has been used to
launder money, the European Commission adopted the Fifth Money
Laundering Directive in April 2018 to include virtual
currencies. The massive fall in the bitcoin price after the
directive came into force could be coincidental, but it could
also be indicative of the scale of the problem before the
directive came into force.
Yet legitimate exchanges wanting to conduct business honestly
have a difficult task trying to adapt to different rules in
different jurisdictions. The situation is also constantly
evolving, making it difficult to plan for the long
How are exchanges reacting?
Exchanges are responding positively, however. Many are
customising their offerings for a selected jurisdiction, for
example only offering fiat to crypto trades in selected
jurisdictions that have more generous oversight. Some are
offering selected tokens in a single jurisdiction. It is clear
that overall, exchanges are taking regulation into account, and
making changes in response.
There is however scope for improvement, according to Fern
Karsh, general counsel at fintech company Catalystic AI. "More
exchanges should behave like regulated financial entities," she
said. "They should be getting ahead of regulations and
implementing best practices, even in jurisdictions where
regulations aren't yet in force."
Exchanges should implement risk management programmes, run
external audits and implement anti-money laundering processes.
It is also important to conduct vendor due diligence and
cybersecurity checks to avoid the fate of failed exchanges in
That task is likely to become easier in the coming years after
clear frameworks specific to cryptocurrencies have been adopted
by the major economies. While the position of regulators is
becoming clearer, it is still not certain until these have been
implemented. Once it is, significant legal and regulatory risk
will be reduced.
This would make it easier to establish important commercial
relationships and drive out exchanges with inadequate
standards. This could also help to change the negative
perception some have about the marketplace.
According to Karsh, the main issues exchanges have to deal with
include: securing banking relationships, understanding the
regulatory environment, and implementing compliant anti-money
laundering practices both domestically and globally. These
issues could also be reduced considerably if an effective
regulatory framework is implemented.
Yet for some, it is critical that existing banking regulation
is not applied.
"The major problem is that regulators are applying existing
banking or securities laws," said Angel Versetti, chief
executive of blockchain company Ambrosus. "This inhibits the
sector greatly. These regulations were drafted many years ago
and do not account for technical developments."
While it appears that the US is going in that direction
– in light of Jay Clayton’s repeated
comments that he has never seen an ICO that isn’t
a security – Europe looks to be adopting new
frameworks specific to the cryptocurrency industry. If it does,
this would most likely be welcomed. The hope is that it would
arrest the price slide plaguing the industry over the past 12
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