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  • Connectivity

    New York’s damning report on crypto exchanges will be good for the industry

    Purists won’t like it, but shining a light on the exchanges’ shady practices could trigger big-time growth.

    A fight is brewing over the future of the cryptocurrency exchange, and its outcome will figure prominently in how the industry evolves. On one side are the purists, who believe that crypto exchanges—the on- and off-ramps between the world of crypto and the traditional financial system—can and should remain free of government meddling. On the other side are government regulators, charged with protecting investors from fraud.

    This week the New York attorney general’s office landed a powerful blow in favor of the regulators, with a new report that illuminates the shadowy inner workings of 10 popular cryptocurrency exchanges. The report could dial up pressure on the exchanges to move toward greater transparency and better consumer protection. Like it or not, that could be a boon for the cryptocurrency industry—at least, if mainstream adoption is the goal.

    This piece first appeared in our twice-weekly newsletter Chain Letter, which covers the world of blockchain and cryptocurrencies. Sign up hereit’s free!

    In April, the AG’s office asked 13 popular exchanges to respond to a detailed questionnaire covering a wide range of topics, from trading fees to anti-money-laundering policies to methods for keeping customer assets secure. Ten chose to comply, and the newly released analysis of their responses paints a bleak picture. In particular, Attorney General Barbara Underwood lamented the widespread lack of “necessary policies and procedures to ensure the fairness, integrity, and security” of exchanges.

    It’s not the first time New York has shaken up the cryptocurrency exchange scene. In 2015, it introduced BitLicense, a first-of-its-kind licensing regime for digital currency companies that imposed rules meant to prevent money laundering and provide some consumer protections. As in 2015, the state says it’s intervening now because it’s necessary to shield investors from fraud.

    No federal agency has the authority to directly oversee cryptocurrency exchanges. This has allowed exchanges to operate free of the extensive rules that the US Securities and Exchange Commission imposes on traditional securities marketplaces like stock exchanges and broker-dealers. Meanwhile, recent academic research has suggested that traders may be manipulating Bitcoin’s price, and the US Department of Justice has opened a criminal investigation into the matter.

    The New York AG’s office is uniquely equipped to fill the void. It has broad authority to police fraud in the state’s securities and commodities markets, and “they know how traders can abuse marketplaces,” says Aaron Wright, a professor at the Cardozo School of Law in New York (because, you know, Wall Street).

    The new report hammers exchanges for lacking “robust real-time and historical market surveillance capabilities, like those found in traditional trading venues, to identify suspicious trading patterns.” It says conflicts of interest are rampant. And it raises concerns about an industry-wide lack of transparency regarding several things, including:

    • why exchanges list certain coins and not others
    • whether listings involve payment and how much
    • whether a given exchange’s employees own any of its listed coins.

     As when New York introduced BitLicense, the probe has been met with substantial resistance. Several exchanges—Binance, Gate.io, Huobi, and Kraken—declined to participate, claiming that they don’t allow trading in New York. The AG’s office looked into those claims, though, and has referred Binance, Gate.io, and Kraken to the state’s Department of Financial Services “for potential violation of New York’s virtual currency regulations.” Jesse Powell, Kraken’s CEO, lashed out via Twitter, calling state regulators “abusive.” Powell has argued that being protected from market manipulation “doesn’t matter to most crypto traders.”

     Wright, however, says the report is a good thing for crypto, because it will push the “good actors” to make their processes fairer to customers. “I think ultimately, as this industry matures, the marketplaces that are the most safe and sound and secure will tend to win,” he says.

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