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The Regulation of Crypto Exchanges Moving Forward


Governments across the world initially adopted a policy of ignorance toward cryptocurrency. This was perhaps because of the misguided notion that cryptocurrency was a passing fad that would go away. Over a decade later the crypto industry is large and booming with a total market capitalization of about $250 billion USD. This is still a long way off the record highs of early 2018 but is remarkable nonetheless.

At the height of the ICO boom, the industry attracted tens of millions in investor funds daily. Cryptocurrency exchanges like Coinbase and Binance soon became billion-dollar enterprises. These exchanges largely regulated themselves on all parameters, be it crypto exchange fees, disclosure requirements and even security.

It was not until the FBI investigation into the Silk Road marketplace that crypto really came under the regulator’s radar. Soon after, reports of a devastating hack of the Mt Gox crypto exchange caused shockwaves. The hack which saw the loss of investors’ Bitcoin with a value of about $450 million was headline news worldwide. It was then that people began to appreciate the scale and magnitude of cryptocurrency transactions globally.

Issues with Crypto Exchanges

The unique aspects of cryptocurrency distill into the fact that it does not rely on centralized control to work. This means that is a complete alternative to traditional cash-based systems.  Therefore, the primary concern for governments across the world was the anonymity of crypto transactions. Through the SWIFT worldwide banking standard, authorities are able to track cross-border money transactions seamlessly. Crypto brought a fundamental shift in the way money moves. Regulators were concerned with the potential for money laundering, illegal trade, terrorist financing, among other illicit activities.

Moreover, when looking to set up a crypto exchange, security is a massive consideration. The ease of crypto theft has made hackers go into overdrive trying their next big score.

Measure to Deal with The Issues

At the top of exchange considerations, is putting in place mechanisms to vet prospective customers. The primary mechanism that exchanges use is requiring proof of ID and a rigorous verification process to allow someone to open and use an account.

Requiring proof of user identities obviously poses philosophical issues with some crypto users. After all, anonymity and escaping centralized regulated finance is a huge attraction for crypto users. Know Your Customer (KYC) and AML (Anti-Money Laundering) requirements essentially mean that users waive their anonymity. However, this is a compromise many leading crypto exchanges have seen worth making.

Major Regulatory Development So Far

Before looking at the regulation of exchanges, it is fair to mention the elephant in the room, which is the fact that many governments across the world are yet to make their position clear on cryptocurrency. A few like India have banned crypto totally while most have an unofficial tolerance policy. Still, no country recognizes crypto as legal tender. Therefore, until governments and intergovernmental agencies regulate crypto, there won’t be complete cohesiveness.

That said, some notable regulatory developments have come about in the recent past in relation to exchange activity. Europe does not regulate crypto at a regional level but countries like Germany, France, and Italy require exchanges to register with regulators. The most significant development is the 2018 Fifth Money Laundering Directive (5MLD) which will bring cryptocurrency-fiat currency exchanges under EU’s anti-money laundering legislation. This directive requires exchanges to perform KYC/CDD on customers and fulfill standard reporting requirements.

In the USA, the Securities and Exchange Commission (SEC) has indicated that it intends to regulate crypto as a security. Recently, the battle with Telegram over its TON Network crowdsale brought this perspective to the fore. Telegram conducted a blockbuster $1.7 billion ICO in 2018 which the SEC alleged violated securities laws. The SEC is looking at broader compliance and governance crypto exchange regulations.

Above all, is the G20 FATF regulations on cryptocurrency exchanges. Given the composition of the G20, these regulations are the most significant globally. Member countries can adopt these measures and compel exchanges to collect and transfer customer information. The information extends to details such as originator’s and benefactor’s name, account number and location.  The June 2019 guidelines came in the wake of a G20 summit in Osaka, Japan.

Likely Future Developments

From the aforementioned, it is apparent that crypto regulation is fragmented and immature. Moving forward, the rise of the financial technology (FINTECH) sector is likely to give government impetus to develop regulations. Blockchain finance is a form of Fintech and can benefit from such developments.

Crypto exchanges, currently, face mostly disclosure requirements. However, as regulatory developments, especially by the SEC, continue to emerge, their operating costs could rise substantially.  It is no longer an option for governments, especially in the developed world, to continue ignoring the crypto sector. Appropriate and sound regulations can contribute to the development of a unique digital financial system.

Feature Image Courtesy of Flickr: Quote Inspector.


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