Should Crypto Exchanges Be Regulated?
Tags: Bitcoin

By Jill Anderson

Are Crypto Exchanges regulated? The short answer is yes and no. Some are, and others are not. But why is regulation important? To provide an insight to this answer, we need to back track to 2009, when blockchain technology emerged.

A Brief History: the New, Unregulated Currency Exchange

When Bitcoin hit the scene in 2009, it was revolutionary in a multitude of ways. Backed by blockchain technology, cryptocurrency was innovative because any transactions made by means of Bitcoin were immutable — they could not be duplicated or altered due to the nature of the peer-to-peer validation system of blockchain technology. Once a transaction is completed, an update is sent to the blockchain network wherein it undergoes a calculation to validate it. Once validated, it is written to a ledger — or the blockchain — that is shared among all the peers, worldwide, throughout the network.

This technology not only revolutionised the ledger system of transactions, but it also cut out the middleman, with the most obvious beneficiary being the financial market. The concept of removing centralised banking and financial institutions from the transactions of our daily lives attracted investors worldwide. With the sudden and growing popularity of Bitcoin, a new gold rush was born.

Cryptocurrency as an Investment

Investors started buying Bitcoin (and other altcoins such as Litecoin, Dogecoin and Ethereum) speculating on value increases. The craze pushed Bitcoin to the realm of a commodity. People then started buying it, not at face value, but at the value it was deemed to have and would have in the future.

One of the most widely accepted uses of an altcoin is to fund start-up and existing businesses by means of ICO (initial coin offering), akin to the IPO, where stock in a business is sold to generate funds. In exchange, the investor owns a piece of the company (stock) and his/her investment grows or declines in value in accordance with the value of the company. An ICO merely trades in altcoins instead of stocks.

To Regulate or Not to Regulate?

Businesses are able to create altcoins and sell them to investors who are gambling that the coin will go up in value in direct correlation to the increase in the value of their business. The business owner or entrepreneur uses the proceeds to finance the business.

Because of its novelty and with huge numbers of speculators chasing the dream, the market for altcoins grew at phenomenal rates. Bid and ask prices became extremely volatile as everyone attempted to join the wave, and because there is nothing stopping (or regulating) speculators’ irrational actions to buy and sell — and at what price — markets became increasingly unpredictable.

Now, volatility is not always a bad thing. In fact, this is exactly why altcoins attract investors looking to get rich quick, and one of the primary reasons Bitcoin became so immensely popular after launching in 2009. Here was an opportunity to buy low and sell high; an opportunity to make solid cash on an investment — fast. Volatility is a direct result of having no regulation. But if the price of a currency begins to radically rise or fall in value, there is no authority to step in and implement stop measures to prevent mass panic or hysteria.

Not everyone can ride the wave to the top. As the popularity of altcoins has grown, so too have the predators who feed on the vulnerable. Scams quickly surfaced, with questionable characters publishing false business plans backed by altcoins sold in ICOs. In some cases, they just as quickly disappeared with the cash, leaving many people holding valueless coins. Also, at work here are pump and dump schemes — buy low, generate hype and excitement, getting everyone you know (and everyone they know) to buy in, driving the price higher, then dumping the coin when it’s at its peak.

Without governmental regulations, there is no recourse for an investor who’s fallen foul to scams. Without regulations, coin trading is essentially relegated to small exchanges that have proved to be susceptible to questionable practices and hackers. These vulnerabilities have scared away large, corporate-backed lending and financial institutions who are reluctant to enter the market due to their obligations to secure and safeguard investors’ funds, for example, as indicated by notices of “Insured by FDIC” (Federal Deposit Insurance Corporation of the US) — the government’s way of protecting the individual from fraudulent activities.

But alas, there is too much interest — both intellectual and financial — for large exchange desks to stand idly by and watch the frenzy. Paired with public outcry (whether genuine or manufactured by the government) for consumer protection, regulators are being pressured to step in.

Who’s Regulated and Who’s Not?

There is currently no global regulation of crypto exchanges. Further complicating matters, the worldview of cryptocurrency as a legal tender depends entirely upon the country. Below, we look at some key players and try to decipher their position on governmental regulation. Keep in mind, the positions of some of these countries are as changeable as the cryptocurrency market itself.

Japan

As of April 2018, Crypto exchanges in Japan are legal and regulated if they are registered with the Japanese Financial Services Agency. Japan instituted the regulations after a number of serious hacks, including a ¥58 billion JPY ($530 million USD) heist from Tokyo-based digital currency exchange, Coincheck in early 2018.

United States

The United States is all but united. In some states, crypto exchanges are legal and regulated, in others they are not. The Security Exchange Commission (SEC) is working hard to classify cryptocurrencies as a security, not legal tender, and is looking to apply securities laws to exchanges and wallets alike. The Commodities Future Trading Commission (CFTC) classifies Bitcoin as a commodity and the IRS also considers that cryptocurrencies are not actually a currency but rather property and seeks to tax it as such, making county-wide regulations ultimately inevitable.

The European Union

European Union regulations differ by country or bloc. According to Reuters, France and Germany are working together on joint proposals to regulate the cryptocurrency market. And in August of this year, Bitcoin.com News reported: “The European Parliament has voted in favor of stricter regulations in the crypto sector. Crypto exchanges and wallet providers will be required to introduce customer due diligence procedures, including identity verification. The platforms will have to apply for registration in order to offer their services.”

Exchanges in the UK are legal and must register with the Financial Conduct Authority (FCA), demonstrating that they “meet the same anti-money-laundering and counter-terrorism standards as other financial institutions.” Further, a self-regulated group called CryptoUK is calling for Parliament to enact (among other things) a “Crypto-License” for exchanges, brokers, and other trading platforms dealing with digital currencies, while emphasising the need for regulations to focus on the intermediaries rather than the currencies themselves.

South Korea

In July 2018 the South Korean government officially announced that it would recognise crypto exchanges as a “regulated financial business.” In addition to “stricter Know Your Customer (KYC), Anti-Money Laundering (AML), and customer verification policies,” CCN reports, “exchanges will be required to get approval from the cybersecurity agency and department of financial intelligence.”

China

It is currently illegal to exchange cryptocurrencies in China. Financial institutions have been prohibited from participating in cryptocurrency exchanges dating back to 2013. In 2017, the government extended the ban to include ICOs and crypto-to-fiat exchanges. Earlier this year, the government blocked access to foreign exchanges and ICO websites.

However, the China Center for Information Industry Development (CCID) Research Institute of the Ministry of Information and Technology are assessing the blockchain technology and establishing a committee to oversee a “national standard” for the implementation of the blockchain technology.

What does this mean? As Hackernoon.com reports: “[it] indicates that the Chinese government indeed does want to educate people on blockchain technology while they wait for the volatility to die down.”

Singapore

Crypto exchanges are legal, and as yet, unregulated in Singapore — but there is a fine line. Known for its crypto-friendly position, Singapore is emerging as an ICO hub, launching two of the largest 15 ICOs in recent years. However, as recently as May this year, the Monetary Authority Singapore (MAS), issued warnings to eight exchanges, stating that they are not to engage in trading in securities or futures contracts. It even halted one unnamed ICO, stating it was offering tokens in exchange for equity ownership — considered a security under the country’s Securities and Futures Act.

India

Exchanges are considered legal in India, which makes little sense when considering that the Indian Supreme Court, led by Chief Justice Dipak Misra, upheld a government mandate from April 2018 dictating that banking institutions must discontinue any working relationships with exchanges or related firms dealing in cryptocurrency. The reasoning? Indian law requires Indian currency to be “to be made of metal or existing in physical form and stamped by the government.” Backed by the Reserve Bank of India (RBI) and the Supreme Court, the ban has pushed the cryptocurrency market underground. In effect, the ban prohibits regulated financial firms from doing business with the country’s crypto exchanges which are, officially, legal and unregulated.

The most crypto-exchange friendly country? Switzerland

Switzerland is likely the most cryptocurrency, crypto-exchange friendly country in the world. And who would be surprised by that? Exchanges are regulated but must be registered with Swiss Financial Market Supervisory Authority. The owner of the Swiss Stock Exchange (SIX) announced in May that it will be launching a fully regulated crypto exchange. According to Thomas Zeeb, head of Security & Exchanges at SIX, the platform will provide digital asset custody, with “regulation that ensures official safety, security, stability, transparency and accountability,” as reported by Business Insider (July 2018). The exchange is slated to open in the first half of 2019.

Regulated crypto exchanges may mitigate radical fluctuations in the market. Generally speaking, governments are starting to scrutinise ICOs and protect their citizens. But some early supporters of the technology argue that the regulations negate the innate beauty of the original idea — giving power to the people by removing it from governments known for oppressive tactics to ensure control and cooperation from the masses.

Unregulated exchanges still exist, providing opportunities for those who wish to and who can tolerate the risk of explosive markets. For others, the number of regulated exchanges is growing daily. In fact, in the list of countries above, nearly half imposed new regulations since the beginning of this year alone. The trade-off: regulated exchanges will have less volatility, providing safer investments and recourse for those pilfered of their savings by ill-intentioned scammers.

Before choosing your platform for investing, do your due diligence. Understand the currencies you are considering investing in, know the company behind the coin, and never invest more than you can afford to lose. Also, investigate the exchanges before deciding which to use.

See Revain’s past articles, CryptoExchanges: What are They and Which is Right For You, and Decentralised Cryptocurrency Exchanges, for insights to the most (currently) reputable exchanges. Remember, this is an ever-evolving system, where cryptocurrency and it’s exchanges are illegal today, it’s likely to change — maybe by tomorrow.