Crypto Exchange Guardrails Are Coming Whether Gary Gensler Wins His Crusade Or Not DL News

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The Securities and Exchange Commission wants to dismantle exchanges offering multiple functions. Market forces could eventually provide protections even if SEC Chairman Gary Gensler fails in his lawsuits against Coinbase and Binance, whether regulators or rivals, judgment is approaching.

If it looks like an exchange, is called an exchange, but isn’t regulated as an exchange, it’s not an exchange.

So says Niki Beattie, founder of consulting firm Market Structure Partners, of crypto platforms.

Calling yourself an exchange is a pie in the sky, really, unless you’re regulated, Beattie told DL News.

As scandals mount and regulators come under increasing pressure to crack down more heavily on crypto firms, giants such as BlackRock, Fidelity, and Citadel Securities are expanding their offerings and threatening crypto-native business models.

Market forces could eventually provide protections even if Securities and Exchange Commission Chairman Gary Gensler fails in his lawsuits against Coinbase and Binance. And if user protection doesn’t attract customers, lower fees might.

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Whether regulators or rivals, a settling of scores is approaching.

Exchange-traded funds, prime brokerage, execution, and clearing offerings have recently emerged in the crypto industry, noted Brandon Mulvihill, CEO of Crossover Markets.

The institutional market is resetting the fundamentals of the crypto market structure, he told DL News, adding that it portends not just transparency and security, but massively greater competition.

In traditional finance, firms that provide different market functions must be entirely separate entities, Beattie said. Exchanges and custodians have different licenses and must be capitalized separately, maintaining sufficient funds to operate independently, which will protect users.

The SEC argues that Coinbase and Binance, among others, confuse the functions of brokers, exchanges, and clearing agencies. He claims that Binance also mixed client assets.

The exchanges say they have tried to register with the regulator and say the agency is harming users.

NOW READ: BlackRock and Fidelity hit Bitcoin ETF snag amid graveyard of past apps

By offering multiple functions under one roof, these companies have removed layers and middlemen that, while clumsy and cumbersome, help protect users, Beattie said.

EDX Markets, the exchange firm backed by Citadel Securities, Fidelity, and Charles Schwab, among others, touts its safe and compliant features.

Ultimately, if crypto is to survive, it will end up looking much more like TradFi, Sean Tuffy, former director of market and regulatory intelligence at Citigroup, told DL News.

Eleftheria Panagiotopoulou of Oxford Business School told DL News that some level of regulatory intervention is imminent, but cautioned against breaking up multifunctional crypto firms and argued for integration.

Calls for regulation

Regardless of the future of crypto exchanges, the crypto industry faces hurdles and lessons already learned by TradFi, Tuffy said.

Calls for regulation are becoming more and more pressing. In late June, Nevada regulators placed Prime Trust in receivership, saying it was using customer money to buy cryptocurrency to satisfy withdrawals.

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It follows a banking crisis in March, the fall of FTX in November, and the implosion of Terra and Three Arrows Capital last summer.

NOW READ: Hackers exploit weakness in smart contracts to raid AzukiDAO’s unofficial airdrop of BEAN tokens

For the crypto industry, the concern should be that the more obvious wrongdoing like Prime Trust comes to light, the tighter the regulatory screws are likely to be, Tuffy said.

Regarding traditional finance, Tuffy said: There is a segregation of duties and exchanges are exchanges, custodians are custodians, everyone does it [know your customer checks]and customer money rules apply.

Retail vs Institutional

The lack of intermediaries messing up transactions with slow and cumbersome checks is a feature, not a bug, of crypto.

Bitcoin was envisioned to eliminate third-party users who can trade seamlessly with each other. This user-first nature has led to conflict in the way the market is structured.

For retail customers, crypto provides ease of access. But for institutions, it’s not as flexible as traditional markets and it’s a KYC nightmare.

Split functions are needed, Brandon Mulvihill told DL News, adding that crypto exchanges are primarily retail and/or institutional brokers operating four to five lines of business.

The nuance of each business sector requires specific regulatory structures and requirements to help protect the consumer, the institution itself and the market at large, Mulvihill added.

As for institutions, operating multiple regulated functions, siloing each line of business helps mitigate unintended conflicts of interest, he said.

The model in which a company operates multiple functions is popular among users who prefer simplicity over other value propositions, such as flexibility. These are typically retail customers who prefer one-stop shopping, he said.

A disadvantage of this model? The customer only has access to products offered by that company, Mulvihill noted.

In Tradfi, market participants can own one institution, while trading across multiple venues, and net-settle all of their business with an entirely different counterparty, he said, the flexibility provides operational efficiency.

Scandals and lawsuits

Without clear safeguards, other scandals could loom.

With settlement, custody and trading under one organization, there is a risk of foreground, mixing of client funds and, in particular, the risk that client funds cannot be independently verified, said to DL crypto index trading firm Trakxs Ryan Shea. News.

Last month, a Financial Times report revealed how Crypto.com operated an internal dealing desk and traded against clients. The exchange confirmed that it has an internal market maker, but treats it like any third party.

It’s not a controversial practice, the company told the FT.

The SEC sued Coinbase in June. Regulators issue: It is not registered to offer brokerage, exchange or clearing services. These functions are generally carried out by separate entities in the stock exchanges.

The SEC wants to separate these functions to provide crypto users with more security against the harmful practices we’ve seen exposed in the industry over the past year, Shea said, even if creating additional intermediaries is potentially more inefficient.

To share advice or information on the regulatory calculation of cryptos or another story, please contact the author at [email protected].

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