Can You Trust Crypto Exchanges After FTX's Collapse?
On October 25, 2022 – roughly two weeks before the collapse of the world's third-largest cryptocurrency exchange, FTX – prominent DeFi architect Andre Cronje published an ominous article with a chilling warning about the state of centralized cryptocurrency exchanges:
“Remedies under the current regulatory regime are ineffective. Most investors waive their rights to their crypto in bulky terms and conditions of crypto exchanges and many will (at best) be classed as unsecured creditors if these exchange services are liquidated. Crypto exchange and crypto investment service providers essentially operate like banks, but without the safeguards and regulations that banks are required to follow."
What happened next is history. With the precipitous fall of FTX, clients suddenly discovered that despite all previous safeguards, their assets had been locked in as the defunct exchange filed for bankruptcy in the midst of a – the consequence of siphoning off client assets by senior executives to trade in hedge fund Alameda Research. Even though the new management claims to have recovered some client assets, client funds still remain frozen in bankruptcy proceedings, with no end in sight and heavy legal costs to follow.
Subsequently, the crypto community raised serious concerns about the state of CEX. Requirements such as proof of assets and liabilities, segregation of client funds and voluntary registration as brokers have found resonance in the industry. That said, haven't CEXes come this far in making an effort to legitimize their operations? Here's why the problem is more complicated than it seems.
Jack Graves, a professor at Syracuse University, told Magazine: "To my knowledge, no one acts as a cryptocurrency and digital asset exchange in the United States that is registered with the SEC. Instead, they simply said they weren't trading securities. And that's a key difference."
Graves explains that while exchanges such as Coinbase are licensed money transmitters, they are not brokers. “As soon as you talk about stockbrokers, that triggers a bunch of disclosure and custody requirements,” Graves says. “I happen to use Fidelity as my brokerage firm, and if Fidelity goes bankrupt, I am not a bankrupt unsecured creditor, so I am entitled to my assets before all unsecured creditors.”
At least in the US, crypto exchanges cannot become brokers because the digital assets they facilitate are not classified as securities by the SEC. Yet there is also great confusion about this.
“Gary Gensler basically said anything but Bitcoin and maybe Ether is probably security,” Graves says. "So the exchanges believe that until the SEC says it's a security, they're going to trade it. And as soon as the SEC says the crypto assets are securities, they're going to give up. »
The problem is not not unique to the United States. Lennix Lai, Managing Director of Singaporean crypto exchange OKX, explains to Magazine that crypto exchanges cannot, for now, be registered as brokers due to a fundamental difference in their business model:
"By definition, a crypto exchange is actually a matching engine that matches orders from buyers and sellers. A broker's license only governs the relationships that you, as a business, have the ability to handle client orders and route them to an exchange.However, in the crypto world, most of the trading models going on are not the broker-dealer model, but actually an "exchange" model. So it gives governments regulatory difficulties in that we don't have to apply for an exchange license.”
Canada is one of the few jurisdictions to offer a ...
On October 25, 2022 – roughly two weeks before the collapse of the world's third-largest cryptocurrency exchange, FTX – prominent DeFi architect Andre Cronje published an ominous article with a chilling warning about the state of centralized cryptocurrency exchanges:
“Remedies under the current regulatory regime are ineffective. Most investors waive their rights to their crypto in bulky terms and conditions of crypto exchanges and many will (at best) be classed as unsecured creditors if these exchange services are liquidated. Crypto exchange and crypto investment service providers essentially operate like banks, but without the safeguards and regulations that banks are required to follow."
What happened next is history. With the precipitous fall of FTX, clients suddenly discovered that despite all previous safeguards, their assets had been locked in as the defunct exchange filed for bankruptcy in the midst of a – the consequence of siphoning off client assets by senior executives to trade in hedge fund Alameda Research. Even though the new management claims to have recovered some client assets, client funds still remain frozen in bankruptcy proceedings, with no end in sight and heavy legal costs to follow.
Subsequently, the crypto community raised serious concerns about the state of CEX. Requirements such as proof of assets and liabilities, segregation of client funds and voluntary registration as brokers have found resonance in the industry. That said, haven't CEXes come this far in making an effort to legitimize their operations? Here's why the problem is more complicated than it seems.
Jack Graves, a professor at Syracuse University, told Magazine: "To my knowledge, no one acts as a cryptocurrency and digital asset exchange in the United States that is registered with the SEC. Instead, they simply said they weren't trading securities. And that's a key difference."
Graves explains that while exchanges such as Coinbase are licensed money transmitters, they are not brokers. “As soon as you talk about stockbrokers, that triggers a bunch of disclosure and custody requirements,” Graves says. “I happen to use Fidelity as my brokerage firm, and if Fidelity goes bankrupt, I am not a bankrupt unsecured creditor, so I am entitled to my assets before all unsecured creditors.”
At least in the US, crypto exchanges cannot become brokers because the digital assets they facilitate are not classified as securities by the SEC. Yet there is also great confusion about this.
“Gary Gensler basically said anything but Bitcoin and maybe Ether is probably security,” Graves says. "So the exchanges believe that until the SEC says it's a security, they're going to trade it. And as soon as the SEC says the crypto assets are securities, they're going to give up. »
The problem is not not unique to the United States. Lennix Lai, Managing Director of Singaporean crypto exchange OKX, explains to Magazine that crypto exchanges cannot, for now, be registered as brokers due to a fundamental difference in their business model:
"By definition, a crypto exchange is actually a matching engine that matches orders from buyers and sellers. A broker's license only governs the relationships that you, as a business, have the ability to handle client orders and route them to an exchange.However, in the crypto world, most of the trading models going on are not the broker-dealer model, but actually an "exchange" model. So it gives governments regulatory difficulties in that we don't have to apply for an exchange license.”
Canada is one of the few jurisdictions to offer a ...
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