28 April 2021
With the appearance of Security Token Offerings (STOs), the drive toward legal compliance is enhanced and many exchanges have applied for regulation to be able to list this type of tokens. Requiring much tighter regulation than Initial Coin Offerings (ICOs), STOs are also likely to attract institutional money which was until now hesitant to enter crypto markets due to lack of financial supervision.
One still finds substantial differences between jurisdictions in terms of requirements and the speed of licence issuance, with UK, Switzerland, Singapore, Malta, Gibraltar and Liechtenstein in the forefront as the most popular ones. There is a distinct advantage to exchanges that are being founded now in strong jurisdictions, adhering to regulatory standards from the start, as the process of adaptation of the existing crypto platforms might be time-consuming and an inconvenience to their clients with no certainty about the final result.
The best regulated exchanges will set the bench mark for the developing crypto industry, as regulators around the world are preparing interventions in this field that is still vulnerable to illicit activities. They will provide retail and institutional investors with the security and safety they need to benefit from crypto assets and bring increased liquidity to the field.
The existence of sites promoting participation in pump and dump events tells us that unregulated exchanges are either powerless or unwilling to prevent organized fake rallies of tokens followed by a massive sell off. Using applications like Slack, Telegram and Discord, a group of individuals collude to start buying tokens at the same time to lure inexperienced investors into buying tokens on their way up. When those who are in the know suddenly sell their tokens, the investors who had entered later are often left with a loss.
While pump and dump schemes may damage the reputation of unregulated exchanges, they benefit from the financial aspect as they get an increase of liquidity and user activity. Regulators would need IP addresses and Know your Customer (KYC) records to identify those who sold at the peak of this process. Unregulated exchanges are not obliged to help foreign authorities investigating such illicit activities or even their own users. Even if they have a KYC process, they do not have to share the data. Hence, security audits should be added to strict KYC/AML standards combined with the obligation of exchanges to make all trades transparent to regulatory bodies.
In this way exchanges will also be prevented from buying and selling into their own orders, thus inflating the volume and presenting it as organic interest by investors.
There will be an added benefit to sending all information about trading to a supervisor. Such monitoring will preclude front running and wash trading.
Regulation will also require that the prices of services quoted by an exchange are fixed, providing a better starting position for new tokens whose listing price will not be dependent on the evaluation of their growth potential by the platform managers. This will eliminate bargaining and level the playing field. This step also presupposes that there is a standardized classification of crypto assets, which is another important issue to be resolved.
Regulators also need access to the data of trading to establish where the crypto business need more regulation and what measures to prescribe.
Security standards are directly related to legal compliance. Having a working KYC and AML process provides an incentive toward tighter security. Security breaches are a common phenomenon in the crypto world whose threat can be substantially diminished by enforcing the highest regulatory standards.
Regulatory authorities are preparing to intervene in the crypto sphere. In some jurisdictions they are not much farther beyond the stage of data gathering, but one can be certain that firms that are not preparing for regulation enforcement will find themselves in a difficult position.
Regulatory pressure will increase as more experienced market participants display interest in crypto assets. When crypto exchanges adhere to the strict standards of traditional finance, they will finally be able to enjoy the trust of experienced market participants.