28 April 2021
The first question you should ask before opening an account on a crypto exchange is: How does this platform ensure consumer and investor protection? From the investor’s standpoint there are two major risks related to the crypto account on an exchange — the funds may get either stolen or frozen.
The gaps in regulation are far from insignificant and negatively impact on the crypto market integrity and investor protection. A recent study revealed how important this issue is in the current crypto landscape as only 14% of 216 global crypto exchanges are licenced by regulators.
An investor on an insufficiently regulated exchange is exposed to risk from two sides. If your wallet is hacked and your funds stolen, you cannot refer the problem to authorities that will launch procedures similar to those that apply in similar cases within traditional finance.
Unlike banks and exchanges, crypto intermediaries are not required to submit to any specific standards of cyber security — a fact hackers are constantly taking advantage of. It is, of course, in the interest of the exchanges to provide some security to the platform, but regulators should not and will not leave such an important issue to the voluntary actions of companies.
On the other hand, regulatory authorities themselves may freeze the funds in your account when an unregulated exchange comes under scrutiny because of suspicion of illicit cryptocurrency transactions. The most important takeaway when it comes to unregulated exchanges is the following: There are no authorities holding them responsible to return the lost funds to clients.
Moving on from the big problems of asset freezing and theft, regulation needs to address several issues related to the exchange operations: There are no specific guidelines that require the segregation of customer funds from proprietary funds. There is also no requirement for third party audits that would establish that the exchange really has the assets equal to the customers’ claims.
A trader might also want to know if he or she is entitled to the best price and how fast a trade will be executed or settled. This information is disclosed in financial instruments’ trading, but in crypto the rules have not been established yet. This leaves the door open for shady practices such as wash trading or front running your trade at proprietary desk.
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.
As regulators and supervisory bodies strive to outline a more comprehensive and universal regulatory framework, investors should look for crypto platforms that proactively seek embedding crypto landscape into legal guidelines. Waiting for the regulators to come to your door or even shifting the business to other jurisdictions for the purpose of regulatory arbitrage will not benefit the clients in the long run. In the best case it will be an inconvenience to them when regulators eventually catch up.