Crypto exchanges and regulation - a hinderance or an opportunity?
With regulation beginning to encompass cryptocurrency and crypto exchanges we look at the doors that are opening as well as closing within this marketplace.
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From simple beginnings
Cryptocurrencies have been making news headlines for a number of years now, often with catchy or entertaining headlines (Dogecoin taking off after Elon Musk’s tweets and losing 7,500 bitcoins in a landfill).
The subsequent rise of cryptocurrency exchanges, like Binance, Coinbase or Gemini, which allow consumers to easily buy and sell cryptocurrencies, showcases the consumer appeal of this type of investment. In the first six months of 2021 alone, the global number of cryptocurrency owners more than doubled from 100m to 221m. And just like in other fast-moving sectors such as tech, social media and the sharing economy, the regulators have struggled to keep pace and are now playing catch-up
A quick timeline of crypto
“Whilst Bitcoin peaked to a USD 60,000 valuation in 2021, it was merely eleven years ago that two pizzas were bought for 10,000 BTC”
When we say a quick timeline, it is not to over summarise or skip important details, it is because the rise of crypto has become one of the most debated finance topics of recent times and happened extremely quickly. Bitcoin was only created in 2009 and whilst it peaked to a USD 60,000 valuation in 2021, it was merely eleven years ago that two pizzas were bought for 10,000 BTC. The race to dominate the crypto market featured the entry of many players like Namecoin, Swiftcoin and Litecoin in 2011, Ethereum in 2015 (today the second highest valued cryptocurrency) and many others, surpassing the benchmark of 1,000 cryptocurrencies in the market in 2017.
As consumer demand for crypto soared, so did cryptocurrency exchanges. Exchanges started emerging in the early 2010s, with the most notorious example being the Mt Gox exchange (now closed). The first ones only sold Bitcoin and, as more cryptocurrencies emerged, the portfolio of crypto exchanges expanded. Today, there are over 100 exchanges, offering a wide variety of crypto investments. Gemini, for example, offers over 30 cryptocurrencies whilst Binance offers over 500.
The evolving regulatory landscape and crypto exchanges
Cryptocurrencies and crypto exchanges are subject to increasing regulatory scrutiny. After growing exponentially in the last decade, governments have woken up to their largely unregulated operations and countries are responding to crypto and exchanges to different extents.
In the US, for example, cryptocurrencies are not considered legal tender and while exchanges are legal, they require additional licensing from the regulators. Similarly, the UK does not recognise crypto as a legal tender but as an asset, and requires exchanges to be registered with the FCA. Other nations like Japan are much more open with Bitcoin being legalised as a payment method in 2017, whereas China sits at the opposite end of the spectrum having made crypto exchanges illegal that same year. Just this week, in September 2021, El Salvador became the first country to adopt Bitcoin as an official currency.
Sudden changes to laws or new interpretations of existing ones are common in an evolving regulatory environment. The most talked about example is Binance. In the UK, the platform was banned from operating for not meeting AML requirements, and banks are stopping customers from depositing money on the platform. Other regulatory bodies are cracking down on the business for not having a clear headquarters and allowing customers to sign-up even when they are resident in a country where they do not hold a license to operate. This opens the market to other competitors, like Bitstamp, Gemini and Coinbase. These have all gained users in the UK following the FCA ban on Binance. Bitstamp especially saw a 138% increase in new customer applications.
This shows that the lack of regulatory compliance of some platforms creates a huge opportunity for those proactive enough to anticipate regulatory shake-ups and comply to stricter frameworks. Bitstamp, for example, moved all its customer accounts from London to Luxembourg in 2020 ahead of Brexit to remain compliant with European Union laws and, by doing so, it ensured its operations would remain sustainable across both the British and the EU market. Unlike Binance, it has an established headquarters and has a temporary registration under the 2017 AML requirements. Similarly, Gemini, headquartered in the USA, acts in compliance with AML, capital reserve and cybersecurity requirements.
What is the right approach?
Stricter regulatory requirements are coming, whether we like it or not. Cryptocurrencies will not be recognised as a safe payment method or a secure investment asset as long as the market is not properly regulated. Crypto exchanges can either wait and respond to the upcoming regulatory frameworks or take a more proactive approach to engaging with regulators.
In the UK, for example, exchanges are not regulated as trading platforms but are scrutinised mainly for AML and KYC. Regulations focused on cryptocurrency trading are most likely going to happen. Proactively engaging with regulators, and lobbying them for fair and pragmatic regulations, is the right way forward.
Meanwhile, exchanges can work to develop operational and risk frameworks that comply with the key laws regulating the financial services sector. For example, itBit, an American exchange, is registered as a bank, meaning it complies to stricter banking regulations in the US, which will safeguard it from laws around crypto exchanges becoming stricter in the coming years. Similarly, Coinbase is working to get regulated on both EMI, that is an Electronic Money License granted by the Central Bank of Ireland, and VASP, a EU law covering AML and counter finance terrorism obligations for crypto asset platforms. With Gemini currently following suit, as it seeks to become regulated in Ireland.
Gaining customer trust to grow a market
Exploiting a low regulatory environment worked for exchanges to gain customers quickly, but it is not a viable strategy for the long-term. Exchanges play a key role in the cryptocurrency market, and they are increasingly involved with traditional financial services. Preparing to comply to a stricter regulatory framework is the right move to maintain sustainable operations and avoid regulatory scrutiny or restrictions. Customer trust will also improve if exchanges become a safer and more stable place to store individuals’ assets, while compliant platforms will see more growth opportunities by avoiding operational limitations.
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