The world’s largest cryptocurrency exchanges have had a difficult few months from a legal standpoint. FTX founder Sam Bankman-Fried was charged with a number of offences, including fraud. As his exchange collapsed in November of last year, taking billions in customer funds with it.
In February, Kraken was sued by the Securities and Exchange Commission for failing to register its’ staking-as-a-service’ business. As soon as the accusations were brought, the exchange consented to stop providing the service and settled them by paying a $30 million fine.
Early in March, Coinbase reported receiving a Wells Notice from the SEC, which is essentially a letter warning that an enforcement action may be forthcoming. At the time, Coinbase had recently settled a $100 million lawsuit with New York regulators.
The Commodities Futures Trading Commission then launched a significant complaint against Binance, the largest exchange in the sector, on Monday, citing several violations of U.S. commodity regulations.
Binance is portrayed in the 74-page CFTC complaint as a business that is dedicated to avoiding regulation wherever feasible. It claims that Binance refuses to disclose its headquarters to make it more difficult for authorities to assert that the company is subject to their control and that officials of Binance used Signal for some business communications to make it more difficult to follow those communications.
More specifically, the CFTC asserts that Binance encouraged American consumers to trade on its platform despite never having been registered as an exchange in the United States and traded on its own platform using hundreds of accounts under the CEO Changpeng Zhao’s control. (In response, Binance referred to the grievance as “disappointing” and said that it was founded on a “incomplete presentation of facts. Moreover, it stated that no staff used the site to trade.)
All of this news might make you believe that business would suffer greatly. The fact that it doesn’t seem to have changed much is what stands out the most, though.
All of this news might make you believe that business would suffer greatly. The fact that it doesn’t seem to have changed much is what stands out the most, though.
Undoubtedly, the collapse of FTX caused billions of dollars to be removed from the major exchanges. But, since that time, crypto prices have increased and money has started to pour back into those exchanges. However, even while the CFTC’s legal action against Binance in particular appears to be a major thing, its effects have been minimal: The exchange has experienced withdrawals of about $1.6 billion, or less than 2% of assets, according to data.
All of this highlights the core paradox of the crypto economy, which is that despite the fact that cryptocurrencies were designed to be used for decentralized commerce and finance, almost all crypto trading occurs on sizable, centralized exchanges, in which crypto investors have an unexpectedly high level of blind faith.
The whole purpose of cryptocurrencies, it was said, was that there was no need for a middleman, allowing people to transact without being influenced by financial institutions or governments. (For this reason, crypto was frequently referred to as providing “trustless commerce,” i.e., allowing you to do transactions without having to have faith in the other party.)
According to a recent editorial, the purpose of cryptocurrencies was to “empower people to determine their own fortunes in the digital world, independently from government and corporate organizations.” Yet, a disproportionate amount of cryptocurrency transactions now occur on centralized exchanges like Binance, which are essentially corporate entities.
In actuality, cryptocurrency exchanges have greater centralization than conventional financial institutions. After all, if you’re an investor who buys and sells stocks, you already have a brokerage account with a company like Charles Schwab, which stores your assets and executes deals. But it rarely operates the exchange where the trades are done or makes markets in stocks or bonds.
The guardians of your funds, in contrast, are centralized crypto exchanges. They carry out your trades. They are in charge of the exchange where the trades are made. In other instances, they might even be on the other side of the trade you’re making, according to the CFTC (or what transpired at FTX). It is incorrect to refer to these businesses as “exchanges.” They are, at the very least, combined broker-dealer exchanges.
This isn’t necessary, though. With cryptocurrency, you can hold your own digital currency in a digital wallet and conduct peer-to-peer transactions with other users on a so-called decentralized exchange, with all transactions being recorded to the blockchain. As your assets are always in your hands, this system provides greater anonymity (you don’t need to register your identity), cheaper transaction costs, and a lack of dependence on an exchange.
But instead of embracing these decentralized solutions, the majority of cryptocurrency traders and investors have tended to favor centralized exchanges. It’s simple to comprehend why. For those new to cryptocurrency, centralized exchanges are significantly simpler to utilize. These are the only locations where exchanging cryptocurrency for fiat money like dollars may be done safely. Also, it is much simpler to locate a buyer or seller and obtain a trustworthy pricing because they have so many more clients.
But as a result of all of this, if you’re a cryptocurrency investor you have to have a lot of faith in these exchanges, assuming that they’re carrying out your trades at the best price, keeping your assets separate from the company’s, and keeping enough capital on hand—all of which are true despite them being only lightly regulated. And as we saw with FTX, you have few options if it turns out they’re not doing those things or if it turns out they’re just lousy at business and go out of business. Which many customers find surprising, as we also witnessed with FTX.
The result is a weird status quo in which, just as in the traditional financial sector, the majority of investors have trusted their assets to powerful corporate entities, but with a much less oversight and regulation. Of course, Binance and its competitors all claim to operate ethically and to scrupulously safeguard the assets of its clients. And there’s a good chance that’s the case. Yet, you must generally believe what they say.
