New York Attorney General Publishes Virtual Markets Integrity Report on Cryptocurrency Exchanges

Some time ago, the New York Attorney General launched the Virtual Markets Integrity Initiative (VMII) to “protect and inform”residents who trade in cryptocurrency.

New York Attorney GeneralGeneral Barbara D. Underwood commented on the release of the report:

“New Yorkers deserve basic transparency and accountability when they invest – whether on the New York Stock Exchange or on a cryptocurrency platform. Yet, as our report details, many virtual currency platforms lack the necessary policies and procedures to ensure the fairness, integrity, and security of their exchanges.”

Investors in crypto typically purchase the various coins on so called “exchanges” or “virtual asset trading platforms” that are frequently not registered  or approved by state and federal regulators. The AG notes that some crypto exchangeds have not “implemented common standards for security, internal controls, market surveillance protocols, disclosures, or other investor and consumer protections,” hence the need for such a report.

It was widely reported this past spring that the NY AGs office sent a letter to many popular exchanges. Some responded with indignation but it appears that most responded to the AGs query. While the AG “invited” fourteen platforms to participate, four decided not to provide information, including: Binance, Gate.io, Huobi Global Limited, and Kraken. These four claimed not to offer services to New York Residents.

The nine that did respond include: Bitfinex, bitFlyer USA, Bitstamp, Bittrex, Coinbase, Gemini Trust Company, itBit, Poloniex (owned by Circle), and Tidex. The AG separately invited HBUS – a platform that is a U.S. “strategic partner” of Huobi.

It should be noted that seven out of ten participating  platforms are already regulated by the New York State Department of Financial Services (DFS). These seven include: bitFlyer, Bitstamp, Bittrex, Coinbase, Gemini, itBit and Poloniex. The report states that “customer protections in place at platforms subject to the BitLicense regime are likely to be better than those prevailing at other platforms.”

So what did the report VMII report uncover? The AG says the three following areas are of greatest concern:

  • the Various Business lines and operational roles of trading Platforms create Potential conflicts of Interest. Virtual asset trading platforms often engage in several lines of business that would be restricted or carefully monitored in a traditional trading environment.
  • Trading Platforms have yet to implement serious efforts to impede abusive trading activity. Though some virtual currency platforms have taken steps to police the fairness of their platforms and safeguard the integrity of their exchange, others have not. Platforms lack robust real-time and historical market surveillance capabilities, like those found in traditional trading venues, to identify and stop suspicious trading patterns.
  • Protections for customer funds are often limited or illusory. Generally accepted methods for auditing virtual assets do not exist, and trading platforms lack a consistent and transparent approach to independently auditing the virtual currency purportedly in their possession

The VMII report states that “managing conflicts of interest is a serious and growing issue in the virtual marketplace.” There are several areas the report highlighted including the opaque manner in which a crypto is listed on the site (and whether payments to the platform drive these listings. Second, the owners and investors in several platforms are “large holders of virtual assets traded on their venue,” thus creating an incentive for these digital assets to rise in price. And finally, the fact that employees are often customers and possibly benefit from non-public information.

So what happens next? Will the NYAG (or OAG) further regulate cryptocurrency exchanges? There is a very good chance of this. In fact, more direct action could be one unintended error away.

There is a self regulatory movement which has received the verbal support by the CFTC. The Virtual Commodity Association (VMA) was created by the following platforms: Bittrex, Bitstamp, bitFlyer USA and Gemini Trust Company. The Association’s first hire was Executive Director Maria Filipakis who was formerly an Executive Deputy Superintendent at DFS. Expect the VMA to move quickly to establish a Code of Conduct and a set of best practices.

The VMII Report by the NY Attorney General’s office is available here.


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