cryptocurrency, bitcoin, ethereum, crypto
On September 18, the Office of the New York State Attorney General (the "Office") released a report following a crypto exchange initiative it began several months prior. The Office has been liaising with crypto exchanges to learn more about the current state of digital asset platforms.
The most notable takeaway is the three areas of concern that the report discusses:
Conflicts of Interest
The report outlined many worrisome conflicts of interest. Exchanges often have several lines of business (e.g. acting as an exchange and a broker-dealer) that pose conflicts of interest, which would be prohibited or monitored if they were traditional exchanges. Additionally, employees of these exchanges may have access to non-public information.
One concerning conflict that the report discusses is that exchanges often trade in their own proprietary accounts (i.e. an exchange buys/sells crypto that it holds in its own account). This should be worrisome for investors because it means exchanges may be artificially affecting crypto liquidity and prices.
Exchanges do not have consistent safeguards in place (e.g. effective trade monitoring), and there currently is no way to monitor suspicious trades across exchanges. Few exchanges restrict or monitor the use of bots. The Office noted that these risks leave exchanges vulnerable to abuse like price manipulation, and only a few crypto exchanges have taken meaningful measures to mitigate these kinds of risks.
Customer Protections Are Limited
Exchanges don't currently have consistent auditing standards for the crypto they have custody over, and a few noted that they don't have an independent audit done at all. This makes it difficult to gauge whether crypto exchanges adequately protect the crypto they hold, especially in light of the significant risks exchanges face (e.g. possible hacks). The Office also questioned the adequacy of any insurance an exchange may have (or lack completely).
The concerns mentioned may stem from the lack of standards in the industry, not necessarily from insufficiency; it's hard to evaluate something with no guiding principles. The NY report doesn't raise particularly novel issues, but it does show that crypto exchanges have their work cut out for them.
Reginald Young is a licensed attorney in San Francisco, California, where he works with private investment funds and startups in the crypto industry. You can connect with him here.