The New York Attorney General issued a report claiming that trading platforms for cryptocurrencies often (1) engage in several lines of business that may pose conflicts of interest; (2) have not implemented “serious efforts to impede abusive trading activity”; and (3) have “limited or illusory” protection for customer positions. Moreover, the report alleged that three cryptocurrency platforms may be operating unlawfully in New York and referred these platforms to the NY Department of Financial Services for possible further action. The three platforms are Binance, Gate.io and Kraken.

The AG’s report followed a voluntary request for information sent to 13 cryptocurrency platforms earlier this year (Click here for background in the article “New York Attorney General Seeks Information From 13 Cryptocurrency Exchanges Even If No State Connection” in the April 22, 2018 edition of Bridging the Week.)

Among specific findings, the NY AG claimed that few trading platforms restrict or even monitor “bots” or algorithmic trading on their systems. Moreover, many venues offer special pricing and other features, including preferential trading access, to professional traders. These circumstances could negatively hurt retail investors, said the NY AG.

The NY AG also raised potential conflict of interest concerns at cryptocurrency trading platforms. The NY AG said it is unclear why trading platforms list certain cryptocurrencies, suggesting that sometimes payments to a platform may drive listings. The NY AG also said that the owners and investors in several trading platforms are large holders of cryptocurrencies trading on their platform, and trading platforms themselves, as well as their employees, are often investors in virtual assets and trade against customers.

Kraken, which chose not to participate with the NY AG’s inquiry, was harsh in its criticism of the NY AG’s report. According to a Twitter post by Kraken, “[w]e must… object to the highly unprofessional/malicious implication that because we did not respond to the voluntary information request, we ‘might’ be operating illegally. We told you we don’t operate in NY. AG trying cases in court of public opinion now?” (Click here for further comments by Kraken.)

Coinbase, a trading platform that voluntarily responded to the NY AG’s information request, disputed the report’s finding that 20 percent of executed trades on its trading platform was attributable to its own trading. According to a Coinbase press release, “Coinbase does not trade for the benefit of the company on a proprietary basis… When Coinbase executes [trades], it does so on behalf of Coinbase Consumer customers, not itself.” (Click here to access Coinbase’s press release.)

In other developments regarding crypto assets:

  • UK – Center for Crypto Asset Activity?: The House of Commons of the UK Parliament issued an overview of the crypto-asset landscape, identifying both advantages and limitations of blockchain technology. Among the advantages noted is that blockchain technology “allows us to validate, store, and synchronise information across many different parties more securely and efficiently than we have been before.” However, the House of Commons noted that “scalability and reliability of blockchain [is] a significant challenge.” The report concluded that if the United Kingdom could develop “an appropriate and proportionate regulatory environment for crypto assets” the country could become a “global centre” for crypto-asset activity.   
  • VanEck SolidX Bitcoin Trust: The Securities and Exchange Commission formally instituted proceedings to determine whether to approve a proposed rule change by Cboe BZX Exchange, Inc. to list and trade shares of SolidX Bitcoin Shares issued by VanEck SolidX Bitcoin Trust. As proposed, each share in the trust would represent a fractional interest in bitcoin holdings by the trust. To date, the SEC has already received over 1400 comment letters on Cboe BZX's proposal after soliciting comments on April 7. The SEC will accept additional comments on Cboe BZX’s proposed rule change through 21 days after publication of the SEC’s announcement regarding its proceedings in the Federal Register; rebuttal comments must be submitted within 35 days. 

Last month, the SEC by its staff declined to approve rule amendments proposed by NYSE Arca, Inc. and Cboe BZX Exchange, Inc. to authorize the listing and trading of shares of nine exchange-traded products that planned to seek exposure to some or all of the bitcoin futures contracts traded on the Chicago Mercantile Exchange, Cboe Futures Exchange and/or any other US exchange that subsequently traded such contracts. Subsequently, the Commission stayed staff’s denial and indicated it would review the delegated action. (Click here for details in the article “SEC Declines to Approve Two Exchanges' Rules Authorizing Nine Bitcoin Futures ETPs” in the August 26, 2018 edition of Bridging the Week.)

  • Bitcoin and Ether Tracker One Notes: The SEC’s Division of Trading and Markets provided further insight into why the SEC suspended offerings of the Bitcoin Tracker One and Ether Tracker One notes in the United States earlier this month. According to staff, the suspension was warranted because of confusion among market participants regarding the nature of the notes (e.g., were they exchange-traded notes, exchange-traded funds or equity-linked certificates?). Staff indicated that the SEC and Commodity Futures Trading Commission are currently consulting regarding “regulatory considerations” applicable to the notes. (Click here for further background on the SEC’s suspension of these notes in the article “SEC Suspends Trading of Two Cryptocurrency Notes” in the September 9, 2018 edition of Bridging the Week.) 

My View1: The NY AG’s report’s most valuable contributions are identifying useful questions for investors to ask a cryptocurrency trading platform prior to signing up and providing a comparison among cryptocurrency exchanges of certain important features. 

However, the value of the NY AG’s report is tarnished by what seems like petty retaliation against three entities that declined to participate in what was alleged to be a “voluntary” survey and, apparently, as a result, were publicly identified by name for possibly violating NY law by doing business with NY persons. 

It may be, as alleged, that the NY AG has incriminating evidence on the three entities. If that is the case, the better course would have been for the NY AG to make its referral to the NY DFS privately, and then let NY DFS follow its own processes to investigate and take appropriate action if warranted. Public shaming outside of judicial process is not appropriate by government officials or agencies under any circumstance and raises due process concerns.

My View2: SEC Commissioner Hester Peirce’s speech two weeks ago before the Cato Institute’s FinTech Unbound Conference was a humorous and insightful commentary on the SEC’s approach to cryptocurrencies and how it could be improved -- particularly in the context of the Commission's recent consideration for approval of exchange-traded products based on bitcoin. (Click here for background in the article, "SEC Says 'No' to Winklevoss Bitcoin Trust While NFA Says 'Yes' to Intermediaries’ Crypto Businesses but Requires Disclosures" in the August 5, 2018 edition of Bridging the Week.) In response to her recent designation as “CryptoMom” by some in the blockchain community, Ms. Pierce discussed the differences between helicopter moms – who hover over their kids’ every activity – and free-range moms – who let their kids take limited risk under limited supervision. 

Ms. Peirce likened the SEC’s current approach to cryptocurrencies as being like that of a helicopter mom: instead of allowing investors to make their own choices regarding potential investments in bitcoin-related exchange-traded funds, the SEC is simply precluding such investments because of its concerns regarding the underlying risks of bitcoin trading. Ms. Peirce argued this is the wrong approach. She said that the SEC should not require that crypto markets be subject to comprehensive regulation like securities markets “as a precondition to allowing products linked to those markets to be traded in markets that we regulate.” According to Ms. Peirce, regulators should not be restricting investors from taking risks and realizing losses.

Ms. Peirce’s arguments are very compelling although a bit extreme. The SEC or any government law enforcement agency should not stand on the sidelines and allow a known fraudster to seduce retail customers to part with their money on the principle of investor choice. However, concerns about new technologies and financial instruments can be addressed through enhanced disclosures of potential risks. Banning investments is not the answer. In Ms. Peirce’s words, “the losses of prohibiting risk-taking are… real. Even when we cannot readily measure them or even because we often cannot measure them, these losses are potentially very threatening to investor welfare.”

Once again, mom has it fundamentally right. (Click here to access Ms. Peirce’s full speech.)