Virtual Currency Markets: More Regulation Forthcoming?

November 6, 2018

Last month, New York took yet another step toward regulating nascent virtual currency exchanges, which are largely used as a platform to trade virtual cryptocurrencies in a way that is similar to how securities are traded on a more traditional stock exchange.  The Office of the New York State Attorney General released its “Virtual Market Integrity Report,” which outlined and discussed several aspects of virtual currency exchanges that could be ripe for regulation.
The report, which was focused on addressing issues of “transparency, fairness, and security” in the context of virtual asset trading, highlighted five main aspects of how virtual exchanges currently operate: (1) how individuals sign up for and pay to use the exchanges, (2) the rules of the exchange, (3) how the exchanges mitigate conflicts of interest, (4) the internal security and accounting methods of the exchanges, and (5) general customer relations issues, including how the exchanges suspend trading or notify traders ahead of scheduled maintenance or outages.

…the NY Attorney General’s report calls attention to the most glaring gaps in the current regulatory scheme.

The report found three main weaknesses in the business models of the virtual exchanges it studied. First, the similarity of the virtual exchanges’ role to the role traditionally played by stock exchanges was conducive to inappropriate conflicts of interest.  Second, the exchanges were severely deficient in maintaining the level of security and surveillance capabilities necessary to prevent abusive trading or unregulated algorithmic trading.  Finally, the report found that the protections and accounting methods that the exchanges do have in place for consumers are likely insufficient to adequately safeguard against cybertheft or accurately audit the assets being traded on their platforms.
The trading of virtual assets has been especially litigious over the past two years, and the Securities and Exchange Commission has filed at least six suits – half of those in the Southern District of New York – against various cryptocurrency traders in 2018 alone.  This upshot in litigation could be the precursor to more stringent regulation of cryptocurrency markets, and the NY Attorney General’s report calls attention to the most glaring gaps in the current regulatory scheme. 
In the coming months and years, cryptocurrency traders should expect regulations to require more vigorous protections against money laundering, a frequently cited concern in the report, that could be mitigated through common-sense identification policies, such as eliminating VPN access.  VPNs allow traders to access exchanges in anonymity, without revealing their location or other personal information.  Traders might also expect a regulatory regime more akin to the regime that governs more traditional securities trading.  The report notes that one trading platform, Gemini, has already partnered with Nasdaq to coordinate market surveillance and prevent unfair manipulation of virtual currency prices by unscrupulous traders. 
It’s unclear how far regulating authorities will go to strengthen consumer protections in cryptocurrency markets, but it is fair to say that, at least according to the New York Attorney General, there is plenty of work still to be done.