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The diverse roles of the crypto exchanges raise concerns about conflict

Cryptocurrency trading platforms have a little secret: They pretend to be “exchanges” but are mostly actually brokers.

In almost every way, these digital asset exchanges are radically different from traditional stock exchanges, although they have names that suggest they are replicas of the marketplaces for stocks and other securities.

In reality – and unlike traditional exchanges – trading platforms for Bitcoin and other digital assets offer much more than just an electronic platform for investors to buy and sell securities. They take care of the custody, manage customer funds, act as counterparty for commercial transactions and – more recently – have begun to issue and borrow credits.

And according to Simon Forster and Duncan Trenholme, co-heads of digital assets at broker TP IC -: “If you have an exchange that does custody, staking, lending and borrowing. . . it looks like a broker or a bank. ”

This multifaceted role has raised concerns that platforms may not always serve the best interests of the customer. Instead of being a neutral party to transactions like an exchange, a crypto platform can trade against customers, creating a situation where one side has to win and the other has to lose – meaning retail customers run the risk of being treated unfairly will.

Risks like this have been identified in recent studies. In October, the National Bureau of Economic Research found that unlike regulated exchanges, cryptocurrency platforms have no precautions to ensure investors get the best possible price.

Anton Katz, CEO of software company Talos, says this is a problem for professional investors entering the market, as some of them have “best execution” obligations – that is, they need to execute transactions at the best possible price.

In the crypto sector, most exchanges not only offer matching services, but also custody, clearing and settlement

As a result, they feel more comfortable spreading transactions among different vendors in order to minimize conflicts of interest and the magnitude of the impact if a platform breaks down or is hacked.

“In the crypto sector, most exchanges not only offer matching services, but also custody, clearing and settlement, to name just a few,” emphasizes Katz. “That means that in reality they are more like a [traditional] Broker, as a customer effectively competes against the exchange itself in a trade, in contrast to another customer of the exchange.

And crypto exchanges do this with little, if any, regulatory oversight. Policy makers say this becomes an issue with the ever-increasing financial and stability risks in a $ 2 trillion market today. Many are making concerted efforts to bring the mushroom industry under supervision.

As the largest owners of Bitcoin and other major digital assets, the exchanges, along with the “miners” who create new currency units, are among the most influential players in the crypto world.

They hold customers’ money and require traders to post money to fund the trade in advance. They regulate trades and make sure all parties get paid. But they do so in an environment where hacks are rampant and transparency about prices and what is h -pening in the exchange is almost nil.

Regulators have been aware of the problem for a number of years. Ashley Alder, chief executive of Hong Kong’s Securities and Futures Commission, said in a 2018 speech that crypto exchanges can act both as agents for their clients and as their own self-interest in trading – making it difficult to deal with major conflicts of interest detect and monitor. He added that investors also face “additional vulnerabilities” because they are trading directly with these platforms, not through an intermediary.

“These are activities of particular interest to securities regulators as, on the surface, these platforms mimic conventional funds and exchanges,” said Alder. He also noted that the safekeeping of investors’ funds was a “primary concern”.

Last year, the Hong Kong regulator ruled that all of these platforms must register with them, prompting FTX and others to seek a warmer regulatory climate in the Caribbean islands.

For traditional exchanges, the huge sums of money amassed by crypto startups in a short space of time have made it difficult to withstand digital assets as a potential market. They also hope that their background in regulated markets will give them an advantage.

$ 2 trillion

Size of the Crypto Assets Market

Jürg Schneider, Head of Media Relations at the Swiss stock exchange operator SIX, hinted at this when he received official  -proval to introduce a digital asset platform in September.

“We are a globally recognized and regulated stock exchange,” he said. “All of this represents a completely different construct than the crypto trading exchanges currently on the market. From a regulatory point of view, they are not viewed as stock exchanges. ”

But while cryptocurrency platforms face fewer challenges from regulators, they have other pesky interest groups to deal with: retail customers.

“The reality [is] dissatisfied customers are just a few clicks away from transferring their assets to a competitor, ”notes Fadi Aboualfa, research director at the London-based digital infrastructure provider Copper.

As regulation intensifies and competition from established exchanges intensifies, the ability of investors to move around freely could be the biggest test for digital startups.

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