9/26/18 - Promontory Currents: New York Raises Concerns over Cryptocurrency Markets
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9/26/18 - Promontory Currents: New York Raises Concerns over Cryptocurrency Markets

By Daniel Bufithis-Hurie

On Sept. 18, New York state’s office of the attorney general published its report on the integrity of cryptocurrency markets. As the product of the OAG’s fact-finding inquiry into the transparency, fairness, and security of cryptocurrency trading, the report analyzes the policies and practices of 10 major U.S. crypto platforms that participated in the OAG survey.

The report highlights three areas of concern:

  • Conflicts of interest: The report notes that crypto-trading platforms often engage in multiple, potentially conflicted business activities — e.g., executing customer trades while simultaneously conducting proprietary trades for their own account, a practice that raises the risk of fraudulent activity and requires effective risk-based controls.
  • Limited efforts to combat market abuse: Drawing a contrast with trading platforms for more established markets, such as equities, the report finds that most crypto-trading platforms have yet to implement controls to detect and prevent suspicious trading activity or market manipulation.
  • Lack of protection for customer funds: The report points out that there is no standard approach for crypto-trading platforms to obtain independent audits of their crypto holdings, which makes it difficult to determine whether platforms are holding customer funds responsibility.

Observers may critique some of the report’s characterizations. For example, the report claims that “most trading platforms lack a relationship with a bank and allow only trades involving two virtual currencies,” but then notes that seven of 10 firms surveyed accept fiat currency, implying that those seven trading platforms have banking relationships. The report’s critics may also note that allegations of crypto-market manipulation are already widespread.

But crypto-trading platforms, as well as other crypto-market participants, would be wise to take the report seriously. Viewed in tandem with recent statements from other regulators (such as the Securities and Exchange Commission) on crypto-market manipulation, the report is a clear sign that regulators are moving toward establishing higher supervisory expectations — and potentially explicit regulatory requirements — for crypto-trading platforms to establish clear policies and procedures regarding conflicts of interest, market surveillance, and safeguarding customer funds. Indeed, the New York State Department of Financial Services has already published guidance on this topic for holders of the NYDFS BitLicense.

Platforms should view this development as an opportunity to differentiate themselves vis-à-vis their competitors to both customers and regulators. Proactive firms should identify and assess their fraud and market-abuse risks and develop effective controls to mitigate these risks. In much the same way that anti-money-laundering compliance for crypto-trading platforms has become a baseline requirement for firms seeking and maintaining licenses and banking relationships, crypto-trading platforms can expect that regulators and banking partners will begin to expect comprehensive controls to combat fraud and market manipulation on their platforms.


Daniel Bufithis-Hurie is a principal in Promontory’s San Francisco office.