The New York Office of the Attorney General (NY OAG) recently published the results of its Virtual Markets Integrity Initiative, which examined the policies and practices of platforms used to trade virtual or “crypto” currencies like bitcoin and ether. The report warns that crypto exchanges may not be doing enough to protect customers from fraud, theft, and abuse. The NY OAG also referred three platforms — Binance, Gate.io, and Kraken — to the New York State Department of Financial Services (NYDFS) for potential violations of New York law.
Virtual Markets Integrity Initiative
In April 2018, the OAG launched the Virtual Markets Integrity Initiative (Initiative), a fact-finding inquiry into the policies and practices of virtual asset trading platforms. The OAG sent letters and questionnaires to thirteen major trading platforms, which asked the platforms to disclose information on six major topics, including (1) Ownership and Control, (2) Basic Operation and Fees, (3) Trading Policies and Procedures, (4) Outages and Other Suspensions of Trading, (5) Internal Controls, and (6) Privacy and Money Laundering.
The initiative specifically sought information regarding the platform’s approach to combating suspicious trading and market manipulation; their policies on the operation of bots; their limitations on the use of and access to non-public trading information; and safeguards to protect customer funds from theft, fraud, and other risks.
NY Crypto Currency Report
In its Virtual Markets Integrity Report, the NY OAG concludes that there are vast inconsistencies with regard to how virtual currency trading platforms protect their customers from the risks facing the virtual markets. The Report also raises three broad areas of concern for the virtual currency industry at large:
- Abusive Trading Practices: The Report concludes that platforms have yet to implement serious efforts to monitor and stop abusive or manipulative trading, noting that few platforms seriously restrict, or even monitor, the operation of “bots” or automated algorithmic trading on their venue. “On the contrary, most platforms seem to cater to professional, automated traders – with many venues offering special pricing and other features to such traders, leaving retail customers at a disadvantage,” the Report states.
- Conflicts of Interest: The Report notes that platforms engage in multiple, overlapping lines of business that present serious conflicts of interest. Examples cited by the OAG include: platforms trading for their own account, on their own venue, in volumes that constitute a significant portion of total trading; platforms allowing employees to trade on their venue without ensuring that those employees do not use non-public information to gain an advantage over other traders; and platforms issuing their own virtual currencies or accepting compensation in exchange for listing a virtual asset to trade.
- Protection of Customer Funds: The Report highlights the absence of generally-accepted methods for auditing virtual assets. Because platforms lack a consistent and transparent approach to independently audit their virtual currency holdings, the NY OAG concludes that it is difficult or impossible to confirm that platforms are responsibly holding their customers’ virtual assets as claimed. The OAG also notes that retail investors are at significant risk when a hack or unauthorized withdrawal occurs. “There is no public protection (like FDIC insurance) to cover virtual currency losses, and there are serious questions about the scope and sufficiency of the commercial insurance that some platforms carry to cover those losses,” the Report states.
“By highlighting these weaknesses, as well as other considerations important to consumers, the OAG hopes to educate customers and to encourage the virtual asset marketplace to adopt policies that ensure the integrity of transactions,” the Report states. “As the sector matures, the OAG expects responsible trading platforms – in coordination with consumer advocates, regulators, and law enforcement – to expand the transparency, security, fairness, and accountability of their businesses.”
Crypto Industry Response
Not surprisingly, the crypto industry has a lot to say about the Report and its conclusions. Kraken, which elected not to respond to the AG’s questionnaire, was highly critical of the resulting Report. The company wrote on Twitter that it must “object to the highly unprofessional/malicious implication that because we did not respond to the voluntary information request, we ‘might’ be operating illegally.” Kracken added: “We told you we don’t operate in NY. AG trying cases in court of public opinion now?”
Coinbase acknowledged in a blog post that the AG report “shines a helpful spotlight on important compliance issues in digital asset exchange practices.” However, it also raised concerns about inaccuracies about its alleged proprietary trading. According to the company’s blog post, “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.”
If you have questions, please contact us
If you have any questions or if you would like to discuss the matter further, please contact me, Dan Brecher, or the Scarinci Hollenbeck attorney with whom you work at 201-806-3364.