Set rules for centralized exchanges

Centralized cryptocurrency exchanges have become the backbone of the nascent crypto ecosystem, making way for retail and institutional traders to trade cryptocurrencies despite a constant fear of government shutdowns and a lack of support from policymakers.

Over the years, these crypto exchanges have managed to set self-regulatory controls and implemented guidelines in line with local financial regulations to grow despite the looming uncertainty.

Cryptocurrency regulation continues to occupy mainstream debates and expert opinion, but despite public demand and requests from stakeholders in the nascent ecosystem, policymakers continue to overlook the fast-growing sector that reached a $3 trillion market cap at the peak of the 2021 bull run.

Over the past five years, many local and national governments have shown interest in regulating the crypto market, but have often been confused by the vast ecosystem and complexity involved in regulating certain decentralized aspects of the market. As a result, most of the governments that have issued any guidelines or regulations related to crypto have done so based on existing financial regulations, but the evolving market has proven too fast.

Some countries have moved to recognize crypto trading as a legal activity, while others have approved Bitcoin (BTC)-based exchange-traded funds. Many countries have also made room for crypto platforms to operate with a license, but the strict requirements often deter certain small platforms from staying away. As a result, there is no universal blueprint for regulators to follow, and experts believe leading centralized crypto exchanges could change that.

In traditional markets, it is quite normal for regulators to work closely with industry players, including exchanges, to ensure that regulations and guidance work well and keep pace with rapidly changing technological advances. However, the same cannot be said for the crypto market, as regulators have kept a safe distance from the nascent industry.

Oliver Lynch, CEO of global crypto exchange Bittrex Global, said that regulators need to interact with service providers of the crypto ecosystem to get a better grip on the industry. He cited the example of Bermuda and Liechtenstein, where the crypto exchange has worked with local lawmakers to make way for positive regulations.

He noted that while decentralized exchanges continue to remain the flag bearer of crypto’s decentralized ethos, which are thus more complex to regulate, centralized exchanges will be the key to mass adoption:

“Centralized exchanges have perhaps the most important role to play here. While decentralized exchanges tend to be the “poster boys” for the cutting edge of the industry, they are naturally hesitant to engage in regulatory issues. Anyway, most of the activity, especially for regular retail users (who are ahead of regulators) happens on centralized exchanges.”

He added that regulation of the entire crypto market will follow, but the approach of “Liechtenstein, Bermuda and now the EU, in regulating service providers, including centralized exchanges, is a good starting point. By properly regulating centralized exchanges, regulators and legislators create a legitimate way for users – from individuals to giant enterprises – to get involved in crypto in a safe and regulated way.”

A spokesperson for Binance told Cointelegraph that as a centralized exchange, it needs a centralized entity to work well with regulators.

“Binance believes it has a fundamental responsibility to cooperate with regulators and believes that a well-regulated crypto market provides greater protection for everyday users. We strongly believe that a stable regulatory environment can support innovation and is essential for establishing trust in the industry which will lead to long-term growth, said the spokesperson.

Centralized exchanges are proving to be the regulators’ allies

In major economies and developed countries, regulators have not been very keen to involve industry players, but those nations that see the future in the emerging technology have actively partnered and brought in leading centralized crypto exchanges to not only help them build the infrastructure, but also help them with formulating the right guidelines for the crypto market.

Binance recently signed a memorandum of understanding with Kazakhstan to help fight financial crime. The program also aims to identify and block digital assets acquired illegally and used to launder criminal proceeds and finance terrorism. Similarly, Busan brought on board Huobi to develop blockchain infrastructure in the region.

Many countries already regulate centralized exchanges, but there is still much uncertainty about which regimes apply and how they will be enforced. For example, US-based exchanges operate under licenses from the Financial Crimes Enforcement Network, but have been alleged to list tokens and offer financial products (such as derivatives, bets and interest-bearing deposits) that fall under the purview of the Securities and Exchange Commission. or the Commodity Futures Trading Commission.

The Lummis–Gillibrand bill is considered one of the most comprehensive crypto bills proposed in the United States. South Africa has recently classified crypto as a financial product and will regulate it accordingly. South Korea implemented strict rules last year that require exchanges to track all transfers to and from their platform, including identifying the owners of wallets. As a result, exchanges there restricted transfers to and from unverified private wallets.

Thus, it is clear from existing regulations that centralized exchanges have become the main point of interaction for not only traders, but also regulators.

Mohammed AlKaff AlHashmi, co-founder of Islamic Coin, told Cointelegraph that regulating centralized exchanges will help regulate the broader crypto market, explaining:

“Firstly, there is Know Your Customer and Anti-Money Laundering. I see most of the exchanges will outsource it to very well known and authentic KYC/AML entities as it will bring more reliability and trust instead of doing these procedures at exchanges themselves. Secondly, taxation is an important topic when we talk about regulation. Many countries will regulate crypto if they can do the taxation, and I suggest that the exchanges will develop the taxation of the crypto transactions and be the one to collect this data and hand it over to the authorities.”

Habeeb Syed, senior associate at Vicente Sederberg and co-organizer of the Blockchain Technology, Law and Policy Meetup, told Cointelegraph, “Crypto exchanges often determine the winners and losers of the crypto world, being listed on one is an almost sure way to increase your token price and provide early investors an opportunity for liquidity. Thoughtful regulation of centralized exchanges can also ripple out into the wider ecosystem.”

He added that regulating crypto exchanges would force legitimate projects to know they cannot engage in certain actions “if they ever want to list a token on say Binance, FTX or Coinbase, which would be a powerful motivating force. With regulated options for trading, staking and lending, players may choose to forego riskier and unregulated DeFi ecosystems.”

Regulators must proceed with caution

Crypto exchanges play a central role in the vast crypto ecosystem, as they have many services and facilities, many of which are trying to become an all-in-one platform. Some experts are of the opinion that while regulation of centralized exchanges can certainly be the first step towards broader regulation of the crypto market, it is not enough to ensure the smooth operation of the entire industry.

Aleksandra Shelepova, head of legal at crypto-backed loan service provider CoinLoan, told Cointelegraph:

“When it comes to imposing regulations on any new and developing market, everything should be done step-by-step. In addition, the regulators should have a proper understanding of how this market works in detail, including technological aspects. Regulation should come from the middle bottom, something which means that the contribution of the market participants’ knowledge is decisive.”

She added that it is not enough to regulate only the exchanges as there are many popular and widely used crypto products, including crypto loans, deposits, etc. that also need to be regulated. Extending regulation to all aspects of the crypto community ensures a unified understanding of the products themselves.

While monitoring centralized exchanges can definitely pave the way for a better understanding of the crypto market, regulators should refrain from a “one size fits all” formula.

Nicole Valentine, fintech director at the Milken Institute, told Cointelegraph that regulators should be more focused on decentralized platforms:

“Just as there is variation in the digital assets themselves, there is variation in the types of exchanges that enable buyers and sellers to trade these digital assets. While regulation of centralized exchanges can be seen as useful, there are nuances in decentralized exchanges that should be considered, including the use of digital wallets and smart contracts.”

Centralized exchanges are a key part of the cryptocurrency ecosystem; they are where most new crypto users go to buy their first coins. Many leading centralized exchanges already have strict onboarding and identification procedures in place and want more clarity from regulators on issues such as whether digital assets are securities or not.

Increased regulation for centralized exchanges is a double-edged sword where, on the one hand, it will lead to more new interactions and greater adoption, but on the other hand, increased regulation could drive the more experienced crypto users towards decentralized exchanges, which experts believe regulators would have difficult to handle.