Should Cryptocurrency Exchanges Self-Regulate?

The ever-increasing list of hacks and scandals at bitcoin exchanges have garnered an infamous reputation for the cryptocurrency. Regulation might offer a way out for exchanges to clean up their act. But it will take time as governments around the world grapple with understanding and accommodating crypto behavior within existing legal frameworks. 

Meanwhile, CFTC commissioner Brian Quintenz has called for cryptocurrency exchanges to regulate themselves. The concept is not new. Establishment of the National Futures Association, a self-regulation agency for the futures industry, has helped spur industry growth.  

Here’s a brief primer on self-regulation. 

Within the context of cryptocurrencies, self-regulation is the establishment of guidelines and a code of conduct for market participants to operate businesses within the ecosystem. Those guidelines span a broad spectrum, from knowing your customers (KYC) to maintaining transparency to ensuring security against hacks.

In a paper, the International Organization of Securities Commissions (IOSCO) has defined a set of elements that comprise self-regulation. These include transparency and accountability, contractual relationships, and coordination and information sharing.  (See also: Bitcoin Has A Regulation Problem.)  

Government regulatory agencies typically oversee self-regulation agencies. For example, major rules promulgated by NFA (the National Futures Association) are approved by the CFTC. At the same time, NFA has the authority to audit and regulate non-clearing Futures Clearing Merchants (FCMs). 

Bringing order to an unregulated financial ecosystem is typically the task of government regulatory agencies. (See also: Can Government Regulation Affect Bitcoin Prices?) But self-regulation can aid a government agency’s task by ensuring that development of the nascent crypto ecosystem does not take place in a haphazard manner.

Because the best practices outlined in its guidelines are adhered to by member organizations, self-regulation agencies can also help establish customer trust. It also drives down costs for implementing regulation through self-policing.

“Beyond the constraints and legal burdens, the emergence of regulatory compliance via the use of DLT and smart contracts could represent a significant opportunity for financial institutions from a cost perspective,” writes Roy Keidar, special counsel with an Israeli law firm and a doctoral candidate on blockchain regulation at the Sorbonne in Paris. 

The results of self-regulation can be seen in the responses of cryptocurrency exchanges following recent hacks. For example, cryptocurrency exchanges in Japan bolstered regulatory measures related to security following the recent Coincheck hack. (See also: Coincheck May Have Suffered Worst Hack In Cryptocurrency History.) 

Coincheck also offered partial refunds to customers affected by the hack. After the South Korean government warned against overheated trading, digital currency exchanges, which are part of the Korean Blockchain Association, said they were planning to implement strategies to help protect investors’ assets and introduce greater transparency to their listing process. 

There has been a worldwide move towards self-regulation of cryptocurrency exchanges. Japan and South Korea, which are the first and third most-traded cryptocurrency markets in the world, pioneered self-regulation in cryptocurrency exchanges. 

The Japan Blockchain Association (JBA) boasts 127 members with 35 crypto exchanges among them. It sets standards and promotes the “development of sound business environment and user protection system of virtual currency and blockchain technology.”

South Korea’s blockchain association has 25 members and similar aspirations. Seven cryptocurrency exchanges in India recently formed the Blockchain and Cryptocurrency Committee (BACC) after the country’s finance minister declared cryptocurrencies “illegal tender.” 

The UK’s seven biggest crypto companies have formed CryptoUK, a trade body with its own self-regulatory code of conduct. Among the measures listed on the organization’s website is a commitment to segregating fiat customer money from company funds and to ensure that customer funds are payable if there is a hack or crash (which are part of “insolvency events”) at the exchange.  

Until the time comes that governments around the world are able to evolve a suitable regulatory response to the rise of cryptocurrencies and blockchains, self-regulation offers a way out to ensure that customers are not duped by fraudulent elements within the ecosystem.

Investing in cryptocurrencies and other Initial Coin Offerings ("ICOs") is highly risky and speculative, and this article is not a recommendation by Investopedia or the writer to invest in cryptocurrencies or other ICOs. Since each individual's situation is unique, a qualified professional should always be consulted before making any financial decisions. Investopedia makes no representations or warranties as to the accuracy or timeliness of the information contained herein. As of the date this article was written, the author owns small amounts of bitcoin.