Deterring adoption? Balancing security and innovation in crypto


The cryptocurrency space is changing rapidly, so much so that every year a new trend emerges: from initial coin offerings (ICO) to non-fungible tokens (NFT), only a few years have passed. Faced with such astonishing innovation, crypto companies and regulators face a growing challenge: balancing security practices with new products and features.

The approach of some companies is to act quickly and embrace new innovations as they become available, leaving security processes such as Know Your Customer (KYC) and Anti-Money Laundering (AML) as the focus. secondary. The popular cryptocurrency exchange Binance apparently used this strategy until this year, when regulators began to crack down.

Binance’s KYC policies initially allowed users who had not fully verified their identity to withdraw up to 2 BTC per day. The exchange listed on margin trading pairs with the major fiat currencies and allowed leverage up to 125 times that of its futures trading platform, but had to reduce leverage. available and remove the margin trading pairs when it first began to be investigated by the Internal Revenue Service and the United States Department of Justice.

The exchange has since taken a compliance-friendly approach to its business and implemented mandatory KYC processes for “global users, for every feature.” This decision caused it to lose around 3% of its total number of users.

While Binance has been forced to cut some of its offerings and reduce leverage on its platform, other exchanges are still providing users with these same products. Speaking to Cointelegraph, Yuriy Kovalev, CEO of crypto trading platform Zenfuse, noted that finding regulations that allow compliant companies to compete is a challenge that must be addressed:

“Finding a way to balance regulation that protects investors and innovation is difficult, especially in a space where new financial offers appear every few months. “

Speaking to Cointelegraph, Bittrex cryptocurrency exchange CEO Stephen Stonberg pointed out that cryptocurrency regulations are now “quite complex” and are handled differently in different jurisdictions.

Stonberg hinted that customer safety should nonetheless remain a priority because “stronger and clearer regulation – like in the traditional financial industry – is needed to truly ensure the safety of customer assets and data.” As an example, Stonberg cited Liechtenstein’s blockchain law, which “provides much more certainty and clarity on how an exchange should onboard new clients and protect a client’s assets.”

Regulatory clarity is seen as a necessity by some industry players because without it innovation can be left behind. In a recent blog post, the Nasdaq-listed cryptocurrency exchange Coinbase noted that its plans to launch a lending program were halted by the United States Securities and Exchange Commission (SEC), which threatened to sue her “without ever saying so.” [them] Why.”

Coinbase said it tried to “engage productively” with the SEC, but never received any clarification on the SEC’s reasoning or how it might modify the product to be compliant. One proposed alternative was to leave the regulators out of the picture. Commodity Futures Trading Commission (CFTC) Commissioner Brian Quintenz defended the alternative, calling at one point to regulate cryptocurrency trading, echoing the sentiment of many in the industry.

Is self-regulation a viable alternative?

The concept is not new: Organizations like the Financial Industry Regulatory Authority (FINRA) have helped implement initiatives to protect securities investors with brokers and brokerage firms. In Japan, a self-regulatory body for the country’s crypto exchange industry, the Japanese Cryptocurrency Exchange Association (JCEA), has been formed.

Stonberg doesn’t think the answer is in the way of self-regulation, because “the complex nature of this digital ecosystem makes regulation tricky.” For him, self-regulation would mean “unrolling” all the hard work done on the regulatory front for crypto and “recomplexing the regulatory environment, putting a blockage in progress.”

The pseudonymous founder of the decentralized finance platform (DeFi) based on the Flare Flare finance network CryptoFrenchie told Cointelegraph that he believes in the “capabilities of decentralized platforms and centralized platforms to provide a self-sustaining environment. regulated that responds effectively to meet (or exceed) the needs of modern regulatory requirements.

The founder of the DeFi project added that the current systems have “proved incapable of meeting the needs of the current financial system”, and added:

“Applying these same systems to an even faster environment like crypto could prove more stifling for its potential than favorable. “

CEX.IO crypto exchange founder and CEO Oleksandr Lutskevych suggested that self-regulation could be an option, saying that, in the company’s experience, self-regulation is the answer “in the absence of an applicable regulatory framework “. Speaking to Cointelegraph on his way to his business, Lutskevych said:

“Until a framework for cryptocurrencies was formalized in some countries, we took a self-regulatory approach, implementing best practices from other major financial organizations.”

Cryptocurrency platforms, both centralized and decentralized, should “seek to analyze their own systems and develop modules specifically designed to meet the needs of current regulatory systems,” CryptoFrenchie said.

Are decentralized exchanges a threat?

As the debate on self-regulation continues, another has developed about decentralized trading platforms and their impact on the market. Decentralized non-custodial exchanges allow users to trade directly from their wallet, often without even registering with an email address.

Some critics have argued that Decentralized Exchanges (DEX) render the KYC and AML efforts of centralized platforms worthless, as bad actors can conduct their illicit activities through these platforms. Others suggest that DEXs, even those run by Decentralized Autonomous Organizations (DAOs), can improve their transparency to help blockchain detectives and law enforcement agencies find illicit transactions.

For chief investment officer of digital asset investment firm Arca Jeff Dorman, decentralized applications (DApps) and other projects can help keep the cryptocurrency space secure. Speaking to Cointelegraph, Dorman said the industry needs to set standards, adding:

“Businesses and projects need to recognize the importance of setting up transparency dashboards, and industry analysts need to roll up their sleeves and do the dirty work of bringing transparency to projects that don’t. not themselves. “

Bittrex’s Stonberg pointed out that “the best way to cover up illicit activity is not with cryptocurrencies, but with old-fashioned money.” The CEO added that blockchain-based transactions are “more traceable than any other financial activity.”

Stonberg told Cointelegraph he believes decentralized exchanges should develop AML and KYC policies that they can implement, but added that the industry “is still in the early stages of seeing how decentralized exchanges play out. “.

Lutskevych suggested that tools to track the origin and history of crypto assets could one day be used in decentralized exchanges to prevent illicit funds from entering their platforms. He noted that “basic information can be traced” on the blockchain, although that data is “far from what Financial Action Task Force guidelines require centralized exchanges to be put together.” Lutskevych added:

“Decentralized mechanisms that can prevent funds of illegal origin (money laundering, ransomware, hacking) from entering a DEX with a protocol smart contract are currently being explored and developed. “

Lutskevych concluded that it is possible for decentralized platforms to take advantage of the KYC and AML procedures to address the concerns of regulators. He noted that the implementation of KYC on its own might not be enough to deter illegal activity and protect users.

Raj Badai, Founder and CEO of DeFi and Traditional Banking Scallop Bridge, told Cointelegraph that the growth of the decentralized finance industry poses a challenge for regulation, but suggested that a solution could be a “blockchain. regulated ”. Referring to products in development, Badai said:

“We can make sure that wallets on a blockchain go through a KYC / KYB process. This means that the account holder is identified and all funds in the chain can be traced, ultimately creating an inhospitable environment for illicit activity and deterring them from the start.

Fundamental cryptographic rights

Binance recently apparently weighed in on the topic by posting what it called “fundamental rights for crypto users.” The exchange argued that every human being should “have access to financial tools” that “allow greater economic independence”. He also noted that “responsible crypto platforms have an obligation to protect users from bad actors” and to implement KYC to “prevent financial crimes.”

Commenting on Binance’s crypto rights push, Lutskevych suggested the move was an “ad campaign” from a company “that only very recently started touting these values,” making it more of a “marketing strategy. “.

Through a website dedicated to the fundamental rights of crypto users, Binance called on industry leaders, regulators and policy makers to “help shape the future of global finance together.” The exchange added that it believes it should be “for the policy makers in each country and their constituents to decide who should oversee the industry.”

Related: The Bane of Stablecoin: Regulatory Reluctance May Hinder Adoption

Crypto, Binance wrote, belongs to everyone. While the exchange believes regulations are inevitable, any decision-maker overseeing the space has a monumental task to accomplish, as keeping bad actors at bay without stifling innovation has so far proven to be a challenge. .

The strategy that cryptocurrency companies seem to agree on is based on working with regulators to find solutions that will not prevent users from gaining access to innovative currencies or digital services created within. their ecosystem. Regulators’ lawsuits against large crypto firms appear to show only one side is happy to cooperate.