Blockchain & Money: Session 17: Secondary Markets and Crypto-Exchanges, by M.I.T. Sloan School of Management with Professor Gary Gensler

Session 17: Secondary Markets and Crypto-Exchanges

Overview: Readings and Study Questions; Crypto Exchanges Review; Public Policy Challenges; The Path Forward; Conclusions.

Session 17: Study Questions
- How have crypto-exchanges become a critical gateway for the vast majority of crypto secondary market trading?
- How does the business model of crypto-exchanges compare to traditional securities and derivatives exchanges? How do centralized crypto-exchanges compare to decentralized crypto-exchanges?
- What do all the hacks, reports of manipulation and failures tell us about the current state of security and investor protection of crypto-exchanges?

Session 17: Readings
- ‘Move deliberately, fix things: How Coinbase is building a cryptocurrency empire’, Washington Post.
- ‘Robinhood rolls out zero-fee crypto trading as it hits 4M users’, TechCrunch.
- ‘After Nasdaq CEO Blesses Cryptocurrency, Investors See Bigger Future for Bitcoin, Others’, Forbes.
- ‘Bitcoin Sees Wall Street Warm to Trading Virtual Currency’, New York Times.
- ‘Cryptocurrency Exchanges Are Getting Hacked Because It’s Easy’, Wall Street Journal
- ‘The sad state of crypto custody’, TechCrunch

Crypto Exchanges
- Centralized–Matching Agents, Counter-parties & Custodians
- Decentralized–Networks for Peer-to-peer Trading
- Responsible for over 95% of Crypto Secondary Market
- Greater than 30 million direct Members.
- Lack Intermediated Access or Meaningful Market Integrity Rules

CryptoCompare Exchange Review
- Spot vs. Derivatives: 68% vs. 32% of Volume
- Crypto to Crypto vs. Fiat to Crypto: 70% vs. 30% of Spot Volume
- Decentralized Exchanges: Only 0.4% of Volume
- Bitcoin vs. Fiat: USD–50%, JPY–21%, KRW–16%, EUR 9%
- Malta, South Korea and Hong Kong Registered Exchanges rank Highest
- KYC: 47% impose Strict KYC; 25% Partial; 28% No KYC

Crypto Exchange Public Policy Challenges
- Markets Readily subject to Fraud, Scams, and Manipulation
- Custodial Arrangements–Exchanges and Wallets
- Complying with AML/KYC and implementing Tax Reporting
- Definitions–Securities, Commodities or Derivatives?
- Tracking Beneficial Ownership
- Remediation of Non compliant Exchanges

Investor Protection
- Investor Protection goes beyond Consumer Protection:
  - Investors get Full & Fair Disclosure from Insurers
  - Fraud & Deceptive Sales Practices Prohibited
  - Market Integrity Promoted with Transparency & Anti-Manipulation
  - Advisors’ Conflicts of Interest Disclosed and Minimized
- Investor Protection Bolsters Confidence in Capital Markets
- Economic Growth, Issuers and Investors all Benefit

U.S. Securities Law
- The Howey Test (1946):
  - Is it an investment of money or assets?
  - Is the investment in a common enterprise?
  - Is there a reasonable expectation of profits?
  - Is it reliant on the efforts of a promoter or others?

Crypto Exchanges–Path Forward
- Custodial Duties–Fix or Spin-Off
- Illicit Activity–Comply with AML and Tax Laws
- Promote Market Integrity–Individually, SRO or Regulatory
- Registration and Remediation–Determine and Comply
- Margin and Fee Compression
- Consolidation
- Decentralized Exchanges–Enhanced Customer UI & Adoption

Conclusions:
- Crypto Exchanges, play a Central Role in Crypto Finance
- Though they do not use Blockchain Technology
- Ironically They are highly Centralized in a Field Inspired by Decentralization
- Investor Protection and Hacks present Major Challenges
- Broader Adoption Depends upon meeting these Challenges
- Investors and use of Permissionless Blockchain Technology all will Benefit

Biblio:

Gary Gensler. 15.S12 Blockchain and Money. Fall 2018. Massachusetts Institute of Technology: MIT OpenCourseWare, https://ocw.mit.edu. License: Creative Commons BY-NC-SA.
Video Link: Session 17: Secondary Markets and Crypto-Exchanges.
Slides Link: Session 17: Secondary Markets and Crypto-Exchanges, Slides.