As the focus on cryptocurrency regulation pick up pace worldwide, exchanges could be the next target of the watchdogs. While the largest exchanges have already implemented necessary Know-Your-Client (KYC) and Anti-Money Laundering (AML) procedures, many still remain unregulated. Four of the largest exchanges by trading volume do not support any fiat currencies natively, but instead have bypassed the banking problem by using the currently contentious US Dollar pegged stablecoin, Tether. And if banking wasn't enough of a problem, the legality of trading some of the ICO tokens that could be considered securities is also uncertain.

With the surge of cryptocurrency trading in 2017, the demand for reliable exchanges grew becoming major revenue-generating business. Binance, which only launched last July, is the largest exchange by traded volume, a mere 7 months on. The popular exchange went from revenues of $7.5Mn in the first quarter to more than $200Mn in revenues in the second quarter and boasts 6 million users on its trading platform.

Unlike traditional financial markets, cryptocurrency exchanges are open 24/7, not location restrictive and have low barriers to entry. And with the potential of quite large audience with trades earning approximately 0.1% in fees, exchanges are certainly cash-cows.

|| HEAVY IS THE HEAD THAT WEARS THE CROWN

Of course, there is a huge responsibility and risk for exchanges to be reliable and safe as cryptocurrencies now represent the largest bounty hunt in the world attracting the attention of hackers en masse.

Diar found that an eye-balling $1.1Bn have been stolen off cryptocurrency exchanges – 60% of which has taken place in 2018 alone ( Diar, 12 February ). Bitfinex, which is currently the third most popular exchange by traded volume, has been hacked twice in 2015 and 2016 for a total amount of $68Mn. After two years, Bitfinex announced that it reimbursed the stolen funds in full. Japanese exchange Coincheck, whose hack in January represented the largest digital heist in history to the tune of close to $500Mn, has also reimbursed its users (Diar, 29 January).

And in early March, Binance has successfully prevented a hack, which was detected by an automatic risk management system and ultimately resulted in hackers losing their own funds. After the failed hack attempt, the company announced that it will offer a $250,000 bounty for details of the hackers and it started a $10Mn fund for future bounty awards.

|| AUTHORITIES GUNNING

Exchanges must comply with regulatory requirements from competent authorities. In November 2017, China shut down the country’s exchanges citing a focus on preventing capital flight. China’s largest exchanges Huobi and OKEx were forced to relocate to Singapore and Hong Kong respectively. In January, South Korean authorities also stepped in and prohibited anonymous trading at their exchanges. The ones that were unable to comply with the new KYC requirements were ordered to halt operations.

Following the U.S. Securities and Exchange Commission’s (SEC) investigation of initial coin offerings (ICO) and the conclusion that some tokens might be considered securities, Bitfinex promptly announced that it will no longer allow U.S. investors to trade on the exchange. In a statement, Bitfinex said that a dramatically outsized portion of their resources goes into regulatory compliance while the revenues from the U.S. customers are limited. Binance, Huobi, HitBTC, Bit-Z, Bittrex and Poloniex still support trading of ICO tokens for US persons (see table). However, notably, none of these platforms support fiat currencies natively as all of them are using Tether as a substitute addressing their banking woes.