One of the challenges faced by investors trading in traditional securities markets is navigating the complex tangle of relationships and incentives that have arisen in the modern market structure. For several years, the OAG has investigated conflicts of interest in the securities markets, uncovering the systemic failures of large broker-dealers to appropriately manage these conflicts, at the expense of their traditional retail and institutional clients.[27] In non-securities contexts, the OAG has taken action against online businesses who failed to implement appropriate internal procedures governing whether and how employees could access and exploit sensitive user data.[28]

Managing conflicts of interest is a serious and growing issue in the virtual marketplace. A review of publicly available information, as well as information provided by trading platforms, suggests several areas of concern. First, there is little information about why trading platforms list a given virtual currency on their venue, and whether payments to the platform (in cash or virtual currency) drive listings. Second, the owners and investors in several trading platforms are themselves large holders of virtual assets traded on their venue, with an attendant interest that the prices of those assets continue to rise. Third, trading platform employees are often themselves investors in virtual assets, and trade on their own platform against customers, potentially using non-public information to inform their trades. Fourth, apart from individual employee trading, several trading platforms themselves trade on their own venue in a proprietary capacity.

Those practices put the interests of customers in tension with the interests of platforms and their employees. In order to protect themselves, customers should seek out platforms that pay careful attention to these issues and use appropriate means to ensure that all traders on the platform are being treated equally and fairly. At the industry level, appropriate management of conflicts of interest is critical if virtual assets are to be integrated into the commercial and financial markets.

The OAG's Initiative sought information about several important issues that directly concern the fairness and transparency of trading platforms, and potential conflicts of interest, including:

Standards applied when considering whether to list a virtual assets;

Compensation received for listing virtual assets;

Policies and procedures regarding platform employee trading;

Proprietary company trading on the venue.

A. Standards and Consideration Received for Listing a Virtual Asset

Some platforms limit the number of virtual assets they list – for instance, offering trading only in bitcoin – while other platforms list dozens of virtual assets, offering hundreds of potential pairings to trade.[29] As of today, there are no regulatory or even generally accepted prudential standards for determining whether a particular virtual asset can or should be listed on a trading platform. This is in stark contrast to the public stock exchanges, which publish their listing standards. [30]

Accordingly, the OAG asked platforms to provide information regarding how they evaluated virtual assets for listing on their venue – in other words, what, if any, criteria do platforms use in evaluating whether a given virtual currency will be listed for trading? Across the board, the OAG found that platforms’ determinations of whether to list a given virtual asset were largely subjective. No platform articulated a consistent methodology used to determine whether and why it would list a given virtual asset. Some objective factors did appear to be considered by many. For instance, platforms often look at the total value or "market capitalization" of a virtual asset, or its average daily trading volume. But the OAG found there is no rhyme or reason to how those objective factors are applied, and there is certainly no consistent application across platforms.[31]

Notably, since the announcement of the OAG’s Initiative in April 2018, at least one trading platform– Circle, the operator of Poloniex – publicly announced an "Asset Framework" that sets forth various factors the company will consider when deciding whether to list virtual currency.[32] Transparency like that is helpful. Customers should know what standards a platform uses to evaluate the virtual assets they list, and should have some assurance that assets traded on the venue conform to those standards. Platforms that have not disclosed their listing standards publicly should consider doing so.

Another important issue for consumers to understand is whether a virtual asset trading platform has accepted compensation for listing a virtual currency. Unlike traditional stock exchanges, which publish listing fees, virtual asset trading platforms generally do not disclose the compensation, if any, received for listing a particular virtual currency. This compensation can come in the form of virtual currency, including a share of the new listing, fiat currency, or other inducements. Disclosure of payments or other compensation would allow customers to consider a platform’s incentives in offering or promoting a particular virtual currency. Accordingly, the OAG asked virtual asset trading platforms to disclose whether they sought or received compensation for listing a virtual currency, and if so, to describe the circumstances. [33] Only one of the participating platforms reported receiving compensation for listing a virtual asset over the last two years; HBUS charges a fee tied to the market capitalization of the virtual asset.

For non-participating platforms (Binance, Gate.io, Huobi, and Kraken), customers should be aware that those platforms may have received compensation for listing virtual currencies on their platform. Customers should evaluate whether that affects their decision to trade virtual currencies on those platforms. One recent report, for example, asserted that Binance had sought millions of dollars in bitcoins in exchange for listing a new token.

B. Restrictions on Employee Trading

Another feature that distinguishes virtual currency trading markets from traditional securities or commodities markets is that the owners and employees of virtual asset trading platforms can trade directly on their own platforms. This stands in contrast to traditional securities markets, where employees do not trade directly on their venue (access to which requires a registered broker-dealer subject to a host of federal or state regulations, as well as the membership requirements of the exchange or subscriber rules of the ATS).[34]

Trading by platform employees poses a conflict of interest. That conflict can be managed if the platform adopts, and its employees adhere to, policies and procedures prohibiting employees from trading on the basis of information that gives them an advantage over customers – for instance, access to non-public news (like the impending listing of a new virtual currency on the platform), information about the status of the platform order book, or information about its customers’ identities.

Overall, the OAG’s Initiative found a range of different policies at the participating platforms as to whether and how platform owners or employees are permitted to trade on their platform or on other platforms. One platform, HBUS, reported that its employees may not trade on its platform. Other platforms reported to the OAG that while employees could trade on their venue, employees had no informational or other advantage over other traders (for instance, access to non-public order book data). The OAG found that the measures taken to monitor or prevent employee trading differed. Some platforms require employees, or a subset of employees with access to sensitive data (for instance, those with knowledge of forthcoming listings), to be pre-cleared before transacting, while others limited employees’ ability to trade on outside platforms, because the platform’s ability to monitor activity on a third-party platform is difficult or impossible. Two trading platforms – Gemini and Bittrex – require regular disclosures from each employee concerning their trading history and current virtual asset holdings. Bittrex goes further, by restricting employee trading to a two-day window each quarter. Bitfinex, itBit, and Tidex did not provide any restrictions on employee trading.[35]

Customers should be aware the platforms that refused to participate in the OAG’s Initiative might not limit the access of employees or other insiders to non-public or otherwise sensitive information, or monitor employees trading to ensure that other customers are not being placed at a disadvantage.

C. Proprietary Trading by Platform Operators

In addition to permitting employees to trade for their own personal accounts, several platforms reported that they engage in proprietary trading on their own venue. In other words, customers who submit an order to buy or sell a virtual asset could have their order filled not by another customer, but by a “trading desk” run by the platform itself, trading on behalf of the platform for its own account.

There are reasons why a trading platform (or its affiliate) might trade on its own venue. First, a platform might engage in trading in order to make a profit, much like any other trader. Second, a trading platform might act as a “market maker,” submitting both buy and sell orders for the same assets in order to promote liquidity – in other words, in order to increase the chances that a customer’s order will execute if another willing buyer or seller does not exist at that moment in time. Those trading objectives are not necessarily exclusive, and indeed can be accomplished by a sophisticated trader at the same time. Such activity is common in the traditional securities marketplace, particularly in broker-operated alternative trading systems (ATSs), but it requires significant commitment to customer protections and transparency to remain in compliance with applicable laws.