Why it matters: Regulators’ hawkish stance on the industry signals a coming torrent of enforcement action — one that the major exchanges might be able to withstand, but that could choke out smaller firms, their products, or shrink the number of jurisdictions they operate in.
State of play: Larger exchanges are already building their own systems or expanding their compliance-dedicated headcount, even in the face of companywide layoffs.
- And State and federal regulators are circling. The Department of Justice, the Securities and Exchange Commission, the Commodity Futures Trading Commission, and the Treasury Department are all homing in on digital assets firms and their practices in the U.S.
Driving the news: Coinbase Global, the U.S.’s largest centralized crypto exchange, agreed to a $100 million settlement with New York state regulators last week over accusations that its failed to conduct sufficient background checks for new customer account applications.
- $50 million was paid in fines with another $50 million pledged toward beefing up compliance.
Be smart: The crypto industry lacks a soup-to-nuts regulatory framework to adhere to, but it has been required to follow some rules.
- The Financial Crimes Enforcement Network in 2013, for example, was among the first to bring to heel digital assets businesses by requiring them to adhere to the Bank Secrecy Act.
- Crypto exchanges follow anti-money laundering (AML) rules, which require them to conduct know-your-customer (KYC) verification, among other things.
Zoom in: Crypto exchange Kraken says it has increased its compliance headcount 55% over the past 12 months, even as the company cut staff in November.
- “For 2023, we are focused on enhancing our utilization of technology to further strengthen our robust compliance program,” David Zacks, the company’s senior director of compliance, tells Axios.
- “These additional investments in our risk-based program will continue to expand our overall compliance budget.”
Between the lines: Crypto exchanges use regulation technology to automate some of the processes of checking customer identities and transactions for suspicious activity in the same way banks and other traditional financial service firms do.
- And some will build their own “reg-tech,” that would allow them to sidestep sending customer data to third-party service providers.
However, they also require teams of compliance experts who can also analyze and investigate transactions that occur on blockchains. And the need for these experts fluctuates based on the load of activity.
- Of note: NYDFS fined both Robinhood and Coinbase for their backlogs of unaddressed suspicious activity alerts.
Meanwhile, in the wake of FTX’s collapse and the rash of crypto lenders’ filing for Chapter 11, the biggest crypto shops are trying to shore up or maintain a certain level of professionalism that shows their good standing.
- “Compliance is critical to create trust among the industry, regulators, and customers.” Paul Grewal, Coinbase’s chief legal officer, tells Axios.
- “Maintaining high compliance standards can also be a competitive advantage, allowing companies like Coinbase to obtain licenses and operate in highly regulated markets that are not open to our competitors.”
No where to hide: “If there’s an enforcement action, it’s going to cost more than what you’re spending,” Tim Byun, government relations officer for crypto exchange OKX, tells Axios.
- “If you get an enforcement action, even to remediate it, it’s going to take significant resources. It’s hard to manage an influx of an army. Your costs can easily triple or quadruple.”
The other side: Investment in compliance isn’t immune to economic realities, however. There’s always a give-and-take in compliance resources, Jeff Horowitz, BitGo’s chief compliance officer, tells Axios.
- “In good times, there are more resources and in tougher times, cuts across the board,” he says.
- “AML [anti-money laundering] is a big umbrella. There are general standards no matter what type of license you have and there’s a cost to that: People or resources, case management, and reporting management. It’s a cost of doing business.”
Reality check: Crypto firms that spent the most recent bull run launching new products and business lines willy-nilly — from the U.S. to Japan and everywhere in between — will have to reconsider, according to compliance officers.
- There’s the threat of enforcement action, but also, the exams, licensing requirements and processes, plus, the fees.
- Public crypto banks like Silvergate have already said they are reviewing their products and services, while others like Metropolitan, are exiting crypto altogether.
Our thought bubble: Maybe the threat of enforcement cuts the industry fat.