Should Cryptocurrency Exchanges Self-Regulate?

The ever-increasing list of hacks and scandals at bitcoin exchanges has garnered an infamous reputation for the cryptocurrency. Regulation might offer a way out for exchanges to clean up their act. But it will take time as governments around the world grapple with understanding and accommodating crypto behavior within existing legal frameworks. 

Meanwhile, CFTC Commissioner Brian Quintenz has called for cryptocurrency exchanges to regulate themselves. The concept is not new, and there are already self-regulating industry associations for other markets. Organizations like the National Futures Association, for commodities traders, or the Financial Industry Regulatory Authority, for securities, have helped spur growth in their respective markets.

Here’s a brief primer on self-regulation. 

What Is Self-Regulation? 

Within the context of cryptocurrencies, self-regulation is the establishment of guidelines, industry organizations, and a code of conduct for market participants to operate businesses within the ecosystem. Those guidelines can span a broad spectrum, from knowing your customers (KYC) to maintaining transparency to ensuring security against hacks.

In a paper, the International Organization of Securities Commissions (IOSCO) has defined a set of elements that comprise self-regulation. These include transparency and accountability, contractual relationships, and coordination, and information sharing.

Government regulatory agencies may provide additional oversight for self-regulation agencies. For example, major rules promulgated by NFA (the National Futures Association) are approved by the CFTC. At the same time, NFA has the authority to audit and regulate non-clearing Futures Clearing Merchants (FCMs). 

Will Self-Regulation Bring Order to the Crypto Wild West? 

Bringing order to an unregulated financial ecosystem is typically the task of government regulators. But self-regulation can aid a government agency’s task by ensuring that the development of the nascent crypto ecosystem does not take place in a haphazard manner.

Because the best practices outlined in its guidelines are adhered to by member organizations, self-regulation agencies can also help establish customer trust. It also drives down costs for implementing regulation through self-policing.

The results of self-regulation can be seen in the responses of cryptocurrency exchanges following recent hacks. For example, cryptocurrency exchanges in Japan bolstered regulatory measures related to security following the recent Coincheck hack.

Coincheck also offered partial refunds to customers affected by the hack. After the South Korean government warned against overheated trading, digital currency exchanges, which are part of the Korean Blockchain Association, said they were planning to implement strategies to help protect investors’ assets and introduce greater transparency to their listing process.

However, some government bodies believe that the cryptocurrency industry is unable to police itself. Senator Elizabeth Warren, who chairs the Senate Banking Committee, has pushed the SEC to "use its full authority" to regulate the cryptocurrency industry, and Commission Chairman Gary Gensler has proposed a multi-agency task force on digital assets.

How Many Countries Have Implemented Self-Regulation? 

There has been a worldwide move towards the self-regulation of cryptocurrency exchanges. Japan and South Korea pioneered self-regulation in cryptocurrency exchanges. 

The Japan Blockchain Association (JBA) boasts 127 members with 35 crypto exchanges among them. It sets standards and promotes the development of a sound business environment and user protection system of virtual currency and blockchain technology.

South Korea’s blockchain association has 25 members and similar aspirations. Seven cryptocurrency exchanges in India recently formed the Blockchain and Cryptocurrency Committee (BACC), with a formal board to establish compliance with its code of conduct.

The UK’s seven biggest crypto companies have formed CryptoUK, a trade body with its own self-regulatory code of conduct. Among the measures listed on the organization’s website is a commitment to segregating fiat customer money from company funds and to ensure that customer funds are payable if there is a hack or crash (which are part of “insolvency events”) at the exchange.

In the United States, the founders of the Gemini Exchange have proposed a Virtual Commodity Association to regulate cryptocurrency exchanges and other businesses. Members of the VCA would commit to following the Association's rules and accept sanctions if they fail to uphold them.

The Bottom Line 

Until the time comes that governments around the world are able to evolve a suitable regulatory response to the rise of cryptocurrencies and blockchains, self-regulation offers a way to ensure that customers are not duped by fraudulent elements within the ecosystem.

Investing in cryptocurrencies and other Initial Coin Offerings ("ICOs") is highly risky and speculative, and this article is not a recommendation by Investopedia or the writer to invest in cryptocurrencies or other ICOs. Since each individual's situation is unique, a qualified professional should always be consulted before making any financial decisions. Investopedia makes no representations or warranties as to the accuracy or timeliness of the information contained herein. As of the date this article was written, the author owns small amounts of bitcoin.