Howard Marks

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New York Puts ALL Exchanges on Notice

As I was furiously working on my company’s summit happening in just a few days, I received a ping from an attorney friend of mine, saying that New York Attorney General Schneiderman has sent a request for information to most of the US-based crypto exchanges. That request included a very detailed list of questions. This is, in essence, a subpoena-lite form that requests all of them to detail how they operate their “exchanges.”

The companies who got this subpoena are the who’s who of the industry: Gdax (Coinbase), Gemini, bigFlyer, Binance, Bitfinex, Bitstamp, Bittrex, itBit, Gate.io, Huobi.Pro, Kraken, Tidex, and Poloniex (Circle).

So what does this mean for these exchanges and the rest of the cryptocurrency marketplace? After all, the SEC has already clearly stated in their bulletin on cryptocurrency trading that most of the exchanges needed to either register as an exchange or seek an exemption, such as become registered as a broker-dealer and then getting approval as an ATS. So far, this notice has fallen on deaf ears. None of those companies have followed the SEC’s requirements. The NY Attorney General seems to have decided to pile on with his own method of getting these companies to follow the rules of the law.

As some of you may know, NY was the first state to create a regulated license for cryptocurrencies, called BitLicense, which went live on August 8, 2015. Since then, only a few companies have been approved. That list includes Circle, Ripple, and Coinbase.

However, many other industry players, including Bitpay, had to remove any resident of New York from their customer list. This also meant that many ICOs stayed away from NY residents because the definition of a money transmitter was so vague that it could also include selling utility tokens to NY residents.

With this new Virtual Markets Integrity Initiative announced today by Schneiderman, New York is paving the way for every other State to conduct the same kind of inquiry. The Attorney General is also probably doing the work for the SEC with this initiative, as the SEC has recently sent a boat load of subpoenas to companies issuing utility tokens through an ICO.

This action is clearly in line with what the SEC has been saying for a while now: either follow the rules or stop doing whatever you are doing. When it comes to an exchange, it turns out the rules for trading securities could not be more clear. You need to be a broker-dealer or a registered exchange. Period. This is going to be a rude awakening for many of the large players. Some are rumored to trade more than $500M in transactions in a single day!

I have written about some of the woes and clearly fraudulent behavior of crypto exchanges in an earlier article 4 Ways Altcoin Exchanges Promote Fraud. It seems that NY may have read it and decided to move forward with the initiative ;)

But I don’t think so. It was probably complaints from NY residents who lost money on some of the public pump and dump schemes, insider trading, and front running schemes that drew the attention of the NY Attorney Journal. Schemes that make Ponzi or Madoff look like angels.

Yet good news is coming. Many companies have already filed with the SEC, either registration applications or amendments to be able to legally operate Alternative Trading Systems (ATS). Companies such as tZERO, Templum, and StartEngine (disclaimer: I am the CEO) are working tirelessly on getting these in place. Clearly, if NY, and other states after, ask exchanges to cease and desist from operating those exchanges, then there will be a large vacuum for the demand from investors. These new companies will be able to fill that void.

The main benefit of an ATS to investors is that the ATS is operated by a broker-dealer, which is registered with the SEC and supervised by FINRA. Add to this a list of rules that FINRA has developed to help investors which make the ATS a transparent and fair platform for trading securities. Also add to this the yearly audits by FINRA and the ability for the regulators to halt trading.

All of this offers investors a better place to trade. However, these benefits also come at an price, and they are not cheap. Implementing regulation costs money, and that cost will be passed on to the investors. What is important is for all of the companies offering trading services to investors to follow the same regulation and thus pay the same costs.

With the transformation of the Initial Coin Offering (ICO) marketplace into regulated ICOs or ICO 2.0s, investors can purchase initial offerings, such as security tokens, and be able to make an informed decision because of all of the required disclosures that regulation ensures companies make public. Now, that same transformation will be expected of the exchanges as well.

One big idea for the marketplace is to create a web of ATS platforms that will work together to offer investors best execution. This is not a new idea for the existing financial services marketplace, but a new one for the cryptocurrencies marketplace. Imagine if all of the exchanges were linked and could expand the liquidity for the cryptocurrencies they trade?

This is possible with broker-dealers because they can share commissions and better match buyers and sellers. This is not the only big advantage for operators of ATS. This will also allow trade with investors in foreign countries, who can tie their regulated exchange with a regulated US-based exchange.

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