It was only a matter a of time. There were clearly signs this was going to happen already out there when the SEC went after defunct “exchange” BitFunder. Today, the SEC made its biggest announcement yet: all the crypto exchanges are illegal unless they register with the SEC. Why is this important? It turns out the entire $400B cryptocurrency ecosystem is based on trading altcoins or utility tokens.
A Short History of Altcoins
After Bitcoin was released in 2009, the only way to trade it was to meet a friend at a coffee shop, open your laptops, and take out cash from your wallet. This trade was effective but clearly slow and inconvenient. Others felt the same way, and entrepreneurs realized there needed to be a better solution.
One of the most famous places to trade Bitcoin was Mt. Gox, which originally was named Magic The Gathering Online Exchange to trade rare playing cards. This exchange evolved into trading Bitcoin exclusively. It was founded by Jed McCaleb and then sold to Mark Karpeles who moved the exchange to Japan. Mt Gox was hacked in February 2014 and lost $460M from thousands of investors.
In September 2017, Japan decided to regulate the exchanges and cleared 11 companies as registered operators of crypto exchanges. China decided otherwise and ordered all of the domestic exchanges to close by the 15th of the same month.
In the US, the largest exchange is Gdax, which is owned by Coinbase. Recently, Coinbase has been hit by a class action suit for leaking the announcement they were going to allow Bitcoin Cash to be purchased on Coinbase to a group of investors. Gdax made a real effort to show they were compliant with a home made set of rules by publishing a white paper on how they select altcoins to be traded on Gdax.
This effort was met with no resistance from regulators at the time. However, it is a demonstration of the defiance these so-called exchanges have against regulators by creating their own watered down set of rules. Next came the Bitcoin Cash insider job. Self-regulation does not work because there are no real-life consequences, such as criminal penalties.
So What Is Next for These “Exchanges”?
Clearly, the notice will be ignored by most exchanges that are located in the United States or operating in other countries while allowing U.S. persons to use their service. Companies ignored the SEC while selling utility tokens through Initial Coin Offerings and now probably regret it.
The all-powerful SEC has not been able to influence the world of operators of unregistered exchanges with published bulletins. Recently, the SEC issued 80+ subpoenas to a large number of companies who issued utility tokens, promoters who helped sell them and professionals who helped structure them. Will this be the same for exchanges? If history holds any lessons, the answer is a resounding YES.
ICO 2.0 and ATS
The SEC has clearly told companies who want to provide trading services to investors to register their trading system as an exchange or use an exemption such as an Alternative Trading System (ATS). Many industry leaders have been talking about this for some time, and now conferences such as StartEngine’s ICO 2.0 Spring Summit are dedicated to discussing crypto marketplaces through the lens of regulation and the path to liquidity for security tokens. However, registering an exchange can take many years, and frankly, there are only 20+ in the entire country. On the other hand, building an ATS is attainable in a short time by registering the company as a broker dealer and then applying for an ATS with the SEC.
This is clearly the future of trading. Today, tZERO (a StartEngine customer), which operates an ATS, has announced they raised over $100M with their ICO. Others have also announced they are working on an ATS that will trade crypto; however, none are live today. This gap is serious because should the SEC shut down most of the U.S. based exchanges, investors will have no place to trade their coins. Some coins such as Bitcoin may be not viewed as securities, but rather as rather a commodity, as the CFTC has proclaimed. This may allow investors to continue to trade Bitcoin, but the vast majority of coins will not have this benefit until 2.0 trading marketplaces launch.