New York Attorney General Releases Report on Market Practices of Virtual Asset Trading Platforms

As part of its Virtual Markets Integrity Initiative (the “Initiative”), the New York State Office of the Attorney General (the “NY AG”) recently released the Virtual Markets Integrity Report (the “Report”). The Report aggregates the voluntary responses of nine major cryptocurrency trading platforms to a questionnaire the NY AG prepared in an attempt to better understand how to protect investors and safeguard the fairness and integrity of the virtual marketplace. Some cryptocurrency platforms contacted by the NY AG chose not to participate in the Initiative.

Here are some key takeaways of the Report:

  1. Virtual asset trading platforms differ in how they verify and monitor authorized access. Most virtual asset trading platforms claim to only allow customers from authorized jurisdictions to access their venues and exclude customers who violate their policies, including those related to market manipulation and money laundering. Although the Report notes that most participating platforms monitor access by IP address, only two of the nine respondents purported to limit VPN access, raising potential questions about the ability of the other trading platforms to restrict access to authorized users. 
  1. Fee structure and the degree of fee disclosure vary between platforms. While some platforms charge the same fee for “makers” and “takers” of liquidity, several others revealed that they charge higher fees for takers than makers. Most reporting platforms also charge fees for deposits and withdrawals of funds, which increases the cost of shifting capital to and from individual platforms and creates a disincentive for customers to switch. Interestingly, almost all respondents offer discounts to high-volume customers, and five platforms indicated that certain traders may receive preferential pricing according to the terms of bilateral agreements that are hidden from public fee schedules. The NY AG cautioned that customers should carefully review and understand the complete fee schedule provided by a platform prior to trading. However, they should also acknowledge that it may not present the entirety of the transaction costs for which they will be responsible. 
  1. Most platforms integrate special features that may preference professional traders. Apart from typical “buy” and “sell” orders, many of the participating platforms offer a variety of different order types such as “fill-or-kill” or “immediate-or-cancel.” These special order types disproportionately advantage professional traders using algorithmic strategies, which automatically submit or cancel orders in response to market signals not visible and possibly unavailable to regular traders. Another feature that tends to favour sophisticated traders is the ability to “co-locate” their terminals directly with the platform’s computers in a data center. Colocation provides a faster view of the platform order book than is available to retail customers. Moreover, though every participating platform allows automated trading, only a few have formal policies in place to oversee and prevent potentially abusive automated strategies. In turn, the NY AG also cautioned that users should be aware that virtual asset trading platforms have attributes that can distort the overall trading environment to the detriment of retail customers. 
  1. Managing potential conflicts of interest remains a challenge in the virtual marketplace. The NY AG found that platforms participate in several practices that put their own interests in tension with the interests of customers. For example, the survey data revealed that platforms’ determinations of whether to list a given virtual asset were largely subjective, and no platform articulated a consistent methodology used to determine whether and why it would list a virtual asset. Further, there is a lack of transparency with respect to whether platforms receive compensation for listing a virtual currency, which inhibits customers’ ability to evaluate a platform’s incentives in offering or promoting a given asset. A potential conflict of interest is also posed by the finding that platforms have a range of different policies as to whether and how platform owners and employees are permitted to trade on their platform or on other platforms. Finally, some platforms disclosed that proprietary trading accounts for almost 20% of executed volume. Such high levels of proprietary trading introduces the risk that the availability of liquidity in certain assets could change without notice, including during periods of market volatility or rapid price movements. Similarly, platforms trading on their own venues may have informational and other advantages over the average trader. In sum, market participants should recognize the possibility of numerous conflicts of interest when using virtual asset trading platforms. 
  1. Security and protection of customer funds are priorities for virtual trading platforms. Given the vulnerability of virtual assets stored on trading platforms relative to traditional securities, few issues are of greater importance to customers of virtual asset trading platforms than the security of the funds entrusted to them. All responding platforms reported to offer two-factor authentication for users, with most using this enhanced security measure as a default option. Along the same lines, most participating platforms purported to keep a high percentage of virtual currency in their possession in “cold storage,” which keeps private keys to virtual currency offline. Most of the respondents also disclosed that they had hired independent security consultants to conduct penetration testing and bolster their security systems. Although the Report indicates reasons for optimism about the security of trading platforms, the NY AG cautioned that customers should understand that there is still a lack of uniformity in auditing standards and that the market for insurance in connection with virtual currencies is underdeveloped.
  1. Most virtual trading platforms prohibit withdrawals during suspensions and outages, and information on the frequency of disruptions can be difficult to obtain. According to the Report, depending on the reason for a trading suspension or outage, some platforms may cancel pending trades and most platforms preclude customers from withdrawing funds during such disturbances. Consequently, the NY AG advises that customers should assume that they will not have the ability to trade or withdraw their fiat or virtual assets during trading stoppages. Additionally, despite almost every responding platform indicating that it informs customers in the event of a trading suspension or outage, only four of the nine respondents published a history of prior occurrences. The Report affirms that the accessibility of this information is crucial for customers seeking to assess the historical stability, reliability and transparency of a trading platform.

In aggregating disclosure from some of the most prominent virtual asset trading platforms, the Report provides a helpful overview of current operating procedures. Furthermore, it can also serve as a valuable resource for Canadian cryptocurrency trading platforms and their users, highlighting suggested best practices and important considerations in a rapidly expanding market.

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