Decentralized Finance: Regulating Cryptocurrency Exchanges

Global financial markets are in the midst of a transformative movement. The creation of Bitcoin and Facebook’s proposed distribution of Diem mark a watershed moment in the evolution of the financial markets ecosystem. Purportedly, peer-to-peer distributed digital ledger technology eliminates legacy financial market intermediaries such as investment banks, depository banks, exchanges, clearinghouses, and broker-dealers. Yet careful examination reveals that cryptocurrency issuers and the firms that offer secondary market cryptocurrency trading services have not quite lived up to their promise. Notwithstanding cryptoenthusiasts’ calls for disintermediation, evidence reveals that platforms that facilitate cryptocurrency trading frequently employ the long-adopted intermediation practices of their traditional counterparts. In fact, when emerging technologies fail, cryptocoin and token trading platforms partner with and rely on traditional financial services firms. As a result, these platforms face many of the risk-management threats that have plagued conventional financial institutions as well as a host of underexplored threats. Automated or algorithmic trading strategies, accelerated high frequency trading tactics, and sophisticated Ocean’s Eleven-style cyberheists leave crypto-investors vulnerable to predatory practices. Early responses to fraud, misconduct, and manipulation emphasize intervention when originators first distribute cryptocurrencies— the initial coin offerings. This Article rejects the dominant regulatory narrative that prioritizes oversight of primary market transactions. Instead, this Article proposes that regulators introduce formal registration obligations for cryptocurrency intermediaries—the exchange platforms that provide a marketplace for secondary market trading. This approach recognizes the dynamic nature of cryptocurrency secondary market actors seeking to achieve disintermediation yet balances the potential benefits of trading intermediaries with normative regulatory goals—protecting investors from fraud, theft, misconduct, and manipulation; enforcing accountability; preserving market integrity; and addressing enterprise and systemic risk-management concerns