Discourage adoption? Balance between security and innovation in crypto

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The cryptocurrency space is moving so fast that there is a new trend every year: only a few years have passed from Initial Coin Offerings (ICOs) to non-fungible tokens (NFTs). In the face of such amazing innovations, crypto companies and regulators face a growing challenge: aligning security practices with new products and features.

The approach of some companies is to act quickly and innovate as soon as they become available, leaving security processes like Know Your Customer (KYC) and Anti-Money Laundering (AML) exams as a secondary objective. The popular cryptocurrency exchange Binance apparently used this strategy until this year when regulators started cracking down.

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Binance’s KYC guidelines allowed users who did not fully verify their identity to withdraw up to 2 BTC per day initially. The listed margin trading pairs with major fiat currencies allowed up to 125x leverage from their futures trading platform, but had to reduce the available leverage and remove margin trading pairs when they were reportedly by the Internal Revenue Service and the United States Department of Justice was investigated.

Since then, the exchange has followed a compliance-friendly approach to its business and implemented mandatory KYC processes for “global users, for every feature”. As a result of the move, it lost around 3% of its total number of users.

While Binance has been forced to remove some of its offerings and reduce leverage on its platform, other exchanges are still offering the same products to users. Speaking to Cointelegraph, Yuriy Kovalev, CEO of the crypto trading platform Zenfuse, noted that finding regulations that allow compliant companies to compete is a challenge:

“It’s difficult to find a way to balance investor protection regulations with innovation, especially in an environment where new financial offers appear every few months.”

Speaking to Cointelegraph, CEO of the Bittrex cryptocurrency exchange, Stephen Stonberg, pointed out that cryptocurrency regulations are now “quite complex” and are handled differently in different jurisdictions

Stonberg implied that customer safety should nonetheless remain a priority, as “more robust and clear regulation – as in the traditional financial sector – is needed to truly ensure that client assets and data are safe and secure”. As an example, Stonberg referred to the Liechtenstein Blockchain Act, which “offers much more security and clarity as to how an exchange has to accept new customers and protect a customer’s assets”.

Regulatory clarity is seen as a necessity by some industry players, as without it innovation may fall by the wayside. In a recent blog post, Nasdaq-listed crypto exchange Coinbase found that its plans to launch a loan program had been halted by the SEC, which threatened to sue it “without ever telling you” [them] why.”

Coinbase said it tried to “work productively with the SEC” but never received any clarification on the SEC’s reasoning or how it could modify the product to make it compliant. One suggested alternative was to leave regulators out of the picture. Commodity Futures Trading Commission (CFTC) Commissioner Brian Quintenz has advocated this alternative and at one point called for cryptocurrency exchanges to self-regulate, reflecting the opinion of many in the industry.

Is self-regulation a viable alternative?

The concept is not new: organizations like the Financial Industry Regulatory Authority (FINRA) have helped enforce security investor protection initiatives with brokers and broker-dealer firms. In Japan, a self-regulatory agency for the country’s crypto exchange sector, the Japanese Cryptocurrency Exchange Association (JCEA), has been established.

Stonberg doesn’t believe the answer lies in self-regulation as the “complex nature of this digital ecosystem makes regulation difficult”. For him, self-regulation would mean “winding up” all the hard work that has been done on the regulatory front for crypto and “re-complicating the regulatory environment and setting a blockade in motion”.

The pseudonymous founder of the Flare Network-based decentralized finance platform (DeFi) Flare Finance CryptoFrenchie told Cointelegraph that he believes in the “capabilities of decentralized platforms and centralized platforms to create a self-regulated environment that responds effectively to (or.” to surpass). Requirements of modern regulatory requirements. “

The founder of the DeFi project added that the current systems “have proven incapable of meeting the requirements of the current financial system,” adding:

“Applying the same systems to an even faster environment like crypto could prove overwhelming rather than supportive.”

CEX.IO founder and CEO Oleksandr Lutskevych suggested that self-regulation could be an option, saying that in the company’s experience, self-regulation is the answer “when there is a lack of an applicable regulatory framework”. Speaking to Cointelegraph about his company’s path, Lutskevych said:

“Until a framework for cryptocurrencies was formalized in certain countries, we followed a self-regulatory approach and implemented best practices from other leading financial organizations.”

Both centralized and decentralized cryptocurrency platforms should “aim to analyze their own systems and develop modules that are specifically tailored to the needs of current regulatory systems,” said CryptoFrenchie.

Are decentralized exchanges a threat?

While the debate about self-regulation has continued, another has developed about decentralized trading platforms and their impact on the market. Non-custody decentralized exchanges allow users to trade directly from their wallet, often without registering with an email address.

Some critics have argued that decentralized exchanges (DEXs) render the KYC and AML efforts of centralized platforms worthless as bad actors can conduct their illegal activities through these platforms. Others suggest that DEXs, even those that run through Decentralized Autonomous Organizations (DAOs), can improve their visibility to help blockchain sniffers and law enforcement agencies find illegal transactions.

For the Chief Investment Officer of the digital asset investment firm Arca Jeff Dorman, decentralized applications (DApps) and other projects can contribute to the security of the cryptocurrency space. Speaking to Cointelegraph, Dorman said the industry needs to set standards, adding:

“Companies and projects need to understand the importance of having transparency dashboards in place, and analysts across the industry need to roll up their sleeves and do the dirty work of bringing transparency to projects that aren’t doing it themselves.”

Bittrex’s Stonberg pointed out that “the best way to hide illegal activity is not cryptocurrencies, it’s old-fashioned money.” The CEO added that blockchain-based transactions “are more traceable than any other financial activity”.

Stonberg told Cointelegraph that he believes decentralized exchanges should develop AML and KYC guidelines that they can implement, but added that the industry “is still in the early stages to see how decentralized exchanges will perform” .

Lutskevych suggested that one day tools that can track the origin and history of crypto assets could be used in decentralized exchanges to keep illegal funds off their platforms. He stated that “basic information can be traced back to the blockchain”, although this data is “far removed from what the guidelines of the Financial Action Task Force require of a central exchange”. Lutskevych added:

“Decentralized mechanisms that can prevent funds of illegal origin (money laundering, ransomware, hack) from entering a DEX with an intelligent contract of a protocol are currently being investigated and developed.”

Lutskevych concluded that it is possible for decentralized platforms to leverage KYC and AML procedures to address regulatory concerns. He noted that implementing KYC on its own may not be enough to deter illegal activity and keep users safe.

Raj Badai, founder and CEO of DeFi and the traditional banking services bridge Scallop, told Cointelegraph that the growth of the decentralized financial industry is a challenge to regulation but suggested that a solution could be a “regulated blockchain”. Regarding products in development, Badai said:

“We can ensure that wallets on a blockchain are subjected to a KYC / KYB process. This means the account holder is identified and all funds in the chain can be traced – which ultimately creates an inhospitable environment for illegal activity and puts it off from the start. “

Basic crypto rights

Binance has apparently dealt with the issue recently by releasing so-called “Fundamental Rights for Crypto Users”. The exchange argued that everyone should “have access to financial instruments” that “enable greater economic independence”. It also noted that “responsible crypto platforms have a duty to protect users from bad actors” and implement KYC to “prevent financial crime”.

Commenting on Binance’s crypto rights push, Lutskevych suggested that the move would be an “advertising campaign” by a company that “has only recently started promoting these values,” making it more of a “marketing strategy” .

Through a website dedicated to the fundamental rights of crypto users, Binance called on industry leaders, regulators and policymakers to “shape the future of global finance together”. The exchange added that “it should be left to the policymakers of each nation and their voters to decide who should oversee the industry.”

Related: The Stablecoin Scourge: Regulatory reluctance can hinder adoption

Crypto, wrote Binance, belongs to everyone. While the exchange believes regulation is inevitable, any policymaker tasked with overseeing the space has a monumental task to perform, as keeping bad players at bay without stifling innovation has so far proven to be a challenge .

The strategy that cryptocurrency companies seem to be agreeing on is based on working with regulators to find solutions that won’t prevent users from gaining access to innovative digital currencies or services that have been created in their ecosystem. Regulatory lawsuits against large crypto firms seem to show that only one side likes to cooperate.