Exchanges are largely underestimated for their power over the world's -- purportedly -- decentralized cryptocurrency markets.
The majority of cryptocurrency volume is derived from retail traders using centralized exchanges, and these platforms are the very reason that eager hordes of investors pushed prices higher in late 2017.
However, if exchanges didn't exist and had never provided a portal where prospective participants could skip the rigors of cryptocurrency mining, or enter the market with fiat, cryptocurrency would remain the purvey of a small community of IT professionals exclusively.
The compromise is clear: Centralized exchanges that mimic standard trading platforms are the impetus for crypto's returns but simultaneously sacrifice its original vision.
Traders have made their peace with this fact, but regulators are another story. For a long time, exchanges existed in the shadow of looming regulations. However, authorities traditionally have been uncertain about how to classify cryptocurrencies and didn't want to risk establishing rules that discourage innovation.
These changing tides are evidenced in the settlement between the Securities and Exchange Commission and EtherDelta founder Zachary Coburn. Coburn recently agreed to pay more than $380,000 to the SEC for operating an unregistered securities exchange, even though he had left EtherDelta a year earlier. Coburn should have known that he might be a target, especially given comments from the SEC earlier in the year regarding how the agency intended to define ERC20 tokens - the only assets listed on his exchange.
EtherDelta didn't discriminate in terms of the tokens it listed, which was the impetus for the SEC's intervention. In June 2018, SEC Chairman Jay Clayton was the first to say that currencies mimicking fiat money such as bitcoin and Ethereum are not securities, and that other tokens that act as digital assets are securities.
The SEC's adverse moves against EtherDelta are a shot across the bow of the entire industry. But does this mean it's all over? Unlikely.
Investor Appetite for Crypto Hasn't Waned
The regulatory landscape has always been bleak for bitcoin enthusiasts and activists, and the average trader now has an extremely high tolerance for "FUD" -- fear, uncertainty, and doubt. Even though volatility has drastically decreased since the beginning of 2018, 24-hour volume remains steady at around $18 billion, and has plateaued since April.
As an asset class with extreme sensitivity to social media and news, it's also prudent to look at searches for cryptocurrency-related terms on Google.
Uncannily, Google Trends' chart mirrors the price of the cryptocurrency market well, and so it's a good sign that searches for the word "crypto" have held strong during the second half of this year. A large part of the inextinguishable enthusiasm for cryptocurrency is that technical trends have indicated the market is forming a possible bottom.
Other cryptocurrency market staples such as Stellar Lumens, Ethereum, and EOS have also steadied to a large degree, leading many to believe that consolidation is over. This raises the possibility of a sharp shakeout dip before a bullish breakout commences, mirroring past spikes higher.
There Are More Cryptocurrency Exchanges Than Ever
The number of cryptocurrency exchanges being launched is also indicative of their indifference to SEC posturing.
Hundreds of new entrants like Liquid, BitForex, and HotBit plow ahead even though they now know the barriers to entry have grown taller, as well as many decentralized exchanges. It helps that examples like EtherDelta are easily avoidable: If you provide a market for digital assets, simply register with the SEC or proceed with an exemption by consulting with the SEC, anyway. That EtherDelta was decentralized also tells new exchanges something else: it doesn't matter if the exchange is run like a centralized company or as a peer-to-peer network. The creator can always be held accountable.
As cryptocurrency services become more common, it's also apparent that running an exchange is an extremely profitable venture. Overheads associated with blockchain are substantially less when compared with traditional asset trading venues, and customers from around the world can be readily served. An enterprising individual could even start an exchange based in Malta, Japan, or another crypto-friendly jurisdiction from abroad. However, if they serve US-based customers, they will likely encounter the ire of the SEC.
However, look at the settlement reached by EtherDelta's Coburn and the SEC. At just $388,000 in penalties, he walked away remarkably easy, especially when considering that the world's wealthiest crypto enthusiasts are now exchange owners and not talented -- or timely -- investors. So far, modest penalties for bad actors signals to other ambitious founders that a slap on the wrist is all that awaits should they slip up and list a security or provide services to American traders without proper licensing.
Unregulated exchanges are a financial threat to traders everywhere, and though a familiarity with cryptography and tech-savviness are enough for most to avoid risk, sometimes it just isn't possible. But why are unregulated exchanges so risky?
Their regulated counterparts are required to maintain proper trading conditions and employ tools such as circuit breakers to prevent flash price crashes. A flash crash is when liquidity suddenly vanishes, and it happened earlier this year on GDAX when Ethereum dropped from $320 to 10c cents (and then back up) in mere seconds.
Unregulated exchanges also unwittingly permit spoofing, coordinated pump-and-dump schemes, and painting the tape without abandon. Market manipulation is a crime, but without a regulator to enforce it, users have no recourse should their capital be comprised. In addition to popular methods like 2-factor authentication, experts have some other advice on how crypto investors can protect their portfolios. Further, one exchange operator, Amir Bandeali, chief technology officer and founder of decentralized exchange 0x, advised that "if you must use a centralized exchange, withdraw often, and store your tokens on a hardware wallet, which is a hardware device that creates transactions without connecting through the internet."
According to security expert Joseph Steinberg, it is a common best practice to "back up all items related to your cryptocurrency (cryptocurrency, PIN, Private Key, and/or seed) and store them encrypted, in safe places. You'd ideally keep half of each in one location and half in another, both in safe deposit boxes or waterproof and fireproof safes."
Clearly, while picking a regulated and safe exchange is vital, cryptocurrency traders are still largely on their own when it comes to protecting their funds. However, the SEC's recent enforcement efforts present good news for this exact reason. As cryptocurrency is normalized and integrated within the financial status quo, quality standards that equity traders have come to expect, for instance, will also be enjoyed by crypto traders as well. This is what the goal has been all along.
The author holds stock in investment holding company, Leucadia, and is a partner in an emerging technology marketing firm, Notability Partners. He holds no positions in cryptocurrencies nor in any companies that invest in them.