A brief history of exchange compliance


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Compliance and supervision will always be the sword of Damocles hanging on the head of the cryptocurrency exchange.

For many people, the story of cryptocurrency began with “the British Chancellor of the Exchequer considering a second attempt to relieve the banking crisis.” Although Bitcoin is the beginning, before “Satoshi Nakamoto” built this P2P form of encrypted digital currency, exchanges and the infrastructure surrounding the encrypted currency had already appeared on the market. From local area network, consumer Internet, to mobile APP and Web 3-with the changes of the times, generations of enterprising industry practitioners continue to explore faster and newer electronic methods to exchange value.

In the cryptocurrency industry, exchanges have always been a “special existence”. On the one hand, the exchange meets the needs of consumers to exchange cryptocurrencies and is a practical platform for acquiring, selling and custody of cryptocurrencies; on the other hand, cryptocurrency exchanges are more like a kind of creation around encryption protocols/projects. Products”, because almost all encrypted business models will eventually fall on the “transaction” itself.

More importantly, exchanges have become a mirror of compliance and security in the cryptocurrency industry today. Sometimes just by looking at the attitude of regulators towards cryptocurrency exchanges, you can sniff out a “risk signal”. In fact, a number of domestic exchanges represented by Huobi are constantly strengthening their compliance and security strategies, and have gradually become the front runners in this track.


Exchange “Prehistory of Compliance”

In 1996, Gold & Silver Reserve, Inc., which is engaged in the gold and silver reserve business, “on a whim”, launched an online product called “E-Gold”, the value of which is stored offline in the vault The physical gold support in China aims to make it easier for people to transfer gold to each other. This groundbreaking product quickly attracted a large number of investors. The Financial Times even called E-Gold in 1999 “the only electronic currency that has reached critical mass on the Internet.”

At first, E-Gold only provided the exchange service of physical gold and digital gold, but in 2000, Gold & Silver Reserve, Inc decided to redesign this electronic gold system and separate the issuance and settlement of E-Gold from trading activities. As a result, This transformation has led to the emergence of many electronic gold trading platforms that support E-Gold on the market, and users can therefore exchange between fiat currencies and E-Gold, including the Gold Age exchange established in 2002.

Perhaps it is because E-Gold opened up exposure to fiat currency exchange transactions, which eventually triggered a large number of illegal activities related to it in the market. In 2006, the US Federal Bureau of Investigation (FBI) raided Gold Age and accused the exchange of allegedly using E-Gold to assist in millions of dollars in money laundering activities.

In April 2007, the US government ordered the E-Gold administrator to lock/block 58 accounts owned and used by multiple exchanges, including The Bullion Exchange, AnyGoldNow, IceGold, GitGold, Denver Gold Exchange, GoldPouch Express, and Digital Gold Currency 1MDC, then asked G&SR (OmniPay owner) to liquidate all seized assets. A few weeks later, E-Gold was sued in four cases.

In July 2008, three directors of E-Gold were investigated by the prosecutor and finally pleaded guilty to two counts of “conspiracy to launder money” and “operating money transfer business without a license”.

In 2009, E-Gold closed.

However, the most noteworthy thing in the entire incident is actually the official statement issued by the FBI after this enforcement action. James E. Finch, then Assistant Director of the FBI Cyber ​​Enforcement Department, said: The emergence of new electronic money systems has increased. This eliminates the risks of criminals and potential terrorists using these systems to launder and transfer funds on a global scale, while at the same time circumventing the review of law enforcement agencies and bypassing banking regulations and reports. The FBI will continue to work closely with the Department of Justice, federal and international law enforcement partners to actively investigate and prosecute anyone and any organization that uses these systems to promote the dissemination of child pornography and support organized crime and other financial crimes.

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Is the above statement familiar? Yes, more than a decade has passed, and the regulatory attitude towards cryptocurrency and the compliance and security of cryptocurrency exchanges does not seem to have changed much, whether it is Mark Zuckerberg, who is trying to issue digital currency Libra, or recently BitMEX CEO Arthur Heathers, who was sued by the US Commodity Futures Trading Commission, needs to face these issues seriously and cautiously.

What’s “interesting” is that the story behind Gold Age is even more exciting. Although the founder of the exchange, Arthur Bukovsky Bellanchuk, encountered Waterloo on E-Gold, he soon created a new digital currency, Liberty Reserve, and banned it on PayPal. Bitcoin and legal currency exchange services are provided during the period after the Bitcoin transaction. In fact, Liberty Reserve is more like the prototype of the stable currency Tether (USDT), but this digital currency was also forced to close in 2013 due to regulatory compliance issues. Arthur Bukovsky Bellanchuk was eventually arrested in 2016 and sentenced to 20 years in prison. ——After reading this, do you have a feeling of a world away? Because similar stories are still happening at home and abroad today, aren’t they?

You may have discovered that E-Gold, the prototype of electronic currency, has set the tone for early cryptocurrency exchanges in many aspects, especially in terms of compliance and security, which are very similar to many issues followed by the current cryptocurrency industry, such as : Anti-money laundering, fraud prevention, and currency transfer permission, etc. Not only that, compliance and security issues have always been one of the main factors affecting market investment sentiment, and will also lead to increasingly tense relations between cryptocurrency/cryptocurrency exchanges and users. The industry becomes stronger and stronger, and this tension will gradually be amplified.


The Exchange “Modern History of Compliance”

According to the exchange definition standard, the world’s first cryptocurrency exchange should be BitcoinMarket.com. The exchange was founded by Bitcoin Talk member “dwdolla” and went live on March 17, 2010, and used PayPal as Bitcoin/fiat currency exchange means. However, due to compliance issues, there are more and more scammers on BitcoinMarket.com, which ultimately leads to PayPal’s inability to continue the partnership between the two parties.

In July 2010, Mt.Gox took the stage. The most controversial exchange in the history of cryptocurrency also went bankrupt due to compliance and security issues. It has not fulfilled the compensation plan so far (the latest news shows that the compensation plan submission date has been extended Until December 15, 2020). In contrast, Bitstamp, which was established in 2011, Coinbase, which was established in 2012, and Huobi, which was established in 2013, gradually gained a foothold in the market due to strict compliance and security requirements.

According to the latest data from CoinMarketCap, there are currently about 342 global cryptocurrency spot exchanges, 14 cryptocurrency derivatives exchanges, and 39 decentralized exchanges. If you compare the traditional stock market, you will find that there are not so many stock exchanges in the world. For example, China has only three stock exchanges: the Shanghai Stock Exchange, the Shenzhen Stock Exchange, and the New Third Board. The United States is the New York Stock Exchange and the Nasdaq. The three major exchanges of Starck and AMEX. This fact shows that the threshold of cryptocurrency exchanges is low, and there are very few exchanges that can truly meet the compliance and security requirements.

So, how are countries doing compliance restrictions and regulating cryptocurrency exchanges?

Regulators Of course, mainstream cryptocurrency exchanges have realized the seriousness of compliance and regulatory issues, and have begun to try to change this situation, seeking to embrace supervision and actively engage in compliance. The following table shows some of the mainstream cryptocurrency exchanges Compliance measures:

Regulatory Authority

It should be noted that compared with overseas compliant exchanges, domestic exchanges represented by Huobi are not weak in compliance and security. For example, Huobi recently completed the year’s largest anti-money laundering risk control strategy upgrade. The new rules added a time-limited withdrawal strategy and further refined the measures for handling high-risk behaviors, covering logins, transfers, currency transactions, Scenarios such as deposit and withdrawal, data on the chain; later, Huobi launched the “Fraud Prevention” knowledge area on the APP homepage, which introduced in detail investment fraud, fraud by impersonating friends, off-platform transaction fraud, counterfeit currency fraud and other fraud methods to help investors Practice anti-fraud “eyes”.

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It is worth noting that Huobi launched the “Technology Police Channel” as early as the beginning of 2019, and has carried out relevant exchanges and cooperation with the police in many places including Putian, Fujian, Changsha, Hunan, Luoyang, Henan, etc., using self-developed on-chain asset flow. Monitoring and tracking system-the “horoscope system” provides important data and powerful technical support for judicial authorities in the data analysis, evidence collection, and fund tracking of blockchain fraud, money laundering and other cases. It has also received thank-you letters from police in many places.

At present, Huobi “Astrology System” maintains a huge address library, which contains tens of millions of tags and tens of thousands of blacklisted addresses. These address libraries will be automatically updated and expanded to help Huobi detect malicious attacks more effectively. Accounts can even detect dark web transactions in many complex transactions, realizing the functions of active tracking and monitoring of the asset flow on the chain and event correlation analysis, and actively tracking and inflowing suspicious or malicious, dark web, mixed currency services and other risky assets The platform automatically handles and analyzes horizontal attacks, and fully connects with relevant regulatory authorities.


The Exchange’s “Future History of Compliance”

Both the commodity market and the securities market have experienced a barbaric era of no regulation and no compliance. After that, they began to gradually establish regulatory compliance standards and finally formed a standardized and complete regulatory compliance system. Take U.S. stocks as an example. It took 200 years for U.S. stocks to grow from barbarism to rational prosperity, creating the most prosperous financial secondary market in human history so far. Supervision and compliance are the firm main themes of its development, and laws and regulations at all levels have been organized. A comprehensive compliance ecology.

The same is true for the cryptocurrency industry. As digital assets gradually move toward the mainstream and attract regulatory attention, many cryptocurrency exchanges have found that compliance is the only way for future business development, so they have put compliance work on an important agenda.

Of course, there are also big differences between cryptocurrency exchanges. For example, the top exchanges are relatively conservative and usually do not and are not willing to take too many risks; while the new exchanges are slightly more aggressive, and they are listed quickly in order to attract traffic. , Once the market environment changes, the currency will be released to survive. Therefore, the compliance measures taken by different cryptocurrency exchanges are not the same. After the exchange industry leaders like Huobi moved their trading business overseas, they began to focus on the domestic layout of blockchain-related businesses and cooperate with major exchanges. Universities, listed companies, state-owned enterprises, and government departments have signed strategic cooperation agreements to better adapt to the mainstream regulatory compliance environment by actively integrating into the mainstream economic system.

On the other hand, as the business iteration of cryptocurrency exchanges accelerates, risk control and compliance issues are gradually increasing. Taking the decentralized exchanges that emerged in 2020 as an example, some people in the crypto community have a fluke mentality and believe that decentralized exchanges will not be subject to regulatory compliance constraints, but this is not the case. As early as 2018, the United States Securities and Exchange Commission’s cyber enforcement agency has clearly pointed out that, even though there is no centralized operation or management for any exchange created using blockchain technology, the founder of the exchange still has to take responsibility. Rober Cohen, who was the head of the U.S. Securities and Exchange Commission’s Cyber ​​Enforcement Department at the time, said that using blockchain to create an exchange without a central service does not exempt the original creator from the responsibility. The point is not what label you put on or what you use. What technology, the focus is on the function and what the platform is doing, regardless of whether it is decentralized or not, whether it is just a smart contract, the important thing is that this is an exchange.

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For now, the global regulatory system of the crypto asset industry has become increasingly clear. Although the current regulatory policies of various countries are different, in order not to stifle financial innovation, basic regulatory systems including traditional license plates, sandbox supervision and industry self-discipline have been formed. Dynamic comprehensive supervision system. At this stage, the countries that have issued relevant licenses to digital currency exchanges are mainly Japan, the United States, Switzerland, Thailand, Canada, the Philippines, etc. The issuance of licenses is used to bring exchanges into supervision, and in general, it is also for better protection Investors, ensure the healthy development of the encryption market, and promote the existence of digital assets in compliance with the domestic legal framework.

Judging from the compliance restraints implemented by regulatory agencies for cryptocurrency exchanges, the future “licensing” of compliance may be a major trend in the future. Recently, Li Lin, the founder of Huobi Group, pointed out in his internal letter that Huobi has always aspired to become a pioneer in the Internet of Value era and become the world’s leading digital financial service provider. Globalization, compliance, specialization and diversification have always been It is the core strategy of Huobi in recent years. Today, the company has relevant digital financial business licenses in the United States, Japan, many European countries, Hong Kong, Thailand and other countries and regions. At the same time, some new businesses and licenses are being planned and applied.

It can be seen from Huobi’s strategy that cryptocurrency exchanges are actually very willing, and even actively cooperate with regulatory and law enforcement agencies to help combat illegal behavior in the industry, and make more efforts in anti-money laundering, such as Coinbase, Huobi, The compliance supervision work done by Kraken and other top exchanges in KYC and AML may be more stringent than some traditional small and medium banks.


to sum up

Compliance and supervision are of great significance to the long-term sustainable development of cryptocurrency exchanges. The current compliance gap in the crypto market still exists-and this is actually the driving force that major exchanges need to continuously optimize and improve. Any innovative products and services need to be built under regulatory compliance conditions.

Some exchanges may think that compliance and security require a lot of costs, which may eventually lead to more input than output, and the gains outweigh the losses. This idea is not unreasonable, but the cryptocurrency industry is solving this problem in its own way: you will find that most of the large cryptocurrency exchanges such as Coinbase and Huobi are currently exploring compliance and regulatory methods. The head exchange has explored a path in this field, and small and medium exchanges can “copy” the way to success.

On the other hand, the early investment of cryptocurrency exchanges in compliance supervision can save a lot of time and money in the long run. For example, encryption projects such as Telegram, EOS, and KIK were caught in lawsuits with regulatory agencies due to compliance issues in the later stages of development. Some had to pay huge compensation to reach a settlement, while others took too long to cause the project. stranded. Therefore, for cryptocurrency exchanges, the sooner they pay attention to compliance and regulatory issues, the more they will be guaranteed and the return on investment will be greater.

In general, the compliance and supervision of cryptocurrency exchanges are developing in a positive direction. As the so-called Tibetan is famous for its people, as some leading exchanges gradually figure out “the way of compliance” and become a model in the industry, it is bound to promote the prosperity of the entire encryption industry.