Crypto-Trading Platforms as Exchanges

The past few years have been intense for crypto-market infrastructures. The FTX scandal proved to be a profoundly challenging event for the crypto ecosystem, culminating in the conviction of Sam Bankman-Fried and his associates. On the enforcement front, the US Securities and Exchange Commission (SEC) took action against Binance and Coinbase in 2023, while the European Union moved to regulate crypto-asset service providers—including crypto-trading platforms—through the Markets in Crypto-Assets Regulation (MiCA). This regulation has spurred additional regulatory initiatives to support its implementation and to define technical standards. Simultaneously, International Organization of Securities Commissions (IOSCO) has actively contributed to the discussion, publishing significant public consultations following an important report released in 2020.

In my recently published article ‘Crypto-Trading Platforms as Exchanges’ (Michigan State Law Review), I examine the business model of crypto-trading platforms. I provide a conceptual and empirical analysis of the platforms and their activities, identify and document the causes of their concentration of functions, and illustrate how such concentration poses risks to investors and the financial system. I also propose regulating crypto-trading platforms as exchanges, examining the transformation of trading venues, from public stock exchanges to fragmented private marketplaces, and providing context for the rise of crypto-trading platforms as part of this broader transformation. Stock exchanges have evolved gradually, leading to organizational, legal, and business changes. Technological advancements greatly contributed to market fragmentation, as they enabled multiple and varied competitors, including trading desks of large broker-dealer firms and alternative trading systems (ATSs), to compete with established stock exchanges. The business model of crypto-trading platforms is surprising when compared with that of traditional stock exchanges such as the New York Stock Exchange (NYSE) or the London Stock Exchange (LSE). Traditional stock exchanges have contributed to the growth of capitalism and the financial economy and remain important. Stock exchanges provide a marketplace where the demand and supply for stocks meet, and they contribute to market fairness, integrity, and transparency. Additionally, as self-regulatory organizations, stock exchanges play a role in regulating entities involved in this market.

My article demonstrates that crypto-trading platforms have shifted towards a full-service business model for the crypto-economy, changing the traditional market structure. They act as intermediaries, issuing their own stablecoins, offering custodial services, accepting deposits, making loans, and distributing risky financial instruments. This creates unprecedented conflicts of interest and systemic risks that have not been previously associated with traditional market structures.

The current business model of crypto-trading platforms and the resulting market structure have profound implications for financial law and policy. Because of vertical integration, crypto-trading platforms have become catalysts for financial interconnectedness within and even outside the crypto-economy, building bridges with crypto- and traditional financial institutions. This could make them the next too-big-to-fail financial conglomerates.

In light of this, I suggest limiting the services crypto-trading platforms could provide, which would lead to a shift in their business model. A reasonable separation of these activities and services would enhance investor protection while reducing systemic risks and addressing the challenges of technology-driven financial capitalism. Regulators could require crypto-trading platforms to focus solely on providing fair and transparent marketplaces and exclude any activity not functionally and structurally connected to their primary role. In this way, they would pursue separation between trading and lending and borrowing platforms and proprietary trading. The Celsius and Voyager market crashes show the perils of coupling trading and lending activities, while the failure of FTX clearly shows the dangers of proprietary trading, as seen with its affiliate, Alameda Research, which drove the company to ruin.

A fundamental question is whether crypto-trading platforms should issue their own stablecoins. Although issuing a stablecoin can lead to economies of scale, it can also pose a risk to investors, exposing them to manipulative practices, and to the financial system, by increasing interconnectedness. Binance is a noteworthy case. Starting from the end of September 2022, Binance began converting its customer’s holdings in three stablecoins into BUSD, its own stablecoin. This included all customer holdings of USD Coin (USDC)—the second-largest stablecoin with a market cap of $50 billion—Pax Dollar (USDP), with a market cap under $1 billion, and True USD (TUSD), with a market cap of $1 billion. BUSD became the world’s third-largest stablecoin, with a market cap of $20.5 billion. The business decision of a crypto exchange like Binance to leverage its market dominance to promote its own stablecoin raises questions about fairness and trust in stablecoins.

I also suggest strengthening international cooperation to prevent fragmentation of how crypto-trading platforms are regulated. The number of scandals and the magnitude of the crises in the crypto-economy suggest analogies to the financial crisis of 2008. At the time of the crisis, the G20 recognized the need to regulate derivative contracts and their market infrastructures, particularly clearinghouses, and urged securities and banking regulators to do so. The Dodd-Frank Act aimed to strengthen the financial system’s resilience and mitigate any systemic risk originating from this sector. Crypto-trading platforms require similar action. The IOSCO launched a Crypto-Asset Roadmap for 2022-2023 with two efforts, one focused on crypto and digital assets and the other on decentralized finance, or DeFi, both relating to crypto-asset trading, lending, and borrowing platforms, among other market participants. The success of this initiative will depend on the ability to involve the most reputable and influential market actors and national regulators, with the goal of creating robust best practices, appropriate regulation, and effective enforcement mechanisms.

A copy of the author’s article is available here.

Marco Dell’Erba is Professor of Law at the University of Zurich, Global Research Scholar at New York University School of Law, and Visiting Senior Fellow at the Program on Corporate Governance at Harvard Law School.