The rampant growth of trading platforms has caused significant harm to investors in various countries, severely disrupting market order, and there is an urgent need to establish comprehensive regulatory policies.
Written by: Deng Jianpeng, Professor at the Law School of Central University of Finance and Economics, Doctoral Supervisor, Director of the Financial Technology Legal Research Center; Li Chengyu, Doctoral Student at the Law School of Central University of Finance and Economics.
This article is published in the 6th issue of "Comparative Economic and Social Systems" in 2024.
Abstract: Cryptocurrency trading platforms are centers of financial risk accumulation and are the main venues for money laundering and fraud crimes. The rampant growth of trading platforms has caused significant harm to investors in various countries, severely disrupting market order, and there is an urgent need to establish comprehensive regulatory policies. Comparative research shows that the United States has established a relatively comprehensive regulatory mechanism at both federal and state government levels, actively preventing five major risks: hacking, money laundering, platform fraud, insider trading, and market manipulation, achieving effective law enforcement in the fields of securities, commodity futures, and payments. Reflecting on the experiences and shortcomings of the United States, Chinese regulators can establish a platform registration system to strengthen platform information disclosure, emphasize the platform's anti-money laundering regulatory obligations and fund security obligations, implement financial rectification work, reference and adjust existing regulatory approaches, and achieve the goal of maintaining financial market security while protecting investors' legitimate rights and interests.
Keywords: Cryptocurrency trading platforms, U.S. Securities and Exchange Commission, financial risk, financial regulation, blockchain finance
I. Introduction
Cryptocurrencies, represented by Bitcoin, are the key point of the combination of blockchain technology and finance, existing in the financial market in a non-physical digital form, also known as "virtual currency" or "crypto assets." Many investors have rushed into the market due to the wealth effect of cryptocurrencies, rapidly expanding the market size and giving rise to centralized platforms that provide trading services for cryptocurrencies. Most leading trading platforms (such as Coinbase, Binance, and OKEx) establish platform rules, maintain market order, and are responsible for price discovery, order matching, and settlement custody services. Trading platforms often exceed the scope of "intermediaries," integrating market regulators, participants, and service providers.
The complexity of platform operations and the overlap of different risks within the same entity make them the core of risks in the crypto market. The mixing of various functions can easily lead to self-dealing by trading platforms, which may not only fail to maintain market order but also harm investors' rights while seeking huge profits. From a global perspective, the lack of public power regulation and security vulnerabilities in platforms increase the risks of trading platforms and exacerbate market turmoil. In November 2022, FTX, once hailed as "the second-largest trading platform in the world," fell from grace due to misappropriation of customer funds and market manipulation, leaving over a million users unable to withdraw their funds, with nearly $1.8 billion in assets evaporated, and many platform shareholders and blockchain gaming project companies were implicated, with losses reaching over $100 million. This risk event triggered a major shock in the industry, prompting governments in multiple countries to once again be vigilant about trading platform risks and gradually recognize that trading platforms are the storm center that cannot be ignored.
In response to financial risks related to cryptocurrencies, since 2013, the People's Bank of China has continuously tightened regulatory policies, clearly defining the "red lines" involving cryptocurrency trading and illegal financial activities. In September 2017, the People's Bank of China and seven other ministries jointly issued a notice on preventing risks from token issuance financing, prohibiting ICO-style financing activities and the establishment of cryptocurrency trading platforms. In September 2021, the People's Bank of China and ten ministries issued a notice on further preventing and addressing risks from virtual currency trading speculation, reiterating the above regulations and prohibiting criminal activities that may involve money laundering, illegal operations, and financial fraud related to cryptocurrencies. After strict rectification, a confusing phenomenon emerged in practice: theoretically, there are no cryptocurrency trading platforms in China, but in recent years, public security agencies have discovered frequent occurrences of domestic cryptocurrency trading and related crimes. In 2021, China cracked 259 related cases, seizing cryptocurrencies worth over 11 billion RMB. In December 2022, Chinese police arrested a money laundering gang that used online blockchain to exchange digital cryptocurrencies, with the gang's money laundering amount reaching as high as 12 billion RMB. These signs indicate that "prohibition-type" regulatory policies can manage domestic platform risks in the short term but have not completely extinguished the domestic "speculation frenzy" (Deng Jianpeng, Ma Wenjie, 2022), and underground trading platforms continue to secretly provide cryptocurrency trading services. Furthermore, although restricted from establishing trading-related websites domestically, platforms have moved overseas to continue serving Chinese citizens, and "prohibition-type" regulatory policies have played a "displacement" role, failing to stop the globalization of platform risks. The effects of sporadic financial rectification efforts are prone to rebound, trapping China in a cycle of governance and chaos (Tang Shiya, 2022). Therefore, in the current predicament of limited regulatory effectiveness, the risk management of trading platforms remains an important task for Chinese regulators, and how to achieve effective regulation is also a key issue that scholars urgently need to study.
From my observation, in recent years, only a few scholars have focused on the issue of trading platform regulation. Some researchers have summarized the main risks of platforms as automated trading risks, high-frequency trading risks, network risks, systemic risks (Johnson, 2021), and proposed that trading platforms should conduct self-regulation under government guidance, formulating regulatory rules for basic business of intermediary institutions, investor protection on the funding side, and information disclosure on the asset side (Zhang Chao, 2020). Although the above research is quite enlightening, some regulatory suggestions are not very operable and cannot comprehensively address the risks present in platforms, and the depth and breadth of research need to be improved. Currently, mainstream research related to cryptocurrencies mainly explores their legal attributes, securities regulation, and anti-money laundering crimes (Zhao Ying, 2021). Although some scholars point out that trading platforms are an important lever for cryptocurrency regulation (Wang Yanchuan, 2020), platforms are involved in insider trading, pyramid schemes, and illegal fundraising (Ma Yongqiang, 2022). Chinese regulators can draw on foreign experiences, using U.S. regulatory experience as a model to establish a strict market access system (Zhang Tianxing, 2019) and require platforms to fulfill anti-money laundering obligations (Li Min, 2022). However, most studies merely point out that platforms are highly risky without specifically analyzing the concrete content of those risks. Some scholars focus on sorting out the regulatory experiences in the U.S. securities and money laundering fields (Zhao Binghao, 2020; Johnson, 2020), but most lean towards introductory research, with only a few scholars noting the defects of U.S. regulation, such as rule uncertainty and overlapping jurisdiction (Goforth, 2021). Most studies have not meticulously examined and reflected on foreign regulatory experiences, and the proposed regulatory countermeasures are too abstract and lack specificity. Therefore, this article will deepen the analysis of trading platform risks, combining practical cases to elucidate the causes of various risks and enhance understanding of platform risks. Additionally, this article will conduct an in-depth analysis of the U.S. regulatory system for trading platforms, focusing on the actual quality and effectiveness of U.S. regulation, experiences, and lessons, and propose more feasible and specific regulatory suggestions.
This article intends to focus on U.S. regulatory experience, as the U.S. has better regulation in the cryptocurrency field (Eakeley et al., 2020). In addition to having relatively complete regulatory rules, the enforcement intensity is also higher than in other financial centers (Jackson, 2007). Its years of trial and error in regulation contain important insights and lessons, becoming a model for other countries to learn from or reflect upon. In 2022, the U.S. ranked third globally in cryptocurrency trading volume for the entire year, being an important market with a huge economic scale and high risk concentration. For China, which also has a large market scale, the U.S. is more suitable as a research and reference object compared to other countries. Since the risks of centralized platforms are the most concentrated, this study focuses on such platforms, and decentralized platforms will not be discussed for now. The remaining parts of the article are arranged as follows: the second part discusses the risks of cryptocurrency trading platforms, the third part summarizes the U.S. regulatory experience for trading platforms, and the fourth part reflects on the experiences and shortcomings of the U.S. to propose effective regulatory suggestions.
II. Risk Analysis of Trading Platforms
Cryptocurrency trading platforms can be divided into various roles such as exchanges, brokers, and custodial wallet providers based on their functions, and trading activities also span from the payment field to investment and financing. Trading platforms often face multiple risk resonances, which can bring profound and broad risk fluctuations to the crypto market. Based on years of assessment of risk instances in this field, I believe that among the many risks, the common and significant risks mainly include: hacking and theft risk, money laundering crime risk, fraud risk, insider trading and market manipulation risk, and user fund misappropriation risk.
(1) Hacking and Theft Risk
Hacking and theft of cryptocurrencies are among the most significant risks for platforms, having a large impact on investors and a wide reach, with great uncertainty. According to statistics, since 2012, at least 47 trading platforms worldwide have suffered major hacking attacks, with a total stolen amount of nearly $2.72 billion. Most platforms have failed to fully recover stolen assets over several years, causing irreparable losses to users. The most famous incident was the 2014 hacking of the Japanese exchange Mt.Gox, which accounted for 70% of global Bitcoin trading volume at the time. The exchange claimed that 100,000 Bitcoins from the platform and 750,000 Bitcoins from users were stolen, leaving many investors unable to withdraw their funds, resulting in significant financial losses. Researchers argue that platform wallets are highly attractive to hackers and have become common "system failure points" (Johnson, 2021). Therefore, an effective preventive measure should be for trading platforms to actively set up defense tools and regularly check for technical vulnerabilities to ensure the security of platform custodial wallets. However, some scholars point out that many trading platforms, including Mt.Gox and Poloniex, have security vulnerabilities (Johnson, 2021), leaving opportunities for hackers. Various oversights and inadequate prevention have kept trading platforms exposed to risk, putting investors' funds directly at risk of theft by hackers.
(2) Money Laundering Crime Risk
Cryptocurrencies inherently possess characteristics of decentralization and quasi-anonymity, often being used as primary tools for money laundering. Therefore, trading platforms should be the focus of anti-money laundering efforts. However, many platforms have failed to maintain sufficient anti-money laundering responses, lacking experience or unwilling to invest energy and costs in the anti-money laundering processes of the platform (Comolli & Korver, 2021). The core content of anti-money laundering includes platforms fully understanding customer information (commonly referred to as "KYC"), retaining customer and transaction information, and providing anti-money laundering reports to financial regulatory agencies. Taking Binance and Huobi as examples, a detailed examination of their anti-money laundering rules reveals that both platforms only set up simple identity verification processes and do not conduct stricter due diligence on customers with high money laundering risks, lacking dynamic monitoring of suspicious activities and regular reporting.
Oversights in the operational details of platforms may lead to the failure of global cryptocurrency anti-money laundering initiatives, exacerbating money laundering crimes and affecting normal trading for investors. Relevant research and litigation have proven that current trading platforms exhibit prominent money laundering risks. In October 2021, the National Bureau of Economic Research in the UK released a study indicating that among the cryptocurrency exchanges used by users of the largest dark web market in Eastern Europe, Hydramarket, the platforms with the highest traffic were Binance and Huobi, which researchers referred to as "non-KYC" entities and major gateways for gray activities such as money laundering. In September 2020, the well-known Japanese trading platform Fisco pointed out in litigation that hackers from Zaif, after stealing funds from the Fisco platform, transferred the stolen money to wallet addresses controlled by Binance, suggesting that the hackers were attempting to launder money through the Binance trading platform. Additionally, in recent years, Chinese judicial authorities have repeatedly discovered criminal gangs relying on well-known platforms to launder or transfer criminal proceeds, turning the platforms into major money laundering venues.
(3) Fraud Risk
Fraud is rampant in cryptocurrency trading, and trading platforms are often involved. Scholars believe that the design of online products that hides key information or uses special technical means to create cognitive biases in users, leading to irrational behavior, is widespread. This dark pattern and manipulation issues have become one of the focal points of regulatory scrutiny on online platforms (Li Qian, 2023). Specifically in the cryptocurrency field, on one hand, criminals set up trading platforms to defraud investors, falsely claiming high returns through promotions like "platform rebates" and "trading and advertising arbitrage," attracting investors to purchase cryptocurrencies or participate in activities on the platform. Once the trading platform holds sufficient funds, it quickly transfers them away, completing the fraud.
On the other hand, fraud risk also arises from fraudulent projects on the platform, where the platform itself is not involved in the fraud but intentionally or negligently lists high-risk projects, resulting in investors' funds being misappropriated by the project parties. For example, in April 2018, the U.S. Securities and Exchange Commission (SEC) pointed out that the Centra (CTR) project team fabricated false team information and was an unregistered fraudulent project, which had already been listed on Binance and OKEx before being identified as fraudulent, raising questions about the completeness of the token listing rules and review processes of leading platforms. The New York Attorney General's Office's "Virtual Market Integrity Initiative Report" noted that the decisions regarding token listings on platforms are often very subjective, and even when objective factors of the token project are considered, stable judgment criteria have not been established. Some scholars have found that the screening mechanisms of various platforms are not transparent, and some voting mechanisms for listing tokens lack effective security measures (Chang Ying, 2020). For instance, although Binance has published listing rules, it admits that there are "no established requirements" for project evaluations and does not emphasize the need for scrutiny regarding fraud or other illegal activities. Currently, the entire industry lacks a publicly transparent token listing mechanism, significantly weakening the effectiveness of fraud risk prevention.
(4) Insider Trading and Market Manipulation Risks
Trading platforms not only assume the supervisory and management functions of traditional securities exchanges but can also participate in market trading themselves or privately, creating a conflict of interest that facilitates profit-making through insider information for the platform and its employees. Such behavior has caused significant dissatisfaction among crypto investors, including Coinbase, which has been criticized by users for insider trading for years. In July 2022, the SEC formally filed a lawsuit, accusing a former product manager of the platform of obtaining over $1.1 million in illegal profits through long-term insider trading. This directly proves that insider trading risks severely disrupt market order, placing investors in an unfair trading environment.
Moreover, the crypto market also faces many manipulation risks, where platforms use large amounts of capital and fabricated information to create false trading conditions, manipulating the price fluctuations of cryptocurrencies. Some scholars have found that, on average, 70% of the trading volume reported by unregulated platforms consists of wash trading. In 2022, the well-known U.S. financial magazine Forbes published an article that comprehensively assessed 157 trading platforms globally using quantitative and qualitative analysis methods, finding that over half of the trading volume could be fake, with certain platforms having very few visitors yet fabricating huge trading volumes to create a false sense of business prosperity. Additionally, trading platforms often collude with others through "pump and dump" schemes to inflate coin prices and then sell off (Gazi, 2021), causing significant harm to investors.
Some scholars have pointed out that real, accurate, and timely information disclosure can increase trading transparency and reduce improper behavior by trading platforms (Johnson, 2021). However, most leading platforms have not established specific information disclosure rules, and the publicly available trading information only involves token sales data, community ecosystem overviews, official websites, and white papers, with few platforms providing timely dynamic updates on the later operational status of project parties or disclosing significant matters such as changes in project funding or personnel. The lack of a comprehensive information disclosure system across platforms exacerbates investors' information disadvantages, fostering insider trading and market manipulation.
(5) User Fund Misappropriation Risks
Trading platforms provide custodial wallet services for users to uniformly safeguard assets such as cryptocurrencies. Many platforms claim that they cannot misappropriate the assets stored in the platform wallets. However, as early as 2014, the former head of the Bitcoin trading platform Mt.Gox was accused by the Japanese prosecutor's office of transferring customer funds to other companies under his name, leading to a severe shortage of funds and the platform's collapse. In November 2022, FTX was accused of misappropriating user funds to invest in other affiliated companies, ultimately leading to the exchange's bankruptcy. A series of actions by the platform indicated that it did not have sufficient user funds in its custodial wallets, and the funds deposited by users were transferred elsewhere by the platform's controllers, resulting in significant losses for many investors.
III. Overview and Analysis of U.S. Regulatory Experience
The United States implements a multi-tiered decentralized regulatory approach for domestic cryptocurrency trading platforms: vertically, based on the federal decentralized system, both the federal and state governments have independent regulatory powers, with each side formulating and executing trading platform regulatory policies within their jurisdiction, and no unified regulatory consensus has been reached, forming a "dual-track parallel" system. Specifically, in March 2022, President Biden signed an executive order on "Responsible Development of Digital Assets," which first clarified the federal government's overall regulatory approach to cryptocurrencies, aiming to protect investor rights, promote financial stability, and combat illegal financial crimes, requiring the Treasury Department, SEC, Commodity Futures Trading Commission (CFTC), and other agencies to jointly regulate and prevent major risks from platforms. State governments operate independently, with some regulators establishing comprehensive and stringent regulatory rules (such as New York and California), while others have relaxed regulations (such as Wyoming) or have not yet formed a clear stance (such as Pennsylvania). Horizontally, various levels of government conduct detailed divisions of regulatory authority based on regulatory goals and needs, formulating differentiated regulatory rules and adopting a "multi-headed approach." For example, the federal government allocates the securities regulatory business, commodity futures regulatory business, and money laundering enforcement business of trading platforms to the SEC, CFTC, and the Treasury Department's Financial Crimes Enforcement Network (FinCEN), with each agency cooperating to jointly carry out trading platform regulatory work. In summary, the "dual-track multi-headed" model is the basic approach of the U.S. to govern trading platform risks. The differences in regulatory positions and specific policies among various levels of government lead to a consistent approach to certain risk issues by regulators, while in other regulatory areas, each has its considerations, complicating the risk governance work of trading platforms.
(1) Cybersecurity Regulation
Hacking attacks cast a huge shadow over the cryptocurrency market. Although external shocks are the main cause of such risks, the platforms' neglect of cybersecurity is also a significant factor exacerbating the risks. To this end, U.S. regulatory agencies require platforms to take on cybersecurity responsibilities to prevent hackers from causing damage. At the federal level, both the SEC and CFTC have proposed that platforms and their employees should fulfill cybersecurity risk management and disclosure responsibilities and establish accountability mechanisms for preventing platform oversights. At the state government level, New York's "Virtual Currency License Regulation" stipulates that service providers offering cryptocurrency trading must establish and maintain an effective cybersecurity system to ensure that the platform is not subject to illegal access, data breaches, malware, and other cyberattacks, and must regularly submit cybersecurity reports to regulatory agencies.
In terms of regulatory effectiveness, many federal policies are still in the opinion-gathering and discussion stages, and final regulatory rules have not yet been formed, resulting in a lag in the risk governance process. In contrast, some state governments have promptly carried out enforcement actions, imposing hefty fines on platforms that fail to fulfill cybersecurity obligations, urging them to comply with trading monitoring responsibilities and improve cybersecurity plans.
(2) Anti-Money Laundering Regulation
Money laundering can facilitate more serious upstream and downstream criminal activities and is one of the financial crimes that countries vigorously combat. The overly lax management systems of most platforms provide convenience for money laundering activities, objectively giving rise to criminal risks. At the federal level, there is a high emphasis on anti-money laundering regulation for platforms, with Congress repeatedly promoting the establishment of anti-money laundering systems and enforcement actions, with FinCEN playing an important role in updating and enforcing regulatory policies. From federal legislation and various rules issued by FinCEN, several important tasks run through the anti-money laundering work of trading platforms: first, trading platforms that meet the definition of "money services businesses" must register with FinCEN as subjects of anti-money laundering obligations; second, trading platforms should fulfill basic anti-money laundering obligations, including conducting customer due diligence, filing anti-money laundering reports, and monitoring suspicious activities; third, considering the quasi-anonymity and cross-border nature of cryptocurrencies, trading platforms must implement anti-money laundering policies that are stricter than those for traditional financial institutions. For example, the Financial Action Task Force (FATF) stipulates that traditional financial institutions must conduct customer due diligence for all transactions exceeding $15,000/€15,000, while in the cryptocurrency field, FinCEN has lowered this risk threshold to $3,000, requiring platforms to monitor more accounts with potential money laundering risks. Some state governments have also conducted regulatory work on platforms, such as New York and California requiring platforms to establish specific anti-money laundering rules, regularly reporting anti-money laundering results in writing to regulators, and designating personnel responsible for the platform's anti-money laundering work.
The U.S. government has achieved significant enforcement results in this area. FinCEN and the New York State Department of Financial Services, as leading agencies in this field, have respectively imposed bans and hefty fines on trading platforms suspected of money laundering crimes and required them to take appropriate anti-money laundering measures. FinCEN actively collaborates with other departments to carry out enforcement activities, arresting and severely punishing platform operators who deliberately violate U.S. anti-money laundering regulations. The deterrent effect of FinCEN's enforcement is continuously extending overseas, effectively protecting the legitimate rights and interests of U.S. citizens and addressing the challenges posed by platforms using foreign identities to evade regulation.
(3) Fraud Risk Regulation
After experiencing multiple fraud incidents involving trading platforms, both the federal and state governments have placed importance on preventing fraud risks on platforms. First, based on the nature of cryptocurrencies and the functions of trading platforms, the SEC and CFTC are responsible for securities trading regulation and commodity futures trading regulation, respectively. The fraud risk control systems of these two agencies are divided into three stages: pre-access, monitoring during the process, and post-disposal. In the pre-access stage, the SEC and CFTC require domestic platforms or foreign platforms providing services to U.S. citizens to register as exchanges, blocking some "fraudulent operators" from entering the market. In the monitoring stage, the SEC has established an educational website called "Investor" and a fraud complaint channel specifically for securities investors, jointly issuing alerts with the CFTC to urge investors to identify platform fraud. In the post-disposal stage, when fraud is suspected on a platform, the SEC and CFTC will respectively conduct enforcement investigations against the platform, imposing hefty fines and filing lawsuits in local courts. In multiple enforcement activities, the SEC has established fines as "fair funds" to compensate investors for losses incurred during trading.
Secondly, state governments have also made significant contributions to combating platform fraud. Some state governments have established "licensing systems" or "exchange registration systems" in the access stage, requiring trading platforms to take additional anti-fraud measures and develop anti-fraud plans. Additionally, some state regulatory agencies have investigated or filed lawsuits against fraudulent platforms. For instance, both the New York and Texas governments have revoked the trading qualifications of fraudulent platforms in their states, ordering the platforms to return funds and pay fines.
(4) Insider Trading and Market Manipulation Regulation
Insider trading and market manipulation are prominent illegal activities in trading markets. An increasing number of leading platforms have been pointed out for fabricating an active trading appearance or artificially controlling cryptocurrency trading prices. In response, the federal government focuses on applying information disclosure systems to trading platforms to enhance market transparency and curb insider trading and market manipulation. For example, the SEC consciously emphasizes at the market entry stage that trading platforms must establish reasonable policies and procedures to prevent the misuse of important non-public information and submit information disclosure reports to regulatory agencies. State regulators have also issued announcements requiring platforms operating in their states to proactively identify and assess potential market manipulation risks and develop effective control measures and procedures. From a practical perspective, regulatory agencies at all levels simultaneously adopt effective post-event punitive measures, including proactive investigations, penalties, and lawsuits against trading platforms or related personnel suspected of market manipulation.
(5) Fund Security Regulation
To prohibit platforms from misappropriating customer funds, the SEC is gradually introducing relevant regulatory rules, such as the "Employee Accounting Announcement" issued in 2022, which states that trading platforms should indicate the status of cryptocurrencies held by users and the platform's custodial wallets in their financial statements. In 2023, the SEC proposed that trading platforms should be included in the statutory category of "custodians," requiring platforms to implement fund segregation and bankruptcy isolation measures under federal custodial regulations. At the state government level, represented by New York, regulations require trading platforms to maintain sufficient funds to ensure the integrity of user assets and prohibit them from selling, transferring, or otherwise using assets on behalf of others. Following the FTX incident, the New York State Department of Financial Services issued cryptocurrency bankruptcy regulatory guidelines, proposing more detailed requirements for customer asset segregation and separate accounting, warning trading platforms to strictly implement fund segregation systems. However, compared to their outstanding performance in anti-money laundering, fraud, and insider trading, U.S. regulators' oversight of user fund security is still in its infancy, and questions remain regarding the comprehensiveness and enforceability of their regulatory rules.
IV. Reflections and Insights from U.S. Regulatory Practices
(1) Considerations on the Pros and Cons of U.S. Regulation
First, the effectiveness and comprehensiveness of regulatory rules need to be evaluated. The U.S. government generally adopts an open and inclusive, proactive regulatory attitude, allowing various regulatory agencies to define the attributes of cryptocurrencies based on their perspectives when addressing fraud, manipulation, insider trading, and money laundering risks. They conduct pre-regulation based on different licensing and registration systems under the Securities Act, Commodity Exchange Act, and Bank Secrecy Act to prevent illegal platforms from entering the market. Once platforms are legally registered or exempted from operation, regulatory agencies require them to report trading activities regularly, update trading dynamics promptly, and strengthen ongoing supervision. In terms of cybersecurity and fund security, some regulatory agencies require platforms to ensure that their network systems are not compromised by hackers, develop security plans in advance, report cybersecurity risks regularly, and pay attention to the segregation of user funds from platform funds when managing user assets, as well as timely public disclosure of the status of custodial wallet funds.
However, regarding the effectiveness of regulatory rules, a closer examination of the details reveals that while regulatory efforts can hinder common risks such as fraud and manipulation, they often force platform operators and the market to make unnecessary sacrifices, significantly undermining the long-term effectiveness of regulation. Regulators like the SEC and CFTC focus on information disclosure, but some scholars point out that most of the information required by the SEC for disclosure is not directly related to the primary interests of investors (Goforth, 2021). This irrelevant information disclosure increases investors' "search costs," drowning out genuinely useful information (Xing Huiqiang, 2018). At the same time, it imposes heavy obligations on platforms, leading operators to feel overwhelmed and choose to escape to other jurisdictions.
Moreover, the comprehensiveness of regulatory rules needs to be improved. For instance, the federal government has yet to establish an orderly regulatory path for platform cybersecurity, and regulatory documents are still in a preparatory state, unable to serve as a basis for enforcement. Regarding the security of customer funds, the SEC's employee accounting announcement requires platforms to reflect user assets on their balance sheets, but this announcement cannot compel platforms to implement account segregation. If only existing regulations are relied upon, it is impossible to completely prevent the risk of platforms misappropriating funds.
Secondly, the multiple regulatory models in the U.S. have obvious shortcomings. The regulation of trading platforms exhibits a "functional" characteristic, meaning that regulators are not troubled by the commercial forms of platforms and token projects. Instead, they use functions as regulatory guidelines, clarifying the legal roles of platforms based on actual financial activities and determining the allocation of regulatory authority based on specific platform operations. The functional regulatory model, combined with the long-standing "decentralized governance" in the U.S., has led to an excessive number of agencies at both federal and state levels engaging in platform regulation.
This multi-headed financial regulation ensures that public authority can extend its reach to every corner of the platform, but the "fragmented" regulatory model can sometimes lead to dilemmas, especially evident in the overlapping regulation between the SEC and CFTC. In practice, a trading platform named "1pool" was simultaneously sued by both the SEC and CFTC in September 2018 for mixing securities and futures trading, with both agencies requiring the platform to fulfill its registration obligations as a securities dealer and futures commission merchant and to cease illegal operations. Regulatory overlap means that multiple regulators are involved in risk regulation, significantly increasing regulatory steps and consuming additional human and material resources. Scholars have pointed out that regulatory costs can skyrocket, especially when two agencies are actively regulating the same area (Aagaard, 2011). Therefore, the SEC and CFTC are likely to duplicate efforts in areas such as information disclosure and reporting of significant matters, increasing regulatory costs and wasting regulatory resources (Goforth, 2021).
Finally, the reasonableness of the U.S. long-arm regulation is a subject of debate. It is extremely challenging for a single country to enforce laws against trading platforms providing global services. However, in recent years, U.S. regulators have been overcoming geographical barriers to implement long-term regulation on platforms worldwide, with some platforms or projects registered outside the U.S. facing enforcement actions. First, jurisdiction is a prerequisite for judicial and law enforcement actions. According to federal laws such as the Securities Exchange Act and the Bank Secrecy Act, the U.S. seeks to find connections between its judicial authorities and conflicts based on the "minimum contacts" principle (He Zhipeng, 2022). U.S. judicial authorities have jurisdiction over any disputes related to the country, and this "long-arm jurisdiction" has extended from the judicial realm to the enforcement realm, allowing the SEC and FinCEN to regulate foreign platforms serving U.S. citizens. Secondly, in the field of cross-border payments, the international financial market largely relies on the Society for Worldwide Interbank Financial Telecommunication (SWIFT) and the Clearing House Interbank Payments System (CHIPS), the former being heavily influenced by the U.S. government and the latter being developed under U.S. leadership, serving as an important tool for the U.S. to exercise long-arm enforcement jurisdiction (Yuan Zeng, 2021). Therefore, when U.S. regulators target illegal trading platforms abroad, they can not only freeze and seize assets within the U.S. but also arrest platform personnel in the U.S. and restrict the platforms' payment and clearing activities through global cross-border payment systems, thereby deterring them.
Indeed, the internet has weakened people's "territoriality," making it unrealistic to use "physical addresses" as jurisdictional connection points. It is necessary to consider the inherent connections between defendants and the court's location to adapt to the characteristics and pain points of internet cases (Guo Yujun, Xiang Zaisheng, 2002). Long-arm jurisdiction provides the basis and conditions for sovereign states to enforce laws across borders, aiding in combating illegal activities by foreign trading platforms and protecting investors' rights. However, this concept aims to expand domestic jurisdiction as much as possible to the entire world, breaking through the boundaries of national sovereignty. In litigation activities, U.S. regulators expand extraterritorial jurisdiction, creating jurisdictional grounds based on minimal connections, which can lead to conflicts of international jurisdiction (Xiao Yongping, 2019). Unrestricted extraterritorial jurisdiction will inevitably harm the sovereignty of other countries, especially when the litigation has little connection to the U.S., making it even less appropriate for the U.S. to intervene in judicial activities. Therefore, on one hand, the significance of long-arm jurisdiction for platform risk governance should be acknowledged; on the other hand, there should be vigilance against the abuse of power by U.S. regulators, resisting and warning against malicious extraterritorial enforcement, and considering how to make the long-arm jurisdiction system effective in regulating trading platforms.
(2) Reflections on Risk Management of Trading Platforms
The current cryptocurrency market is still in rapid development and has not yet stabilized, making it particularly easy for regulators to fall into a dilemma between correcting risks and promoting innovation. Simply banning platforms eliminates the superficial crises visible in the market but cannot stop the undercurrents of foreign or underground trading platforms. Overly optimistic encouragement of the cryptocurrency trading market can maximize the potential of blockchain technology but fails to timely guard against platform risks. Seeking a more stable and responsible development path, the regulatory experience of the U.S. can provide some insights for risk management of trading platforms in our country.
First, it is essential to reassess the value of trading platforms and the necessity of regulation. Cryptocurrencies are the cornerstone of building an incentive system for the blockchain economy, with the core of the incentive system being the reasonable issuance of cryptocurrencies to motivate "miners" (such as individuals or institutions operating Bitcoin blockchain systems with dedicated computing devices and accounting for newly generated blocks), investment institutions, and core technology development teams to collaboratively promote the operation and development of blockchain systems. Within this value transmission network of blockchain, cryptocurrencies define the rights and responsibilities of various participants in the blockchain system, constructing a dynamically adjustable and continuously operating economic system, with the incentive carrier being the native cryptocurrency of that system. A blockchain without cryptocurrencies is merely a distributed database, while a blockchain system with an incentive system will gain self-development momentum, giving rise to new business models and becoming an important direction for blockchain development. Therefore, regulators should recognize that cryptocurrencies are the driving force behind the continuous development of blockchain technology, and trading platforms will inevitably exist as long-term infrastructure in the industry.
In recent years, some financially developed countries or regions have planned to reshape or improve regulatory rules for cryptocurrency trading platforms, creating vibrant and diligent regulatory entities. For instance, in October 2022, the European Parliament Committee passed the "Regulation on Markets in Crypto-Assets." In November 2022, Hong Kong included cryptocurrency trading platforms in compliance regulation, issuing licenses to legally operating trading platforms, and in 2023, further disclosed the application list and warning list of cryptocurrency platforms to the public, actively promoting the implementation of regulatory policies. In March 2022, the U.S. federal government emphasized in the "Executive Order on Responsible Development of Digital Assets" that cryptocurrencies promote cutting-edge technological innovation in the U.S. and provide investors with efficient, low-cost inclusive financial channels. Therefore, it requires government departments to coordinate and cooperate, analyze digital asset risks, strengthen risk regulation of trading platforms, and ensure the U.S.'s international leadership position to guarantee the smooth operation and development of cryptocurrencies in the U.S. These regulatory dynamics indicate that financially developed countries or regions, while addressing risks, recognize the significant role of cryptocurrencies in promoting blockchain technology and driving innovation, attempting to play a leading role in global governance of cryptocurrencies through effective regulatory practices. Thus, excessively rejecting public chain technology and incentive carriers may weaken our competitiveness in the field of financial technology.
Furthermore, as mentioned earlier, in the face of new overseas regulatory trends and the continuous emergence of risks, a simple "rejection" approach may not be a good strategy and could even push traders toward decentralized exchanges (such as Uniswap) and offshore platforms not subject to Chinese regulation. The former is decentralized and resistant to censorship, posing significant challenges to regulation, while the latter falls outside the scope of Chinese regulation. In the long run, avoiding issuing blanket bans on platforms, moderately adjusting regulatory strategies, increasing regulatory flexibility, and absorbing excellent regulatory experiences from abroad (Liu Mengfei, Luo Xiaowei, 2022) will benefit the Chinese market in keeping pace with financial innovation and reserving interfaces for embracing public chains and cutting-edge blockchain technologies in the future.
Second, establish a comprehensive and unified regulatory framework for trading platforms. In response to platforms, Chinese regulators may focus on aligning with the development of blockchain technology in the future, optimizing platform governance methods, and implementing refined risk regulation (Sun Jin, 2023). First, explore a platform registration system, combining existing legal provisions in securities, futures, and other fields to establish a registration and licensing system for cryptocurrency exchanges, brokers, and clearing institutions, and impose higher standards of review on mixed-operation platforms. This measure will help filter out trading platforms suspected of fraud during the market entry phase, thereby eliminating some fraud risks. Second, establish an appropriate platform information disclosure system to enhance market information transparency and prevent improper business practices such as insider trading and market manipulation. In addition to requiring platforms to submit platform information during the registration phase, platforms should regularly submit financial operation reports to regulatory authorities and establish a dedicated information disclosure section within the platform for investors to access timely. Platforms bear the responsibility for verifying the authenticity and accuracy of trading information and must not include disclaimers regarding the accuracy and timeliness of information disclosure. Strengthening the transparency of platform information is crucial, as it helps alleviate the disadvantaged position of investors, but care should be taken to avoid imposing heavy disclosure burdens on platforms. Self-regulatory organizations or industry associations could be encouraged to issue disclosure templates to guide platforms in fulfilling their information disclosure obligations. Third, clarify the platform's anti-money laundering investigation and reporting obligations, urging platforms to cooperate with regulatory agencies in anti-money laundering efforts. Drawing on the U.S. anti-money laundering regulatory experience, the focus of Chinese regulators should primarily be: on one hand, promptly including platforms within the scope of anti-money laundering obligations, and on the other hand, treating platforms as key targets for anti-money laundering efforts, applying higher standards than those for ordinary financial institutions, and enhancing due diligence on suspicious users, such as requiring users to submit additional asset verification materials and conducting face-to-face interviews, as well as requiring platforms to regularly submit activity reports to regulatory authorities. Finally, require platforms to assume responsibility for customer fund security and network security, preventing hacking and the misappropriation of customer funds by the platform. Regulatory authorities should mandate that platforms establish comprehensive technical risk monitoring systems, promptly fix platform vulnerabilities, and prevent hacking. Platforms must submit written reports detailing user fund segregation measures and compensation plans and cannot exempt themselves from compensation responsibilities through platform rules.
Third, optimize financial rectification efforts and enhance platform regulatory levels. First, Chinese regulators should promptly initiate financial rectification efforts in the aftermath of large-scale fraud, market manipulation, and other illegal or criminal activities occurring on platforms, implementing strict rectification measures, including restricting or prohibiting platform operations, shutting down trading platforms, and imposing administrative penalties. At the same time, to address the issue of some platforms evading regulation by using foreign corporate identities, regulators can determine the jurisdiction of judicial and law enforcement agencies over foreign platforms based on the concept of "active jurisdiction" (Liu Jingdong, 2016), increasing the supply of extraterritorial judicial systems and moderately expanding enforcement and regulatory powers abroad, while avoiding malicious abuse of "long-arm jurisdiction." Finally, regulators should prioritize the protection and relief of investors' legitimate rights and interests (Deng Jianpeng, Ma Wenjie, 2023), strengthening the principle of combining punishment and relief to prevent falling into the trap of "heavy punishment, light relief" (Yao Haifang, 2018), and avoiding the separation of operator regulation and investor rights protection. Accordingly, regulatory agencies should actively compensate investors for their losses while promptly preventing adverse outcomes from worsening, thereby restoring investor confidence. For example, they could integrate the U.S. Fair Fund system (Xing Huiqiang, 2016), using fines paid by platforms to compensate platform users in the form of a fund.
Fourth, help cryptocurrency investors reshape their risk prevention concepts and strengthen investor education efforts. Platform risks are significant and involve pain points across multiple fields, including finance, law, and computer technology. Due to the complex knowledge threshold, many non-professional investors find it difficult to accurately recognize risks and should not be allowed to participate in trading with speculative and lucky mindsets. The SEC has emphasized investor education in this field for many years, and Chinese regulators could draw on its experience to establish dedicated educational websites to help investors enhance their risk prevention awareness and identify trading scams.
Conclusion
The cryptocurrency field is constantly evolving, with new business models emerging from Bitcoin to non-fungible tokens (NFTs), and the market has undergone multiple reshuffles and iterations. However, trading platforms continue to play a key role in the blockchain financial sector. Scholars point out that trading platforms determine which cryptocurrency assets can be traded on their platforms, and the substantial trading volume and depth of leading platforms provide price discovery, liquidity, monetization capability, investment value, and wealth effects for specific cryptocurrencies (Deng Jianpeng, 2022). In the long term, platforms should become key "levers" for regulating blockchain finance. As the current SEC chair stated, the crypto market resembles the "wild west," and the mixed functions of platforms create inherent conflicts of interest and risks for investors, necessitating stringent regulation. China has taken the lead in launching a strong crackdown on trading platforms, achieving certain results in the short term, but platforms have resurfaced after "going overseas," making regulatory challenges a focal point once again. Current legal provisions lack systematic regulations on related issues, leading to regulatory inertia and delays. The refusal of trading platforms to be regulated or unilateral government bans will harm financial innovation and the development of the blockchain industry. Therefore, a reasonable regulatory approach is to promote communication between both parties, improve relevant rules, and strengthen internal compliance within enterprises. Scholars have pointed out that traditional prohibitive regulation has proven to be ineffective (Zhang Chao, 2020). Drawing on the rich regulatory experiences and lessons from the U.S., attempts to provide normative guidance for trading platforms and create a regulatory environment that balances risk prevention and innovative development should become the future regulatory path.
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Risks and Regulation of Cryptocurrency Trading Platforms: U.S. Practice and Enlightenment
Deng Jianpeng & Li Chengyu
(Law School, Central University of Finance and Economics, Beijing)
Abstract: Cryptocurrency trading platforms are the center of financial risk aggregation and the main place where money laundering and fraud crimes are triggered. The barbaric growth of trading platforms has brought great damage to investors in various countries and seriously disrupted the market order. Consequently, there is an urgent need to establish a sound regulatory policy. A comparative analysis reveals that the United States has established a more comprehensive regulatory framework at the federal and state government levels. This framework actively prevents the five major risks of hacking, money laundering, platform fraud, insider trading and market manipulation, and loss of user funds, achieving strong enforcement in the areas of securities, commodity futures, and payments. Reflecting on the US experience and shortages, Chinese regulators can establish a platform registration system, strengthen platform information disclosure, emphasize the platform's anti-money laundering regulatory obligations and fund security obligations, implement financial remediation work, adjust the existing supervision, and strive to maintain the goal of ensuring the safety of the financial market while protecting the legitimate rights and interests of investors.
Key Words: Cryptocurrency trading platform; SEC; Financial Risks; Financial Regulation; Blockchain Finance
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