Thursday, September 20, 2018

NY AG finds pervasive vulnerabilities in virtual currency exchanges

By Lene Powell, J.D.

A new report by the New York Attorney General reveals serious, widespread deficiencies in customer protections at virtual currency exchanges, leaving customers vulnerable to abusive trading practices, conflicts of interest, and asset losses. The Virtual Markets Integrity Report provides details for 10 virtual asset trading platforms and suggests questions for customers to ask before trading. The AG’s office also referred three exchanges (Binance,, and Kraken) to the New York State Department of Financial Services for possibly operating unlawfully.

“New Yorkers deserve basic transparency and accountability when they invest—whether on the New York Stock Exchange or on a cryptocurrency platform. Yet, as our report details, many virtual currency platforms lack the necessary policies and procedures to ensure the fairness, integrity, and security of their exchanges,” said Attorney General Barbara Underwood.

In addition to the report, the results are presented in an interactive website,

Risks for customers. According to the report, virtual currency trading has spread in the last decade from tech-savvy hobbyists to Wall Street firms and “mom-and-pop” retail investors. There are now over 1,800 virtual currencies exchanged around the world and valuations have skyrocketed, including to over $100 billion for bitcoin since its creation. But unlike traditional stock exchanges, private trading venues, and broker-dealers, virtual asset trading platforms have not registered under state or federal securities or commodities laws. They also have not implemented common standards for security, internal controls, market surveillance protocols, disclosures, or other investor and consumer protections.

As a result, customers of virtual asset trading platforms face significant risks. Trading platforms have been hacked, with billions of dollars’ worth of virtual currency stolen with little or no recourse for customers. Delays and outages are common, limiting customers’ ability to withdraw funds and leaving them vulnerable to significant losses due to price swings. Certain trading platforms have also been linked to deceptive and predatory practices, market manipulation, and insider abuses.

Virtual Markets Integrity Initiative. The Attorney General’s office sent requests for information to 13 major trading platforms, of which nine responded. Analysis of the responses identified three broad areas of concern: 
  1. Abusive trading practices. Although some platforms have taken steps to safeguard fairness and integrity, trading platforms overall have not implemented serious efforts to impede abusive trading activity. Platforms lack robust market surveillance capabilities, and there is no mechanism for analyzing suspicious trading strategies across multiple platforms. Few platforms seriously monitor the operation of “bots” or automated algorithmic trading, and some deny any responsibility for stopping traders from artificially affecting prices. In fact, many venues offer special pricing and other features like co-location to professional automated traders, leaving retail customers at a disadvantage.
  2. Conflicts of interest. Virtual asset trading platforms often engage in multiple lines of business, creating substantial potential for conflicts between the interests of the platform, platform insiders, and platform customers. Platforms often serve: (1) as venues of exchange; (2) in a role akin to a traditional broker-dealer; (3) as money-transmitters; (4) as proprietary traders; (5) as owners of large virtual currency holdings—including by platform employees, who may have access to information about customer orders, new currency listings, and other non-public information; and, in some cases, (6) as issuers of a virtual currency listed on their own and other platforms. Virtual currency exchanges lack the restrictions and monitoring that traditional trading environments have in place to mitigate conflicts of interest.
  3. Limited protection of customer funds. Trading platforms lack a consistent and transparent approach to independently auditing the virtual currency supposedly in their possession, making it hard to check if platforms are responsibly holding their customers’ virtual assets as claimed. Also, due to the lack of FDIC and sufficient commercial insurance, customers are highly vulnerable to hacks or unauthorized withdrawals. 
Based on these concerns, the AG’s office lists eight specific questions for customers to ask before trading on a virtual currency exchange. The AG warns that customers should be wary of any exchange that cannot or will not answer the questions.

Possible illegal operations. Of the 13 platforms originally contacted, four claimed they did not allow trading from New York and declined to participate: Binance Limited, (operated by Gate Technology Incorporated), Huobi Global Limited, and Kraken (operated by Payward, Inc.) However, the AG’s office found that Binance,, and Kraken have all accepted trades from within New York State. Consequently, the office referred these three platforms to the New York State Department of Financial Services for potentially operating in New York State without seeking or receiving approval from DFS to engage in a virtual currency business activity.