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The SEC Weighs in on Secondary Crypto Markets

Traders Magazine Online News, March 12, 2018

David Weisberger

The reecent open letter from the SEC to investors and platforms “that refer to themselves as “exchanges”” is an important step for them to push the crypto markets towards maturation.  While stopping short of immediate enforcement actions, it is clear that the SEC is pushing hard towards a more regulated and stable secondary market for trading crypto-assets.  As with their recent “sweep” targeting the primary issuance (ICO) market, I view this as a constructive step, as long as they provide the current dominant platforms both clarity and time to comply.

The reason that I make the point about both clarity and time to comply is that the SEC’s prime directive is investor protection[1].   If they were, however, to immediately declare that markets such as Gemini, GDAX, Kraken, Bittrex, & others operating in the U.S., had to immediately cease and desist trading of crypto assets, that would cause panic, investor losses and widespread losses. The immediate market reaction to the letter (shown below) shows what could happen, only on a much larger scale.  On the other hand, providing such markets with the opportunity (and obligation) to comply with a principles-based regulatory approach would likely increase investor confidence and institutional participation in the market. [IMGCAP(1)]

(Notice how the market not only fell immediately on the news, but the Consolidated Best Bid and Offer became crossed, with a much higher best bid than the best offer during the volatility.  This signals situations where investors can’t quickly determine the best price and can result in additional losses.)

I think it is worth stressing the point that a principles-based approach to regulation would be superior with regard to the secondary trading of crypto-assets.  The key principles I will articulate below are based on common sense and well-established precedents, but since the technology is new, specific, existing rules often apply poorly.  In addition, we should recognize that the crypto markets are global, and there is a risk that over-regulation could well result in U.S. companies losing out on potentially important technology competitiveness.  Additionally, there is a risk of shutting out U.S. investors from a dynamic new market, and it is likely that many will attempt to circumvent rules by trading outside of the country, where protections will be much less.

So, what are the key principles that I am suggesting that both the SEC and CFTC stress in their evolving regulation?

  1. Just and equitable markets
  2. Best execution
  3. Know your customer

Lets examine each in turn:

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