Blockchain is a new technology that combines a number of mathematical, cryptographic, and economic principles in order to maintain a database between multiple participants without the need for any third party validator or reconciliation. In simple terms, it is a secure and distributed ledger.
Because blockchain technology removes an entire layer of overhead dedicated to confirming authenticity, it has many benefits for consumers and businesses alike, reducing costs, speeding up transaction times and providing a more secure method for transferring assets. The list of potential uses is almost limitless including transferring digital or physical assets, protecting intellectual property, verifying the chain of custody, automating contractual agreements, and much more. However, while its potential is transformational, the landscape is nascent and evolving, and there remain several challenges and barriers to adoption.
CONCERNS OVER CUSTOMER PROTECTIONS
Generally accepted methods for auditing transactions do not exist on the blockchain making it difficult or impossible to confirm whether platforms are responsibly holding customers’ assets. Compounding this further is the absence of a legal framework surrounding smart contracts. The decentralized nature of blockchain technology raises questions of ownership and ultimate responsibility should something go wrong and participants or consumers seek redress.
Compounding this issue, generally accepted methods for auditing virtual currencies do not exist making it difficult or impossible to confirm whether platforms are responsibly holding their customers’ assets. Delays and outages on virtual trading platforms are not uncommon, leaving customers unable to withdraw funds and, as a consequence, exposed to the unnecessary risks of volatile prices.
SUSCEPTIBILITY TO MANIPULATIVE OR ABUSIVE ACTIVITY
The lack of common standards for overseeing and governing digital transactions exposes the network to facilitating illegal activities, for example, money-laundering, illegitimate transfers and fraud. Should such manipulative activities take place, no party is liable for any system errors, payment failures or contractual defaults, increasing the risk of potential adverse impacts on well-meaning users. While exchanges often prohibit market manipulation in their terms of service, not all platforms truly restrict, or monitor, the operation of “bots” or automated algorithmic trading.
Many platforms appear to cater to professional, automated traders, offering special pricing and other features to such traders, leaving retail customers at a disadvantage. However, things like high-speed direct market data feeds and co-location, are commonplace in traditional securities markets. Similarly, fee structures and services, for example, maker-taker pricing models, designed to allow professional traders to leverage access, and speed to power, sophisticated automated trading strategies, have been longstanding feature in regulated markets globally, intended to incentivize market makers to provide liquidity. It is not clear that these practices negatively affect retail investors.
Pervasive conflicts of interest
Sources of conflicts of interest include where virtual trading platforms operate as exchanges, broker-dealers, money transmitters, proprietary traders buying and selling for their own accounts on their own venue, owners of large cryptocurrency holdings and, in some cases issuers of cryptocurrencies.
Different approaches are taken by different exchanges in determining which virtual currencies to offer for trading, with lack of clear objective standards for particular listings. Additionally, employee trading, and restrictions on employee trading, differ widely across the platforms, in contrast to traditional securities markets.
Vulnerability TO CYBER ATTACKS
Cryptocurrency faces the same challenge as traditional currency; theft. In the event of a successful hack, customers have little or no recourse (like FDIC insurance) to cover losses. While the underlying technology has proved to be one of the most cryptographically secure technologies available, no network is ever 100% safe from attack.
MERCURIAL REGULATORY ENVIRONMENT
There is certainly growing interest from legislators and regulators in the crypto-asset and blockchain space, including a spate of enforcement activity involving crypto assets. However, in the absence of clear regulatory guidance, navigating the myriad of emerging and evolving developments across the globe is hampering innovation at blockchain companies.
In an effort to continue moving forward with the development of cryptocurrency and open blockchain networks, the industry are increasingly forming special interest and lobbying groups to try to figure out what they can, and cannot do. While the future regulatory landscape remains unclear, we still expect to see an uptick in transaction volumes and, the associated profit pools, shifting toward owners of highly efficient blockchain platforms, shaking up the future of traditional business models and growth strategies.
We believe that regulators will increasingly play an active role in the oversight of cryptocurrency firms and focus scrutiny on securities law registration violations and fraudulent conduct.
Where relevant, applicable regulated securities trading practices and methods can serve as a blueprint and virtual currency exchanges and other market participants would be well advised to take this time to improve internal security controls, market surveillance protocols, conflicts policies, disclosures, and other investor and consumer protections accordingly.