By now we probably all know someone that has been burnt by crypto by losing a little or maybe a whole lot. It is a highly volatile market and a lot of the coins and tokens that exist seem extremely speculative. One of the biggest problems is crypto as a whole is that it’s a highly unregulated market so there are plenty of shady practices happening out there.
The rise of cryptocurrencies has led to the proliferation of numerous digital asset exchanges. While these exchanges offer a convenient and mostly secure platform for users to trade digital assets, they are also susceptible to various risks, such as hacking, fraud, and insider trading. As such, it is crucial for crypto exchanges to have full transparency of the digital assets they own and hold on digital exchanges. But right now most of them don’t have the means to do so and don’t have any incentive to do so until regulators step in.
Transparency is essential for regulatory compliance in many countries to make sure that people are paying their taxes. Digital asset exchanges are subject to various regulatory requirements, including anti-money laundering (AML) and know-your-customer (KYC) regulations. So most exchanges already comply with this and are happy to hand over AML & KYC information to the appropriate authorities but what about the company’s books?
It’s pretty easy for normal companies to trade insolvent, rack up a heap of debt and then go bankrupt owing debtors money, crypto exchanges are no different. This is where the “not your keys, not your crypto” saying comes into play and I wrote an entire article about it. If you hold assets on an exchange do you really own them and did the exchange really buy them or are they just writing an IOU next to your name? This is where transparency of exchanges is important.
Last year alone we saw the collapse of FTX with $8B USD of customer funds going missing, Celsius owing $4.7B to investors, Tera Luna collapsed with $2B, Voyager with $1.4B, Three Arrows Capital with $1B and BlockFi owing over $1B. A bad year for crypto and most of these were perfectly avoidable if they were actually going to do what they said they were going to do. Most of them over-leveraged themselves, were gambling with users' funds, were trading insolvent for a long period of time, or outright knowingly defrauded investors. If we had more transparency in their balance sheets you would be able to see if they are good places to put your money or not.
Just listening to those numbers may make you think that crypto & blockchain is unsafe but it all comes down to the implementation. In the above collapses the point of failure was outright fraud or over-leveraging. Blockchain, the technology that allows crypto to exist, actually holds the answer to the problem. With blockchain, you can prove ownership of assets and be more transparent.
Transparency builds trust, crypto exchanges that are transparent about the digital assets they hold and their trading practices are more likely to attract users and investors. Transparency allows users to make informed decisions about which exchanges to use and which digital assets to invest in. It also helps to prevent market manipulation, as users can identify any irregularities in trading practices.
Transparency promotes market stability by providing regular reports on digital assets holdings, exchanges can reduce the likelihood of sudden price fluctuations. This is especially important for large exchanges that hold significant amounts of digital assets, as sudden selling or buying can have a significant impact on market prices. By being transparent about their holdings, exchanges can help to create a more stable market environment.
This week we saw Brian Armstrong from Coinbase announce that he is creating a Layer-2 on Ethereum called “Base”. This will allow for a lot more transparency around the use of assets and be able to have a lot of other added features and benefits. This is a great step forward because the company is jumping ahead of regulators and paving a best-practice path to what will be future compliance.
Coinbase already reports more than most exchanges because Coinbase is a publicly listed company. This means the SEC (Securities and Exchange Commission) sets stringent reporting requirements to publicly disclose financial statements and an annual financial report that gives a comprehensive summary of its financial performance. Many crypto exchanges establish themselves in countries that are tax havens to not only circumvent paying taxes but also reduce their risks of litigation &/or extradition should they go belly up.
Transparency encourages responsible behavior. Exchanges that are transparent about their digital asset holdings are more likely to adopt responsible trading practices, such as not engaging in insider trading or front running. This promotes a fairer and more ethical trading environment, which benefits all users.
The sooner large exchanges embrace full transparency of their books the better. It will help to attract more mainstream investors and improve the overall reputation of the crypto industry by significantly de-risking the balance sheet of the exchange as a point of failure.
