On September 18, 2018, the New York State Attorney General issued a 32- page report on its findings on the state of cryptocurrency platforms with respect to consumer protections. The Virtual Markets Integrity Initiative Report summarizes the results of the New York Attorney General’s April 2018 survey sent to 13 cryptocurrency platforms, including some located outside the state of New York. Our blog post on the issuance of the survey can be found here.
The 32-question survey requested information on the following topics:
(1) ownership and control;
(2) basic operations and fees;
(3) trading policies and procedures;
(4) outages and other suspensions of trading;
(5) internal controls;
(6) privacy and money laundering;
(7) protections against risks to customer funds; and
(8) written materials.
The New York Attorney General received written responses from ten platforms and has referred an additional three platforms to the New York Department of Financial Services for further investigation into whether those three platforms were engaging in virtual currency business activity without a license.
The report focused on three areas of particular concern with respect to consumers:
(a) Potential conflicts of interest. The report found that many platforms trade cryptocurrencies on their own account and/or permit their employees to trade on the platform. Because both the platform and the employees would have access to consumer trade information, there is a potential for use of this information to the detriment of the consumers. The report also pointed out that, where a platform has a high percentage of trading for its own account, consumers may face a liquidity risk during times of rapid price movement because they may not be able to exchange their cryptocurrency for fiat currency or other cryptocurrency if the largest participant goes silent.
(b) Abusive trading activity. The report found that some platforms had not taken measures to safeguard the platform against abusive trading activity, such as monitoring for suspicious trading activity. The report stated that the platforms lack robust real-time and historical market surveillance capabilities. The report goes on to find that only a few platforms restricted “bots” or automated trading—and some have pricing mechanisms that encourage the use of these technologies. There is also a potential broad effect of abusive trading activity: “Because the prices of virtual assets move in concert across different venues, manipulative activity on one venue affects price and liquidity on other venues.”
(c) Consumer protections. The report stated that “protections for consumer funds are often limited or illusory.” The New York Attorney General found that no current auditing methods exist for virtual assets, so it would be difficult or impossible for consumers to confirm whether platforms were actually holding the claimed assets. There is no FDIC or similar federal insurance to protect the virtual assets and there are “serious questions about the scope and sufficiency of the commercial insurance” that platforms currently carry. With respect to cybersecurity, the report states that “While all participating platforms reported to offer two-factor authentication [a data security measure where before accessing the platform, users need to input both a password and an additional piece of information such as a code sent separately to the user] for customers in certain circumstances, the better practice is to require two-factor identification by default” (emphasis in original).
The report also contains several charts comparing various characteristics of the platforms.
While the report does not address whether virtual currency “represents a sound investment decision,” it nevertheless provides a list of “Questions Customers Should Ask a Platform” before trading on a virtual currency exchange platform.