A Compliance Culture in the Crypto Space?
Karen Wendt, SFTL President & expert in responsible, impact and sustainable investing
A Compliance Culture in the Crypto Space?
Blockchain technology and the associated digital assets raise exciting prospects and create a new vision of money, but at the same time, there are serious challenges to existing regulatory and compliance regimes. These have played out in a number of ways. In the US, the Securities and Exchange Commission (SEC) is targeting Binance and Coinbase, the two most powerful exchanges in the world of cryptocurrencies. The SEC accuses the founder of Binance, Changpeng Zhao, of operating a “web of deception”, bringing forward 13 offences against him and his platform. Binance and Coinbase have made billions in investments. What has prompted the SEC investigation? The Bahamas-based FTX, whose founder, US national Sam Bankman-Fried, has now been charged with securities fraud, money laundering, and other offences,
According to the Federal Trade Commission (FTC), more than 46,000 people reported losing over $1 billion in crypto to various scams from January 2021 through June 2022, and that figure only includes people who willingly shared this information with authorities. The blog Time.Stamped lists the most common scams in crypto, like business opportunity scams promising to help you grow rich. One common scam is to steal your crypto from the exchange, as happened with FTX founder Sam Bankman-Fried (SBF). Investors seem to know very little about how to keep their cryptos safe. According to the Wall Street Journal, “Sam Bankman-Fried built a house of cards on a foundation of deception” while telling investors that it was one of the safest buildings in crypto.
With regard to Binance, the SEC alleges that while Binance publicly claimed that Binance.US was a separate, independent trading platform for US investors, Zhao secretly controlled the US company behind the scenes. Among the products that Binance.US is alleged to have illegally offered its US customers are commodity derivatives.
Perhaps it is worthwhile to revisit what constitutes a free market. A free market is a market that is not controlled by anybody; no single buyer or seller has the power or authority to influence the prices at the exchange. They just build on the market; therefore, large and very liquid markets are needed. One question, besides willful influence by one player, founder, or manager, is the size of the market. If bitcoin is independent, it should not fall by 50% in the moment when Elon Musk decides to sell the bitcoins that have been accepted and used for prefinancing Tesla orders. The market should digest large orders without price influence and be rock-solid and liquid, so that no single player can influence the price. The bitcoin example shows that this condition of market size, liquidity, and independence of players is not always a given.
Gut, let us return to the scam schemes. While educating investors and increasing scrutiny by regulators is a must, we can also question the governance and compliance culture of the crypto exchanges. The Global Investigation Review issued in September 2022 finds a number of compliance issues and regulatory challenges in cryptocurrencies.
Broadly, there are two primary approaches taken by governments, in varying combinations: (1) seek to fit digital assets into existing regulatory and compliance regimes (the approach primarily relied on at the federal level in the United States to date); and (2) create new laws or amend existing laws specifically to address digital assets (as is evident in jurisdictions such as Switzerland and Dubai and certain states in the United States such as New York).
But what about a compliance and governance culture at the level of the exchanges themselves?
A key part of a compliance culture is allowing employees to feel comfortable raising issues and reporting violations without fearing retaliation. It also requires an internal reporting and solution system to tackle issues that arise. This means creating a culture that encourages open and transparent communication and providing the means for employees to voice their concerns. As cryptocurrencies claim to have the value of freedom at their heart and an ecosystem approach, one could expect that this is the industry where a compliance culture can flourish. A compliance culture starts with leadership. The leader has to manifest and live the compliance values. We have enough examples for now to show that this is not happening in the crypto space by itself. Clear policies, procedures, and training seem to be missing too. Where are the speak-up culture and the Kaizen continuous improvement in the crypto space? We can see it in the community engagement for the protocols, yes, but it does not translate into corporations’ behaviour and a corporate culture.
Let’s lean back and think for a moment about risk management. What does this missing link in corporate culture, this missing compliance culture, mean for risk management in crypto assets for investors, regulators, and, of course, the crypto company itself? The risk that has already materialised for investors and companies goes into the 10s of billions in USD. Maybe not all, but some of these losses would have been avoidable by using good business practises like ISO standards, by leading by example, and by creating a compliance culture within the company.