US authorities eager to deter citizens from unregistered crypto exchanges

Many overseas cryptocurrency exchanges would be happy to have U.S. traders as clients, but these days, American residents might as well have a sign around their necks reading “Danger: high voltage!”

That’s been the case since Oct. 1, at least, when the United States Commodity Futures Trading Commission filed a complaint against Seychelles-registered BitMEX for soliciting U.S. residents and thus violating the Commodity Exchange Act. According to the complaint: “BitMEX has never been registered with the CFTC in any capacity and has not complied with the laws and regulations.” This poses a serious problem for the U.S. regulators that try to keep tabs on money laundering, manipulative trading and other illegal activities.

The complaint was viewed by some as a turning point in U.S. crypto enforcement. According to law firm Ballard Spahr LLC, it demonstrated that “the CFTC continues to actively pursue trading platforms and exchanges that solicit orders in the United States without proper registration.” The rule had been on the books for many years, but its enforcement had been spotty.

Some viewed the BitMEX complaint as more of a one-off action — not likely to have lasting repercussions in the larger cryptoverse. The firm hadn’t exactly been a model of compliance — though it did have some controls on U.S. IP addresses. (Unfortunately, these were easy to get around.) “BitMEX is an illegal casino whose executives are frequently caught bragging about ripping off their customers. No doubt, the authorities have been on them for a long time, just looking for something that’ll stick,” wrote Mati Greenspan, founder of analytics firm Quantum Economics, in his daily newsletter. But others believe that offshore crypto exchanges already seem to be changing their ways. Jesse Spiro, global head of policy at Chainalysis, told Cointelegraph:

“Unregistered foreign exchanges soliciting U.S. customers used to be more common. [...] Many international exchanges didn’t care where their customers came from, but more recently exchanges have shut down service to U.S. customers given the threat of U.S. regulatory action.”

Some U.S. players say this circumstance is only part and parcel of continued ambiguity and uncertainty regarding crypto regulation. Ripple CEO Brad Garlinghouse, for instance, recently said that his firm was losing potential U.S.-based customers for its XRP-related services because of the regulatory muddle. He thus claimed that even though the firm is based in San Francisco, 95% of its customers are overseas.

Laush pointed out that there may be truth in that statement: “Ripple’s CEO has a point. It is very difficult to be AML-compliant in the United States. That is why Ripple might not want to be in the field of U.S. regulation.” Meanwhile, Wagster acknowledged that U.S. law hadn’t kept pace with the rapid evolution of blockchain technology: “The seminal case governing whether a cryptocurrency is a security was decided 80 years ago, and it will likely be at least several more years before a combination of case law and regulations allow for bright-line rules.”

However, Spiro believes that the U.S. regulators have upped their game: “In general, U.S. regulators have become more knowledgeable regarding virtual assets, the vendors in the space, and how to analyze blockchains. They’re enforcing regulations more consistently now.” Meanwhile, Wagster added:

“U.S. regulators have not shied away from using long arm jurisdiction to go after exchanges and protocols allowing investments or participation by U.S. residents, and I expect such enforcement actions to continue.”

G20 nations are clamping down

It isn’t only the U.S. that is turning up the heat on unregulated exchanges lately. John Jefferies, chief financial analyst at blockchain intelligence firm CipherTrace, told Cointelegraph, “Most G20 countries are cracking down, and I expect increased enforcement actions globally in 2021.” He also added his thoughts regarding the BitMEX case:

“It reflects the stance of the Treasury Department, which is that exchanges must register with FinCEN and abide by U.S. anti-money laundering (AML) regulations if they do business with U.S. persons.”

In Europe, “the same thing is happening,” agreed Dmitri Laush, CEO of GetID, an identity verification solution provider. “For example, online exchange aggregator Bestchange was recently blocked because of a Russian court decision — the authority assumed that the aggregator is involved in fraudulent schemes,” he told Cointelegraph.

But isn’t it difficult for an overseas exchange — many of them quite small — to really know whether a customer is a U.S resident or Estonian resident, for example? Shouldn’t this be treated more like a matter of “buyer beware”?

“It’s not difficult at all for exchanges to determine if their users are U.S. residents; they just have to ask and require documentary proof,” John Wagster, an attorney at Frost Brown Todd LLC, told Cointelegraph. He further explained, “U.S. regulatory agencies claim jurisdiction over investments by U.S. residents anywhere in the world those residents invest.”

“It is very easy if you have a proper KYC provider,” added Laush, “Proper identity verification can also recognize if the ID document is genuine or fake, so there is no chance that a person can pretend that he or she is not from the U.S.”

That said, it can sometimes be problematic for non-U.S. residents to prove that they are not U.S. citizens -- simply because many people around the world lack IDs. Foreign exchanges, for their part, often say things aren’t so simple. Binance CEO Changpeng Zhao recently told Bloomberg that his exchange must get “smarter about the way we block” U.S. residents from trading on Binance’s platform, adding: “We do continually try to improve our blocking.” Cointelegraph asked Binance for examples of the ways traders are trying to outmaneuver Binance’s defenses, but the firm declined to comment.

In its October complaint, the CFTC suggested BitMEX’s so-called blocking efforts were half-hearted at best. “At the time [CEO Arthur] Hayes wrote that BitMEX was ‘blocking’ U.S.-based users, thousands of U.S. persons were in fact trading on BitMEX’s platform,” the agency noted.

Why use unregistered exchanges?

Why would U.S. traders and investors, for their part, even want to use unregulated overseas exchanges? It’s not as if they lack U.S. dollars or access to capable exchanges (e.g., Coinbase, Gemini) in their own country. “Access to more tokens, lower fees, less friction, anonymity and tax evasion are some reasons,” Jefferies answered, “Crypto is inherently borderless, so it can be easily transferred to offshore exchanges.”

“They may also use overseas exchanges in search of services with less or no compliance or regulatory oversight to transact with illegal entities, such as sending to a service in a high-risk jurisdiction,” added Spiros.

Many of these exchanges are only all too willing to accommodate them, suggested Wagster. “A number of exchanges and protocols embrace the fact that they allow users to participate anonymously. [...] Other exchanges only accept cryptocurrency — as opposed to fiat currency — in the belief that they are not required to perform KYC on individuals paying in crypto.”

What can exchanges do?

In the meantime, what should overseas exchanges do? “It is not enough to put a warning on the website: ‘We do not accept the U.S. citizens.’ You need to check the identity of the trader and the source of his income,” said Laush.

“One potential approach for ensuring U.S. residents do not use the [unregistered] exchange is to ban virtual private network (VPN) access, which presents an awkward inclusion/exclusion trade off,” opined Jefferies, “Overseas exchanges could forbid access to their platforms from VPNs and Tor, but doing so would disable private access by those in oppressed countries. This has caused some large exchanges to create distinct and separate U.S. operations.” Wagster added, “The more reputable exchanges are very careful where and with whom they operate,” and for the present:

“Every exchange with significant trading volume should expect to be scrutinized by U.S. regulatory agencies. Some exchanges, like Binance, set up separate entities in separate jurisdictions so they can comply with local laws wherever they are.”