SSRN Id3831439

DECENTRALIZED FINANCE: REGULATING
CRYPTOCURRENCY EXCHANGES
KRISTIN N. JOHNSON*
ABSTRACT
Global financial markets are in the midst of a transformative

movement. The creation of Bitcoin and Facebook’s proposed distri-
bution of Diem mark a watershed moment in the evolution of the
financial markets ecosystem. Purportedly, peer-to-peer distributed
digital ledger technology eliminates legacy financial market inter-
mediaries such as investment banks, depository banks, exchanges,
clearinghouses, and broker-dealers.
Yet careful examination reveals that cryptocurrency issuers and
the firms that offer secondary market cryptocurrency trading services
have not quite lived up to their promise. Notwithstanding crypto-
enthusiasts’ calls for disintermediation, evidence reveals that
platforms that facilitate cryptocurrency trading frequently employ
the long-adopted intermediation practices of their traditional coun-
terparts. In fact, when emerging technologies fail, cryptocoin and
token trading platforms partner with and rely on traditional
financial services firms. As a result, these platforms face many of the
* Asa Griggs Candler Professor of Law, Emory University School of Law. J.D., University
of Michigan Law School; B.S. Georgetown University School of Foreign Service. My gracious
thanks to Jenny Carroll, Katrice Bridges Copeland, Nakita Cuttino, Lisa Fairfax, Gina-Gail
Fletcher, Veronica Root Martinez, Elizabeth Pollman, Jari Peters, Carla Reyes, Usha
Rodrigues, Stanley Sater, Daiquiri Steele, J.W. Verrett, Petal Walker, Angela Walch, Aaron
Wright, and participants of The Cardozo Law School Blockchain Project First Annual
Blockchain Works-in-Progress Conference, 2020 Tulane Corporate Law and Securities
Roundtable, Lutie Lytle Faculty Workshop at the University of Michigan Law School, and
Internet Law Works-in-Progress at Santa Clara Law School. The author received generous
research support from the Tulane University Law School Summer Research Grant, the
Tulane University Gordon Gamm Faculty Fellowship, the Tulane University Murphy
Institute, and the Tulane University Center on Law and the Economy. Special thanks to
Douglas Peters and Alexandra Calabro for invaluable research assistance.
1911
Electronic copy available at: https://ssrn.com/abstract=3831439

1912 WILLIAM & MARY LAW REVIEW [Vol. 62:1911
risk-management threats that have plagued conventional financial

institutions as well as a host of underexplored threats. Automated or
algorithmic trading strategies, accelerated high frequency trading
tactics, and sophisticated Ocean’s Eleven-style cyberheists leave
crypto-investors vulnerable to predatory practices.
Early responses to fraud, misconduct, and manipulation empha-
size intervention when originators first distribute cryptocurrencies—
the initial coin offerings. This Article rejects the dominant regulatory
narrative that prioritizes oversight of primary market transactions.
Instead, this Article proposes that regulators introduce formal regis-
tration obligations for cryptocurrency intermediaries—the exchange
platforms that provide a marketplace for secondary market trading.
This approach recognizes the dynamic nature of cryptocurrency
secondary market actors seeking to achieve disintermediation yet
balances the potential benefits of trading intermediaries with nor-
mative regulatory goals—protecting investors from fraud, theft,
misconduct, and manipulation; enforcing accountability; preserving
market integrity; and addressing enterprise and systemic risk-
management concerns.

2021] CRYPTOCURRENCY EXCHANGES 1913
TABLE OF CONTENTS
INTRODUCTION . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1914
I. INTERMEDIATION: A FUNCTIONAL ANALYSIS . . . . . . . . . . . . . 1924
A. Traditional Intermediaries . . . . . . . . . . . . . . . . . . . . . . . 1926
B. Governance and Economics of Secondary Market
Trading . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1933
II. CRYPTOCURRENCY PRIMARY AND SECONDARY
MARKET TRANSACTIONS . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1943
A. Cryptocurrency Primer . . . . . . . . . . . . . . . . . . . . . . . . . . 1945
B. Cryptocurrency Exchanges . . . . . . . . . . . . . . . . . . . . . . . 1951
III. MARKET EVOLUTION AND FRAGILITY . . . . . . . . . . . . . . . . . 1960
A. Automating Risk . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1961
B. Accelerating Risk . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1964
C. Cyber-Risks . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1971
D. Systemic Risk. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1973
IV. (RE-)ENVISIONING INTERMEDIARY REGULATION . . . . . . . . 1978
A. Ordering Markets: Proposed Reforms. . . . . . . . . . . . . . . 1980
B. Self-Certification . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1985
C. Collaborative Market Governance. . . . . . . . . . . . . . . . . . 1991
V. BENEFITS AND LIMITATIONS OF SELF-DESIGNATION . . . . . . 1994
A. Benefits. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1994
B. Remaining Questions. . . . . . . . . . . . . . . . . . . . . . . . . . . . 1995
CONCLUSION . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2000

INTRODUCTION
Despite federal and state regulators’ warnings and mounting civil

and criminal enforcement actions, investors continue to flock to
cryptocurrency markets, buying coins and tokens in initial coin
offerings (ICOs).1 At its high-water mark in 2021, exponential
growth characterized the near one-trillion-dollar cryptocurrency
market.2 As governments, private stakeholders, and academics cast
a spotlight on ICOs, a shadow fell, obscuring nefarious activity on
secondary trading market platforms.
Media reports chronicle the endemic challenges in cryptocurrency
secondary markets. Bitfinex, one of the world’s largest crypto-
currency exchanges, is a prominent example. Founded in 2012,
Bitfinex has survived Ocean’s Eleven-style heists that emptied
hundreds of millions of dollars of customer assets from its coffers.3
Periodic cyberattacks have temporarily paralyzed Bitfinex’s plat-
form, suspending trading and halting customer withdrawals.4 Yet,
these incidents are only the tip of the iceberg.
Bad actors swarm secondary market trading in cryptocurrency
markets. Traditional banks are reticent to permit cryptocurrency
exchanges to open accounts; thus, these platforms often rely on
1. See Jake Frankenfield, Initial Coin Offering (ICO), INVESTOPEDIA (Sept. 26, 2020),
https://www.investopedia.com/terms/i/initial-coin-offering-ico.asp [https://perma.cc/VT78-
LB7R] (“An Initial Coin Offering (ICO) is the cryptocurrency industry’s equivalent to an
Initial Public Offering (IPO).”).
2. Global Charts: Total Market Capitalization, COINMARKETCAP, http://coinmarketcap.
com/charts/ [https://perma.cc/NS33-QDQ7].
3. Nathaniel Popper, Warning Signs About Another Giant Bitcoin Exchange, N.Y. TIMES
(Nov. 21, 2017), https://www.nytimes.com/2017/11/21/technology/bitcoin-bitfinex-tether.html
[https://perma.cc/77A6-4GZ7].
4. Daniel Palmer, Major Crypto Exchanges Bitfinex and OKEx Hit by Service Denial
Attacks, COINDESK (June 12, 2020, 3:27 PM), https://www.coindesk.com/major-crypto-ex
changes-bitfinex-and-okex-hit-by-traffic-denial-attacks [https://perma.cc/42EN-2MLP]; Andrey
Shevchenko, Crypto Exchanges OKEx and Bitfinex Suffer Simultaneous DDoS Attacks,
COINTELEGRAPH (Feb. 28, 2020), https://cointelegraph.com/news/crypto-exchanges-okex-and-
bitfinex-suffer-simultaneous-ddos-attacks [https://perma.cc/KS5P-T4FA]. For examples of
earlier cyberattacks, see Steven Russolillo, Hackers Swipe More Than $40 Million of Bitcoin
from Cryptocurrency Exchange, WALL ST. J. (May 8, 2019, 2:27 AM), https://www.wsj.com/
articles/hackers-swipe-more-than-40-million-of-bitcoin-from-cryptocurrency-exchange-11557
296830?mod=article_inline [https://perma.cc/H4RJ-7ZGD].

“shadow banks.”5 For example, Bitfnex initially routed customer

transactions through a Taiwanese bank to Wells Fargo.6 Then, on
April 18, 2017, Wells Fargo began blocking Bitfinex wire transfers.7
Bitfinex pivoted to a Puerto Rican bank—Noble Bank.8 On October
1, 2018, Noble Bank lunged toward bankruptcy.9 Bitfinex trans-
ferred $850 million to a Panamanian nonbank payment processing
platform—Crypto Capital.10 Another fleeting solution. Within a
year, the Polish government arrested Crypto Capital’s President
Ivan Manuel Molina Lee for his role laundering money on behalf of
an international drug cartel.11 Bitfinex shocked the cryptoworld,
announcing that the $850 million in customer funds held by Crypto
Capital had vanished.12
Beyond Bitfinex’s firm-specific risk-management concerns—the
conflicts of interest, woefully deficient compliance controls, anemic
consumer protection policies, and remarkably inadequate cyber-
security measures—the entire industry grapples with operational
and systemic risks: fake bank accounts, mismanagement of
5. Paul Vigna, Lack of Banking Options a Big Problem for Crypto Businesses, WALL ST.
J. (May 17, 2019, 12:34 PM), https://www.wsj.com/articles/lack-of-banking-options-a-big-prob
lem-for-crypto-businesses-11558092600 [https://perma.cc/F7RD-NYN6].
6. Id.
7. See id.
8. Ana Berman, Bloomberg: Puerto Rico’s Noble Bank Reportedly Loses Clients Tether,
Bitfinex, Seeks Buyer, COINTELEGRAPH (Oct. 2, 2018), https://cointelegraph.com/news/bloom
berg-puerto-ricos-noble-bank-reportedly-loses-clients-tether-bitfinex-seeks-buyer [https://
perma.cc/D53Y-RUA9].
9. Id.
10. Paul Vigna, Bitfinex Used Tether Reserves to Mask Missing $850 Million, Probe Says,
WALL ST. J. (Apr. 25, 2019, 11:21 PM), https://www.wsj.com/articles/bitfinex-used-tether-
reserves-to-mask-missing-850-million-probe-finds-11556227031 [https://perma.cc/R4EW-
4NDH]; see also Press Release, N.Y. Att’y Gen., Attorney General James Announces Court
Order Against “Crypto” Currency Company Under Investigation for Fraud (Apr. 25, 2019),
https://ag.ny.gov/press-release/2019/attorney-general-james-announces-court-order-against-
crypto-currency-company [https://perma.cc/G4YV-63A6].
11. Samuel Haig, Bitfinex Cries Fraud as Crypto Capital Executive Indicted by US,
COINTELEGRAPH (Oct. 30, 2019), https://cointelegraph.com/news/bitfinex-cries-fraud-as-crypto-
capital-executive-indicted-by-us [https://perma.cc/M65Y-SVWE].
12. Steve Ehrlich, After an $850 Million Controversy, What Everyone Should Know About
Bitfinex, Tether and Stablecoins, FORBES (May 2, 2019, 9:09 AM), https://www.forbes.com/
sites/stevenehrlich/2019/05/02/after-an-850-million-controversy-what-everyone-should-know-
about-bitfinex-tether-and-stablecoins/?sh=19d2f02e492f [https://perma.cc/4GTT-BH75].

customer funds, blatant theft, garden-variety fraud, and exploitative

and abusive trading strategies.13
Stunningly, none of the three hundred trading platforms facilitat-
ing cryptocurrency secondary market transactions has obtained
requisite approval from federal or state authorities to operate as an
exchange.14 Regulators have formally prosecuted only a handful of
trading platforms.15 Most troubling, however, are the breadth and
depth of these challenges among the small group of actors that has
captured the greatest market share in global cryptocurrency
secondary trading markets. Why have Congress and regulators
failed to impose order in the Wild West of cryptocurrency secondary
market trading?
Financial services regulation is complex and growing more
complex each day.16 Among other challenges, regulators do not
always understand what exactly (transactions, other activities, or
attributes) gives rise to regulatory intervention.17 Complicated
financial products precipitated the financial crisis that began in
2007,18 and, in the wake of the crisis, many were disillusioned.
13. David Floyd, Fraudulent Trading Drove Bitcoin’s $150-to-$1,000 Rise in 2013: Paper,
INVESTOPEDIA (June 25, 2019), https://www.investopedia.com/news/bots-drove-bitcoins-150to
1000-rise-2013-paper/ [https://perma.cc/JQZ3-W3BB].
14. See Today’s Cryptocurrency Prices by Market Cap, COINMARKETCAP, http://coinmarket
cap.com/ [https://perma.cc/RU94-8KH3]; see also Nathan Reiff, How Much of All Money Is in
Bitcoin?, INVESTOPEDIA (June 21, 2020), https://www.investopedia.com/tech/how-much-worlds-
money-bitcoin/ [https://perma.cc/DA2X-CL5R].
15. See e.g., Press Release, U.S. Commodity Futures Trading Comm’n, CFTC Orders
Bitcoin Exchange Bitfinex to Pay $75,000 for Offering Illegal Off-Exchange Financed Retail
Commodity Transactions and Failing to Register as a Futures Commission Merchant (June
2, 2016), https://www.cftc.gov/PressRoom/PressReleases/7380-16 [https://perma.cc/DCZ9-
FUAS].
16. See Shaanan Cohney, David Hoffman, Jeremy Sklaroff & David Wishnick, Coin-
Operated Capitalism, 119 COLUM. L. REV. 591, 603 (2019); see also Examining Facebook’s
Proposed Cryptocurrency and Its Impact on Consumers, Investors, and the American Financial
System: Hearing Before the H. Comm. on Fin. Servs., 116th Cong. (2019) (statement of Chris
Brummer, Professor of Law, Georgetown University Law Center) [hereinafter Statement of
Chris Brummer], https://financialservices.house.gov/uploadedfiles/hhrg-116-ba00-wstate-brum
merc-20190717.pdf [https://perma.cc/T7EU-5NEJ] (describing the structure of Facebook’s
proposed Diem network); id. (statement of Katharina Pistor, Edwin B. Parker Professor of
Comparative Law and Director, Center on Global Legal Transformation, Columbia Law
School) [hereinafter Statement of Katharina Pistor], https://financialservices.house.gov/up
loadedfiles/hhrg-116-ba00-wstate-pistork-20190717.pdf [https://perma.cc/5LJG-CT2P].
17. See Chris Brummer & Yesha Yadav, Fintech and the Innovation Trilemma, 107 GEO.
L.J. 235, 263-64 (2019).
18. See, e.g., Saule T. Omarova, The Quiet Metamorphosis: How Derivatives Changed the

Legacy financial institutions and other market participants’

avaricious, self-serving, and predatory behavior initiated a polarized
debate regarding the federal government’s $700 billion bailout of
Wall Street intermediaries.19 Developers began to imagine a
financial services industry without traditional intermediaries—
depository banks, investment banks, stock exchanges, brokers, and
dealers.
Innovative financial technology (fintech) products and firms
aimed to disrupt conventional financial markets and displace legacy
financial institutions.20 Programmers introduced alternative finan-
cial products and platforms, namely peer-to-peer distributed digital
ledger platforms that originate and distribute cryptocurrencies.21
Since the publication of the Bitcoin blockchain White Paper in
2010, markets have witnessed the origination of more than five
thousand cryptocurrencies.22 In the ensuing decade, regulators have
scrambled to keep pace. Distributed digital ledger technology and
the popular subset of blockchain-based technologies are among the
“Business of Banking,” 63 U. MIAMI L. REV. 1041, 1041 (2009).

19. See David M. Herszenhorn, Congress Approves $700 Billion Wall Street Bailout, N.Y.
TIMES (Oct. 3, 2008), https://www.nytimes.com/2008/10/03/business/worldbusiness/03iht-bail
out.4.16679355.html [https://perma.cc/K6J8-TUHM].
20. Brummer & Yadav, supra note 17, at 263-64; Rory Van Loo, Making Innovation More
Competitive: The Case of Fintech, 65 UCLA L. REV. 232, 232 (2018); William Magnuson,
Regulating Fintech, 71 VAND. L. REV. 1167, 1167 (2018); Adam J. Levitin, Pandora’s Digital
Box: The Promise and Perils of Digital Wallets, 166 U. PA. L. REV. 305, 305-06 (2018); Jeanne
L. Schroeder, Bitcoin and the Uniform Commercial Code, 24 U. MIA. BUS. L. REV. 1, 1 (2016);
Angela Walch, The Bitcoin Blockchain as Financial Market Infrastructure: A Consideration
of Operational Risk, 18 N.Y.U. J. LEGIS. & PUB. POL’Y 837, 837 (2015).
21. This Article refers to distributed digital technology protocols as “enterprises.” A rich
literature explores the development of entities operating in a manner that is colloquially
described as partnerships, trusts, and other business organizational forms notwithstanding
their failure to formally adopt (and in some cases they even reject) the notion that they
operate pursuant to a conventional business structure; an even more interesting discussion
emerges upon recognizing that these entities increasingly rely on algorithms to make
fundamental operational and investment decisions. See Shawn Bayern, Are Autonomous
Entities Possible?, 114 NW. U. L. REV. ONLINE 23, 24-25 (2019) (responding to criticism from
Lynn Lopucki); see also Lynn M. Lopucki, Algorithmic Entities, 95 WASH. U. L. REV. 887, 887
(2018).
22. Compare Historical Snapshot-01 January 2017, COINMARKETCAP, http://coinmarket
cap.com/historical/20170101/ [https://perma.cc/78XM-6FGQ] (listing 636 coins on the market
in 2017), with Historical Snapshot-06 January 2019, COINMARKETCAP, http://coinmarket
cap.com/historical/20190106/ [https://perma.cc/5GUS-3RAA] (listing slightly over two thou-
sand coins on the market in 2019).

most innovative technologies in the financial markets ecosystem.23

Central banks, national governments, and significant financial
institutions increasingly signal an interest in the origination,
distribution, and exchange of proprietary cryptocurrencies.24
Indisputably, these coins and tokens have moved from the shadows
to center stage.
In the summer of 2019, for example, Facebook released a White
Paper announcing plans to issue a stablecoin—Diem, a global
23. While many use the language “blockchain technology” and “digital ledger technology”
(DLT) interchangeably, the two are not synonymous. Media accounts, popular accounts, and
the literature conflate the general theory of DLT with blockchain applications and, perhaps
even more disappointingly, use the terms interchangeably. For the purposes of this Article,
I will aim to use DLT to describe the foundational technology and blockchain to refer to
specific protocols or applications. While DLT and blockchain are not synonymous, the
distinctions are too technical to explore here and do not alter the analysis and conclusions
presented in this Article.
For a useful introduction to DLT and an analysis of the epistemological challenges in the
literature, see Carla L. Reyes, If Rockefeller Were a Coder, 87 GEO. WASH. L. REV. 373, 379-82
(2019) (describing DLT as “computer software that is distributed, runs on peer-to-peer
networks, and offers a transparent, verifiable, tamper-resistant transaction-management
system maintained through a consensus mechanism rather than by a trusted third-party
intermediary that guarantees execution”); see also Angela Walch, The Path of the Blockchain
Lexicon (and the Law), 36 B.U. REV. BANKING & FIN. L. 713, 719-20 (2017) (“Blockchain
technology, sometimes called ‘the blockchain’ or just ‘blockchain,’ is alternatively referred to
as ‘distributed ledger technology’ (DLT), ‘shared ledger technology’ (SLT), ‘consensus ledger’
technology, ‘mutual distributed ledger’ technology, or even a decentralized or ‘distributed
database.’” (footnotes omitted)).
For an interesting comparative discussion, see Samantha Stein, Hashgraph Wants to Give
You the Benefits of Blockchain Without the Limitations, TECHCRUNCH (Mar. 13, 2018, 11:00
PM), https://techcrunch.com/2018/03/13/hashgraph-wants-to-give-you-the-benefits-of-block
chain-without-the-limitations/ [https://perma.cc/5V6L-RDJQ]. While the bitcoin blockchain
protocol is one of the most popular and well-known blockchain protocols, there are an
increasing number of financial and nonfinancial blockchain protocols. Consider, for example,
Ethereum (another exceedingly popular blockchain with diverse financial and nonfinancial
applications), Hashgraph (a hashgraph algorithm), or an asynchronous Byzantine Fault
Tolerance (aBFT) consensus mechanism based on a virtual voting algorithm combined with
the gossip protocol or Directed Acyclic Graphs (DAGs). Cf. Press Release, Globe Newswire,
tune.fm Launches New Token Protocol on Hedera Hashgraph (Aug. 5, 2020), https://ap
news.com/press-release/globe-newswire/3601a20bf7c29098f1df2eb77dfee4f9 [https://perma.
cc/XH8C-URZY].
24. Anna Isaac & Caitlin Ostroff, Central Banks Warm to Issuing Digital Currencies,
WALL ST. J. (Jan. 23, 2020, 11:15 AM), https://www.wsj.com/articles/central-banks-warm-to-
issuing-digital-currencies-11579796156 [https://perma.cc/Y9EP-FS4D]; Nathaniel Popper,
Central Banks Consider Bitcoin’s Technology, if Not Bitcoin, N.Y. TIMES (Oct. 11, 2016),
https://www.nytimes.com/2016/10/12/business/dealbook/central-banks-consider-bitcoins-
technology-if-not-bitcoin.html [https://perma.cc/9E5J-Y6HF].

cryptocurrency designed to displace existing government-issued fiat

and introduce a frictionless international financial payment
system.25 Facebook’s description depicts Diem as sharing attributes
with a variety of traditional assets and financial services; according
to Facebook, Diem is a currency or cash-equivalent cryptowallet and
private payment platform.26
Simply stated, Diem defies the rigid, siloed designations charac-
teristic of the laws governing financial markets. Distributed digital
ledger protocols enable developers to create multifaceted entities
and products that play many roles. Diem operates as the issuer, the
investment bank or underwriter for the initial offering of Diem, the
broker-dealer who executes Diem trades for Diem holders, and the
exchange platform that facilitates Diem secondary market transac-
tions.27
Achieving regulatory aims may be difficult, if not impossible, if
lawmakers and regulators do not understand exactly which entity
attributes or characteristics give rise to regulation. For nearly a
century, financial regulators have ordered markets based on the role
that intermediaries play in the development and execution of
primary and secondary market transactions.28 Determining the
25. Jeff Horwitz & Parmy Olson, Facebook Unveils Cryptocurrency Diem in Bid to Reshape
Finance, WALL ST. J. (June 18, 2019, 6:59 PM), http://www.wsj.com/articles/facebook-unveils-
crypto-wallet-based-on-currency-libra-11560850141 [https://perma.cc/52Z2-GRDX]. Libra is,
in fact, Facebook’s fourth attempt at introducing an alternative financial services platform.
26. Examining Facebook’s Proposed Crypocurrency and Its Impact on Consumers,
Investors, and the American Financial System: Hearing Before the H. Comm. on Fin. Servs.,
116th Cong. 2 (2019) (statement of David Marcus, Head of Calibra, Facebook), https://finan
cialservices.house.gov/uploadedfiles/hhrg-116-ba00-wstate-marcusd-20190717.pdf [https://
perma.cc/5CKE-YL89] (describing how Diem will be linked to a number of different real world
assets); Sherman Lee, Explaining Stable Coins, the Holy Grail of Cryptocurrency, FORBES
(Mar. 12, 2018, 12:15 AM), https://www.forbes.com/sites/shermanlee/2018/03/12/explaining-
stable-coins-the-holy-grail-of-crytpocurrency/?sh=f2547ca4fc64 [https://perma.cc/TK7F-FB4N]
(“A ‘stable coin’ is a cryptocurrency that is pegged to another stable asset, like gold or the U.S.
dollar. It’s a currency that is global, but is not tied to a central bank and has low volatility.
This allows for practical usage of using cryptocurrency like paying for things every single
day.”). The structure of Diem operates in tandem with cryptowallets distributed by affiliated
subsidiary Novi. See generally NOVI, http://www.novi.com/ [https://perma.cc/7HRG-VNY9] (“A
connected wallet for a connected world.”).
27. LIBRA ASS’N MEMBERS, WHITE PAPER 4-5 (2020), https://wp.diem.com/en-US/wp-con
tent/uploads/sites/23/2020/04/Libra_WhitePaperV2_April2020.pdf [https://perma.cc/L6CY-
4T5F].
28. See generally Saule T. Omarova, New Tech vs. New Deal: Fintech as a Systemic
Phenomenon, 36 YALE J. ON REGUL. 735 (2019) (describing the New Deal legislation as point

proper timing, scope, and emphasis of regulatory intervention are

questions that scholars, practitioners, and regulators have wrestled
with for decades.
As the pace of innovation accelerates, the divergence between the
limits of existing regulation and the creativity spurring alternative
fintech-inspired financial products and intermediaries becomes
increasingly salient.29 Despite growing complexity, conventional
wisdom continues to suggest that the existing regulatory framework
sufficiently addresses normative goals such as customer protection
and market integrity.30
Yet, the existing framework does not envision fluid intermediar-
ies that have the ability to transform.31 Developers’ continuous
improvement of application programming interface (API) may
enable some cryptocurrency exchanges to create a dynamic opera-
tional or governance infrastructure; in other words, a platform that
relies on intermediary-like functions may evolve or undertake a
metamorphosis that reduces or eliminates reliance on intermedia-
tion, shedding the features of centralization and permitting peer-to-
peer, decentralized transactions. Consequently, questions emerge
regarding the efficacy of applying our existing regulatory framework
to cryptocurrency secondary market transactions. The dynamic
nature or potential for centralized trading infrastructure to morph
into decentralized infrastructure remains undertheorized.32 This
Article helps to fill this gap.
This Article makes three critical contributions. First, this Article
challenges regulatory approaches that prioritize the supervision and
enforcement of primary market transactions. While regulators
generally agree on the normative goals of regulation, opinions
diverge regarding the optimal approach for achieving these aims.
The consensus that drives the dominant narrative portraying
of departure for analysis).

29. See CONGR. RSCH. SERV., IF11195 FINANCIAL INNOVATION: REDUCING FINTECH
REGULATORY UNCERTAINTY 1 (2019).
30. But see infra note 424 and accompanying text.
31. Statement of Katharina Pistor, supra note 16, at 9.
32. Chairman’s Testimony on Virtual Currencies: The Roles of the SEC and CFTC:
Hearing Before the S. Comm. on Banking, Hous. & Urb. Affs., 115th Cong. 2 (2018) (statement
of Jay Clayton, Chairman, SEC), https://www.sec.gov/news/testimony/testimony-virtual-
currencies-oversight-role-us-securities-and-exchange-commission [https://perma.cc/CSV6-
SKPM].

primary market regulation—chiefly mandatory disclosure—as the

“anointed” regulatory approach stems from a belief that imposing
and enforcing material disclosure reduces asymmetries of informa-
tion, fraud, manipulation, and exploitation of unwitting individual
investors. In the context of cryptocurrency markets, emphasis on
primary market transactions means regulating ICOs. Yet, evidence
from Bitfinex and other platforms demonstrates the perilous
consequences of neglecting secondary market infrastructure and the
regulation of trading intermediaries.
Second, this Article identifies a transformative attribute of
cryptocurrency trading platforms that confounds efforts to apply
existing regulation. Cryptocurrency secondary market platforms
have the capacity to change; they are dynamic intermediaries,
meaning the operational attributes of broker-dealers, exchanges,
and clearinghouses developed on distributed digital ledger protocols
may gradually evolve.
Inspired by the goals that prompted the creation of crypto-
currency, programmers continuously adapt distributed digital
ledger platforms in an effort to minimize the attributes that impede
the execution of transactions “on-chain.” In other words, distributed
digital ledger platforms aim to achieve disintermediation, eliminat-
ing the need to shift any aspect of trade execution clearing and
settlement “off-chain.”33 Unlike conventional intermediaries,
dynamic intermediaries that service cryptocurrency markets may
require differing regulatory interventions based on the level of dis-
intermediation that each has achieved.
Finally, this Article proposes a regulatory response to the under-
theorized dynamics of decentralization in cryptocurrency secondary
markets. Notwithstanding the goals of decentralization and the
dynamic attributes of distributed digital ledger platforms, almost all
cryptocurrency broker-dealers, clearinghouses, and exchanges cur-
rently operating in markets rely on various elements of traditional
intermediation. For example, some platforms rely on centralized
order books; others centralize aspects of trade execution or settle-
ment. Decentralization is, thus, often aspirational.
33. See infra notes 244-46.

The limitations of existing regulation leave customers, markets,

and citizens unprotected from the well-established enterprise and
systemic risks that arise from intermediation in conventional and
cryptocurrency markets (intermediary risks). While the market for
cryptocurrency remains relatively small, enterprise risk manage-
ment failures may be contained. As the market expands, however,
cryptocurrency exchanges’ risk management failures may engender
systemic risk management concerns.
This Article recommends employing a registration process
whereby platforms signal and can subsequently amend registration
forms indicating the specific financial product or service they offer
and the extent of their reliance on intermediation. Even firms that
claim to have achieved disintermediation or decentralization would
register to indicate their status. Such an approach creates an imme-
diate pathway to enable regulators to impose order in secondary
cryptocurrency markets.
Part I of this Article briefly describes the history and philosophy
of the regulatory framework that governs conventional secondary
market transactions. This Part focuses on securities markets, but
notes that similar norms motivate regulation in the market for
commodities and other asset classes. It argues that the dominant
narrative in securities markets regulatory discourse prioritizes
primary market transactions, relegating secondary market transac-
tions and (perhaps more importantly) secondary market intermedi-
aries to less attentive regulation. Self-governance is the ethos of
secondary market transaction regulation, and, as such, our regula-
tory framework expressly delegates notable supervisory and enforce-
ment authority to market participants. Adopting such a perspective
may undermine regulators’ efforts to achieve normative goals.
Part II introduces the general attributes of cryptocurrencies and
a developing taxonomy of centralized and decentralized crypto-
currency exchanges. This Part argues that many of the exchanges
that describe themselves as decentralized or disintermediated
continue to rely on some aspect of off-chain or traditional intermedi-
ation. Several exchanges market themselves to trading communities
as decentralized distributed digital ledger platforms; market
participants’ use of the term “decentralized” is, however, a misno-
mer, a mistake, and, in some instances, an active misrepresentation

of the operational infrastructure of the exchange. Regulators must

refuse to elevate form over substance and investigate the central
operational mechanics of the platforms and interrogate the cryp-
tocurrency platforms’ plans to minimize or eliminate attributes that
centralize trading.
Part III contends that cryptocurrency secondary market actors
face many of the same risks and concerns that conventional market
participants struggle to address within their firms and across the
industry. As the Bitfinex example illustrates, regulation (or the lack
thereof) casts cryptocurrency trading markets into the shadows and
invites variegated forms of manipulation and misconduct. The
automation or integration of increasingly sophisticated algorithms
in trading markets has altered the nature of secondary market
trading, resulting in market conditions that may disadvantage less
sophisticated trading counterparties. Coupled with automation,
high frequency trading (HFT) strategies accelerate the pace of
trading. HFT strategies may employ algorithms or bots or co-locate
their server closer to an exchange to take advantage of the delay
between a buyer or seller placing an order and the execution of the
trade (latency). More specifically, this Part explores controversial
trading tactics such as front-running, pinging, and spoofing.
Finally, this Part posits that a third class of pernicious concerns
challenges cryptocurrency secondary trading markets—cyber-
security threats. Evidence of the harms and losses that result from
these enterprise risk-management failures should raise alarms.
These risks will increase as cryptocurrency markets grow and likely
create spillover effects and systemic risks that impact other areas
of financial markets.
Part IV proposes that regulators require market participants to
self-designate the regulatory agency that they believe ought to
supervise their activities. This know-your-regulator approach
acknowledges that cryptocurrency platforms may operate on a
spectrum, offering diverse financial products and services with
varying levels of intermediation. The self-designation process
requires a platform to submit to a specific regulator or indicate why
the platform believes that its operations are not subject to regula-
tory oversight.

This proposal parallels the existing Commodity Futures Trading

Commission (CFTC) practice of self-certification. The CFTC has had
moderate success employing the self-certification process to regulate
Bitcoin futures exchanges. To ensure proper alignment between
regulated entities and regulators, limit territorial disputes among
federal regulatory agencies, and militate against regulatory capture,
this Article further proposes that each regulatory agency direct the
review of self-designation applications to its Financial Services
Office of Innovation (FSOI). The FSOI will evaluate know-your-
regulator registrations and report to its agency and to the Financial
Stability Oversight Council (FSOC) regarding registration applica-
tions and the agency’s approach to processing, assessing, and
managing self-designation submissions.
Part V addresses the benefits and limitations of the proposal and
responds to concerns that regulatory arbitrage, competition, and
costs may stymie adoption of the proposal. While each of these
concerns requires thoughtful consideration, careful construction of
the self-designation process and periodic review and assessment
may address several of these concerns.
I. INTERMEDIATION: A FUNCTIONAL ANALYSIS
Mandatory disclosure serves as a theoretical and practical

linchpin in capital markets regulation. Unless an offering is
otherwise exempt from registration, the Securities Act of 1933
(Securities Act) requires issuers who seek to raise capital to register
the securities with the Securities and Exchange Commission (SEC)
prior to offering the securities to investors for sale.34 Mandatory
disclosure is the normative principle and the central objective of the
registration process. To complete the registration process, issuers
must compile and distribute extensive disclosures describing, among
other matters, the nature of the issuer’s business; the educational
and professional profiles of executives appointed to senior manage-
ment positions and individuals selected to serve on the board of
directors; tangible and intangible property; risk factors; and the
34. See generally Securities Act of 1933, 15 U.S.C. §§ 77a-77mm; see also PATRICK S.
COLLINS, REGULATION OF SECURITIES, MARKETS, AND TRANSACTIONS 31 (2011).

financial health—current and forecasted earnings and revenues—of

the firm.35
Notwithstanding an enduring debate regarding the limits of
mandatory disclosure, regulators, legislators, and commentators’
commitment to this regulatory paradigm persists. Requiring
disclosure of material information regarding issuers of equity and
debt securities mitigates inherent asymmetries of information in
registered public offerings.36
Parallel regulation imposing continuous, periodic disclosure for
publicly traded securities enhances the efficiency, fairness, and
integrity of secondary market transactions.37 The thread of manda-
tory disclosure weaves the two federal securities laws governing
public offerings and trading in secondary markets together.38
Consistent with the regulatory emphasis on mandatory disclosure,
regulators disproportionately allocate supervision and enforcement
resources to the oversight of disclosure-centered aspects of primary
market transactions.39
This standard capital markets regulation narrative mistakenly
signals that mandatory disclosure is a panacea. This Part contends
that myopically focusing on the disclosure obligations that comprise
the registration process in primary market transactions may ob-
scure market misconduct in secondary markets, permitting pred-
atory and fraudulent practices to flourish.
35. See COLLINS, supra note 34, at 22.

36. See Andrew A. Schwartz, Mandatory Disclosure in Primary Markets, 2019 UTAH L.
REV. 1069, 1071-72.
37. See id.
38. Securities Exchange Act of 1934, 15 U.S.C. § 781(b) (requiring registration in order
to be part of a national exchange); id. § 781(g) (requiring registration of securities by issuers
that have assets in excess of $10 million and that have a class of equity securities held by at
least two thousand record holders); id. § 78o(d) (requiring supplementary and periodic
information of issuers that have filed a registration statement registering securities with the
SEC in a public offering).
39. Schwartz, supra note 36, at 1071-72.

A. Traditional Intermediaries
U.S. capital markets promote an efficient allocation of capital.40

Entrepreneurs seek access to capital markets to raise funds by
issuing equity interests (shares of stock) or debt securities.41
Investors exchange their savings for equity or debt interests
distributed by issuers.42 Issuers receive an infusion of capital and
investors hope to receive a return on their investments that exceeds
savings rates.43
Purchasing securities endows investors with certain rights
commonly associated with the class of securities acquired; these
rights often include (but may not be limited to) the right to share in
the issuer’s profits (dividends), the right to vote on certain gover-
nance issues (voting rights), and the right to participate in the
appreciation of the valuation of the firm.44 We describe the origina-
tion and distribution of equity or debt securities from the issuer to
investors as primary market transactions; we refer to subsequent
resales among investors and related trading activities as secondary
market transactions.45
For over 150 years, Congress abstained from formally intervening
in the regulation of capital markets. In the fall of 1929, intense
market speculation and pervasive fraud led to staggering losses for
investors, long-lasting industrial decline, and widespread unemploy-
ment.46 Depressed macroeconomic conditions created political
momentum for the adoption of federal regulation in banking and
capital markets.47
40. See EUGENE F. FAMA & MERTON H. MILLER, THE THEORY OF FINANCE 4-15 (1972)
(explaining the wealth allocation model for utility maximization).
41. Eugene F. Fama, Efficient Capital Markets: A Review of Theory and Empirical Work,
25 J. FINANCE 383, 383 (1970).
42. See id.; FAMA & MILLER, supra note 40, at 4-15; Joseph E. Stiglitz, Pareto Optimality
and Competition, 36 J. FIN. 235, 247 (1981).
43. Fama, supra note 41, at 383.
44. See GARY STRUMEYER, THE CAPITAL MARKETS 21 (Sarah Swammy ed., 2017).
45. See id.
46. Kimberly Amadeo, Stock Market Crash of 1929 Facts, Causes, and Impact, BALANCE
(Sept. 2, 2020), https://www.thebalance.com/stock-market-crash-of-1929-causes-effects-and-
facts-3305891 [https://perma.cc/7PWG-Q5GW].
47. See U.S. Senate Hist. Off., Subcommittee on Senate Resolutions 84 and 239, http://
www.senate.gov/artandhistory/history/common/investigations/Pecora.htm [https://perma.cc/
27VA-GWRC].

Sensational investigative hearings revealed that more than half

of the $25 billion in securities distributed between the end of World
War I and the stock market crash of 1929 were worthless.48 Detailed
accounts of issuers’ intentional dissemination of false and mislead-
ing information49 punctuated spectacular evidence of fraud and
stunning acts of avarice. During this period, securities listed on the
New York Stock Exchange declined from a pre-crash high of $89
billion to $15 billion in 1932.50 The legislative history of the
Securities Act and the Exchange Act of 1934 (Exchange Act) reveals
disturbing illustrations of issuers preying on unwary investors as
well as the limitations of state securities regulation commonly
known as blue-sky laws. One critical investigative report suggested
that “had there been full disclosure,” issuers’ schemes “could not
long have survived the fierce light of publicity and criticism.”51
Invoking the adage made popular by Justice Brandeis—“Sunlight
is said to be the best of disinfectants; electric light the most efficient
policeman”52—Congress enacted the nation’s first federal securities
law—the Securities Act.53 Consistent with the sharp criticisms in
the volumes of evidence gathered by Congress, the legislative
intervention expressly aimed to address fraud in primary market
transactions by imposing mandatory disclosure requirements for
issuers distributing securities to the public. An issuer’s failure to
register securities with the SEC prior to a public offering of the
securities may lead to harsh, if not damning, liability.54 Recognizing
parallel concerns in secondary market transactions, Congress
enacted the Exchange Act a year later, requiring marketplaces that
facilitate the trading of securities distributed in a public offering to
48. H.R. REP. NO. 73-85, at 2 (1933).

49. See MICHAEL PERINO, THE HELLHOUND OF WALL STREET: HOW FERDINAND PECORA’S
INVESTIGATION OF THE GREAT CRASH FOREVER CHANGED AMERICAN FINANCE 288 (2010).
50. JAMES D. COX, ROBERT W. HILLMAN & DONALD C. LANGEVOORT, SECURITIES
REGULATION 1-8 (8th ed. 2017).
51. See James Grant, White Knight, FORBES (May 12, 2002, 11:00 PM), https://www.
forbes.com/global/2002/0513/062.html#388b42a8605a [https://perma.cc/DCK2-4LWD] (quoting
Pecora Report).
52. LOUIS D. BRANDEIS, OTHER PEOPLE’S MONEY AND HOW THE BANKERS USE IT 92 (1914).
53. 15 U.S.C. §§ 77a-77mm.
54. See id. § 77f.

register with the SEC and submit to the agency’s regulatory

oversight.55
As noted above, the registration requirements and liability
provisions of the Securities Act mandate that, unless an exemption
for an offering of securities applies, issuers must register securities
with the SEC prior to sale.56 In other words, in the absence of an
exemption, an issuer must agree to submit to an onerous and
expensive registration process that obligates the issuer to disclose
material information regarding its business, executive managers,
risks, and financial welfare, among other matters.57
The mandatory disclosure requirements in the Securities Act
advance normative objectives such as investor protection and
promote the three central goals of securities market regulation—the
maintenance of fair, orderly, and efficient markets that facilitate
capital formation.58 According to proponents of these norms,
disclosure increases transparency, reduces asymmetries of informa-
tion, and mitigates fraud and manipulation as well as other
misconduct by issuers and affiliates.59 Mandating registration and
incorporating threshold disclosure requirements markedly reduces
issuers’ incentives to misrepresent material information, amelio-
rates the threat of fraud, and alleviates concerns that states with
disparate state regulatory standards may compete to attract issuers,
launching a regulatory race to the bottom.60
Mandatory disclosure reduces the inherent informational advan-
tages or asymmetries of information between the issuers and
investors in capital markets. Entrepreneurs who rely on angel
investors, venture capital funds, or multiple rounds of exempt
private offerings may successfully extend the runway for their start-
up firms.61 However, even the most successful start-ups find that
55. Id. §§ 78a-78qq.

56. See Schwartz, supra note 36, at 1079.
57. See STRUMEYER, supra note 44, at 121.
58. About the SEC, SEC, https:www.sec.gov/about.shtml [https://perma.cc/2Y4D-7XFB]
(“The mission of the SEC is to protect investors; maintain fair, orderly, and efficient markets;
and facilitate capital formation. The SEC strives to promote a market environment that is
worthy of the public’s trust.”) .
59. See Kristin N. Johnson, Regulating Innovation: High Frequency Trading in Dark
Pools, 42 J. CORP. L. 833, 843 (2017).
60. See id.
61. See Elisabeth de Fontenay, The Deregulation of Private Capital and the Decline of the

private fundraising cannot compete with the breadth and depth of

resources available in the public offering market.62
In the absence of mandatory disclosures, investors may have
limited access to the material information needed to make a
reasonable investment decision. Moreover, one expects the insiders
with access to material, nonpublic information about the issuer—the
professional executives and members of the board of directors who
manage the business affairs of the issuer—to engage in puffery
when marketing the issuer’s securities to investors. Mandatory
disclosure neutralizes insiders’ incentives to misrepresent material
information regarding the issuer.63
Finally, the stock market crash of 1929 and similar subsequent
disruptions demonstrate that irrational investor exuberance,
issuers’ self-interested incentives, and investors’ lack of access to
material information undermine arguments in favor of adopting a
caveat emptor or self-regulatory approach to govern primary market
transactions.64 Thus, instead of relying on issuer self-governance,
federal mandatory disclosure requirements introduce an efficient,
uniform regulatory metric. Mandatory disclosure enables authori-
ties to evaluate an issuer’s compliance, creates a point of departure
for investor assessment of the merits of investing in the security,
and provides a focus on securities fraud litigation claims.
While the issuer bears primary responsibility for ensuring ac-
curate disclosure of material information, a small, well-known
cohort of financial institutions serve as intermediaries in both pri-
mary and secondary market transactions.65 Congress and regulators
have increasingly demanded that intermediaries adopt affirmative
measures to promote disclosure norms. In primary markets, for
example, intermediaries may face strict liability for promoting the
sale of unregistered securities.66
Public Company, 68 HASTINGS L.J. 445, 447 (2016).

62. See id. at 448.
63. See Victor Brudney, Insiders, Outsiders, and Informational Advantages Under the
Federal Securities Laws, 93 HARV. L. REV. 322, 326 (1979).
64. See Gary F. Goldring, Mandatory Disclosure of Corporate Projections and the Goals
of Securities Regulation, 81 COLUM. L. REV. 1525, 1527 (1981).
65. CLAIRE A. HILL & RICHARD W. PAINTER, BETTER BANKERS, BETTER BANKS: PROMOTING
GOOD BUSINESS THROUGH CONTRACTUAL COMMITMENT 5 (2015).
66. See 15 U.S.C. § 77e(a), (c).

Most issuers who seek to launch a public offering will engage a

classic financial markets intermediary—an investment bank.
Serving as underwriters, investment banks have traditionally occu-
pied an important role in the initial public offering (IPO) market.67
For more than two hundred years, investment banking firms have
served as elite, dominant intermediaries in IPO markets.68 These
firms offer access to valuable networks, industry expertise, and the
funding required for international road shows marketing an issuer’s
IPO.69 These attributes enable the issuer to market an IPO to
diverse and geographically dispersed investors. The investment
bank relies on its network of investor-contacts, including high-net-
worth individuals, family offices, private equity, and institutional
funds.70
The most striking attributes of investment banking intermedia-
tion in IPO markets may, however, be compensation and risk
exposure.71 Traditionally, an investment bank enters into a firm
commitment agreement with an IPO issuer; if the anticipated
offering reaches the requisite size, the issuer may also seek to list
the offering on a national securities exchange.72 Under the terms of
the agreement, the investment bank agrees to underwrite the offer-
ing, meaning the investment bank enters into a contract committing
to act as the sole investor or acquirer of the entire allotment of the
IPO.73
Despite the contractual commitment, both the issuer and under-
writer understand that the investment bank fully intends to identify
investors who will agree to purchase predetermined allocations of
the IPO allotment ahead of the issuer’s distribution of the shares to
the underwriter.74 Presumably, the investment bank will merely
67. HILL & PAINTER, supra note 65, at 5.

68. In 2006, the six largest investment banking firms accounted for 81.9 percent of the
industry’s capital markets offerings. SEC. INDUS. ASS’N, SECURITIES INDUSTRY YEARBOOK 6-18
(Lisa Dabbraccio ed., 2006).
69. Andrew F. Tuch, The Self-Regulation of Investment Bankers, 83 GEO. WASH. L. REV.
101, 161 (2014).
70. See Bernard Black, The Core Institutions that Support Strong Securities Markets, 55
BUS. LAW. 1565, 1568 (2000).
71. Tuch, supra note 69, at 161.
72. Id. at 114-15.
73. Id.
74. See ANTHONY SAUNDERS & MARCIA MILLON CORNETT, FINANCIAL MARKETS AND

serve as a matchmaker, facilitating the introduction of the issuer

and institutional or other sophisticated investors interested in
purchasing the shares.75
Notwithstanding the parties’ understanding, the investment bank
has assumed notable risk. Having agreed to act as an underwriter
or intermediary in the marketing and sales process, the investment
bank will bear the risk that there is no market for the issuer’s
securities as well as the threat that market conditions or due
diligence during the offering process may lead to a lower than
anticipated valuation of the issuer’s shares.76 In addition to this
sizable economic risk, agreeing to serve as an underwriter exposes
the investment bank to civil liability under federal securities laws
in connection with the offering.77
Unsurprisingly, in exchange for assuming the risk of underwrit-
ing an offering, investment banks receive staggering compensa-
tion.78 To mitigate its risk exposure, an investment bank may enter
into an agreement with a syndicate of investment banks and
allocate the IPO shares as well as the risk exposure related to the
offering among the members of the syndicate.79
Finally, intermediation in IPO markets has an expressive func-
tion. In their service as underwriters, investment banks perform a
gatekeeping role. Relationship managers within the investment
bank aim to identify a continuous stream of issuers whose business
models will engender market interest.80 After general investiga-
tions, the investment bank employs a valuation methodology to
determine the probability of demand for the issuers’ shares.81 The
valuation also offers an important indicator for the potential pricing
for the issuer’s shares.82
INSTITUTIONS 251-52 (5th ed. 2012).

75. Id.
76. Andrew F. Tuch, Securities Underwriters in Public Capital Markets: The Existence,
Parameters and Consequences of the Fiduciary Obligation to Avoid Conflicts, 7 J. CORP. L.
STUD. 51, 55 (2007).
77. See 15 U.S.C. §§ 78a-78qq.
78. See Tuch, supra note 69, at 161.
79. Tuch, supra note 76, at 56.
80. See id. at 61.
81. See id. at 58-59.
82. See id.

An underwriter’s reputational contribution may be one of its most

significant contributions to the IPO marketing campaign.83 Often,
the lead underwriter’s reputation attracts investors and influences
broader market interest in the offering.84 Perhaps most importantly,
investors trust underwriters to accurately price the issuer’s shares.85
Underwriters with strong reputations for identifying issuers whose
shares appreciate rapidly or perform well over the long run often
have little difficulty attracting investors or persuading the investors
to commit to purchase an allotment of the IPO shares.86
For each of the capital markets transactions described above as
well as the broader universe of primary and secondary market
transactions, investment banks and similar financial institutions
function as market intermediaries. The capital markets division of
the investment bank facilitates primary market transactions.87 The
brokerage division of the same bank executes secondary market
transactions on behalf of individual and institutional accounts.88 In
the absence of these intermediaries, it may be difficult, if not im-
possible, for issuers or institutional market participants to execute
sizable, complex capital markets transactions.
Financial institutions that operate as intermediaries play a sig-
nificant role in secondary market transactions. For example, broker-
dealers, often a division within the same investment bank that
serves as underwriter for an issuer’s IPO, execute secondary market
transactions in the issuer’s registered, listed securities.89 In secu-
rities markets, issuers are no longer a party to secondary market
transactions. Yet, issuers of publicly traded securities may remain
subject to mandatory continuous disclosure obligations.90
Arguably, the central actor in secondary market transactions is
neither the issuer nor the trading counterparties. Rather, the
securities exchange has historically played a prominent role in
creating a forum or marketplace for secondary market transactions.

84. See id. at 161-62.
86. See id. at 52.
87. See id. at 52-53.
88. See id.
89. See id.
90. See 15 U.S.C. § 78o(d).

Securities exchanges are a critical infrastructure resource and the

focal point of the Exchange Act. The next Section examines the role
of securities exchanges in secondary market transactions. It con-
tends that a seismic shift in the structure of markets challenges the
underlying assumptions in secondary markets regulation.
B. Governance and Economics of Secondary Market Trading
In primary market transactions, an issuer distributes its equity

or debt securities in a public or private offering.91 In secondary
market transactions, market participants trade the securities pre-
viously distributed by an issuer.92 While primary and secondary
market transactions are distinct, two significant threads—manda-
tory disclosure and registration—weave the two classes of trans-
actions together. These transparency-oriented requirements for
issuers (under the Securities Act)93 and broker-dealers and ex-
changes (under the Exchange Act)94 establish a normative thread.
Thus, in certain respects, the Exchange Act reinforces the commit-
ment to continuous disclosure of material information.95
At the same time, the Exchange Act incorporates oversight regu-
lation of secondary market activities (securities trading) and
intermediaries (brokers, dealers, exchanges, and clearinghouses).96
These regulatory measures aim to ensure fair, orderly, and efficient
trading in secondary markets.97 Yet, unlike the Securities Act’s
disclosure-centered orientation,98 the Exchange Act reflects a
broader focus on market regulation by establishing the SEC and
91. Leslie Kramer, Primary vs. Secondary Capital Markets: What’s the Difference?
INVESTOPEDIA (Oct. 2, 2020), https://www.investopedia.com/ask/answers/012615/whats-dif
ference-between-primary-and-secondary-capital-markets.asp [https://perma.cc/6LAG-535Q].
92. Id.
93. See generally 15 U.S.C. § 77a-77mm.
94. See generally id. § 78a-78qq.
95. See supra note 37 and accompanying text.
96. § 78o(b).
97. See U.S. SEC. & EXCH. COMM’N, STRATEGIC PLAN: FISCAL YEARS 2014-2018, at 3 (2016),
https://www.sec.gov/about/sec-strategic-plan-2014-2018.pdf [https://perma.cc/FJ4V-9BQ3]
(“The mission of the SEC is to protect investors, maintain fair, orderly, and efficient markets,
and facilitate capital formation.”); Janet Austin, What Exactly Is Market Integrity? An
Analysis of One of the Core Objectives of Security Regulation, 8 WM. & MARY BUS. L. REV. 215,
222-24 (2017).
98. See supra Part I.A.

introducing proxy and tender offer regulation, as well as articulat-

ing general prohibitions against fraud, insider trading, and market
manipulation.99 The registration, supervision, and oversight of the
intermediaries that execute day-to-day transactions (brokers and
dealers) and those organizations that facilitate trading (clearing-
houses or exchanges) may, however, be the statute’s most important
contributions.100
Brokers and dealers execute secondary market transactions on
behalf of clients or for their own proprietary accounts.101 These
firms, colloquially described as broker-dealers, submit to the
regulatory authority of the SEC. Section 15(a) of the Exchange Act
requires broker-dealers to register with the SEC prior to engaging
in the business of purchasing and selling securities (excluding
certain transactions or securities, such as intrastate transactions or
exempt securities).102 Under Section 15(b), the SEC may censure
broker-dealers or revoke or suspend broker-dealers’ registration.103
In some respects, secondary market actors such as broker-dealers
and exchanges also serve as gatekeepers enforcing the mandatory
disclosure paradigm. For example, Section 12(a) of the Exchange Act
prohibits a broker or dealer from executing securities transactions
on a national securities exchange unless the security is exempt from
registration or registered with the SEC.104 Alternative trading
platforms facilitate trading unregistered securities, exempt secu-
rities, or securities sold pursuant to a statutory or regulatory safe
harbor. Such resales may be limited based on the volume, the type
of investor executing the transaction in the securities, holding
periods, or other transaction-related limits.105 The prohibition on
99. § 78o(b).
100. See Austin, supra note 97, at 222.
101. Section 3(a)(4) of the Exchange Act defines a “broker” as any person who engages in
the business of effecting transactions in securities for the account of others and Section 3(a)(5)
defines a “dealer” as any person who engages in the business of buying and selling securities
for her own account. § 78c(a)(4)-(5). In contemporary financial markets, financial institutions
often offer these services through a single business division that fills customer orders from
an intrafirm inventory. Consequently, regulators and market participants describe the firms
as broker-dealers.
102. Id. § 78o(a).
103. Id. § 78o(b)(4).
104. Id. § 78l(a).
105. See id.

broker-dealer transactions in Section 12(a) of the Exchange Act106

prevents issuers who distribute unregistered securities from access-
ing the liquidity, economic, and governance benefits that national
securities exchanges engender for the issuers of registered, listed
securities.107
For over two hundred years, broker-dealers and exchanges have
had a prominent role in regulating secondary market transactions.
Notwithstanding the mandate in the Exchange Act granting the
SEC supervisory authority over broker-dealers and exchanges, the
agency has continuously acquiesced to the nation’s 150-year
tradition of permitting broker-dealers and exchanges to operate as
self-regulatory organizations (SROs) or private trade industry
associations.108 While deferential to the SEC’s interpretations and
guidance on federal securities law, SROs operate as the primary
supervisors of broker-dealers. SROs adopt, implement, and enforce
rules governing eligibility, conduct, capitalization, and similar
matters.109 This collaborative governance approach continues to be
a hallmark of U.S. securities regulation.
In contemporary markets, the Financial Industry Regulatory
Authority (FINRA) proposes and implements rules governing
broker-dealer conduct and supervises the examination and licensing
requirements for broker-dealers.110 FINRA evaluates broker-dealers’
compliance with these obligations and enforces its adopted rules,
adjudicating claims involving broker-dealers through its national
dispute resolution forum.111 The rules governing broker-dealer
conduct aim to ensure that market transactions comply with the
normative goals that frame the SEC’s mission and inspired the
adoption of federal securities laws—investor protection and
maintenance of orderly, fair, and efficient capital markets.112
106. Id.
107. See infra notes 120-29 and accompanying text.
108. A broker-dealer must become a member of a SRO that will serve as a primary
regulator, directly supervising the broker-dealer’s compliance with SRO rules and indirectly
monitoring the broker-dealer’s compliance with federal statutes and SEC regulations. See
§ 78s.
109. See id.
110. Tuch, supra note 69, at 104-05.
111. See Jerry W. Markham & Daniel J. Harty, For Whom the Bell Tolls: The Demise of
Exchange Trading Floors and the Growth of ECNs, 33 J. CORP. L. 865, 886-87 (2008).
112. Tuch, supra note 69, at 104-05.

While broker-dealers contribute to the efficient functioning of

secondary markets, national and regional securities exchanges and
clearinghouses create the marketplace where transactions tran-
spire.113 Each securities exchange or clearinghouse provides a forum
for buyers and sellers to submit indications of their interests to
trade eligible securities.114 These trading venues facilitate the
execution, clearing, and settlement of transactions.115 In this
manner, exchanges and clearinghouses serve as critical infrastruc-
ture resources, improving the economics of trading and introducing
a framework for self-governance.116
Economists have long observed that “[c]entralized trading
engenders critical economic benefits such as price discovery, price
accuracy, and liquidity.”117 In order to foster an orderly market that
achieves these important economic goals, the Exchange Act limits
the marketplaces that may trade publicly listed securities to
registered national securities exchanges.118 Exchanges collect and
distribute critical classes of data, such as information regarding the
volume, timing, and pricing of submitted bids, offers, and executed
orders.119
Aggregating this data improves price discovery,120 increasing
investors’ confidence regarding investment strategies. Enhanced
price discovery reduces the spread between offers to buy and offers
to sell for securities and lowers transaction costs, thereby improv-
ing the efficient functioning of secondary trading markets.121
113. See Markham & Harty, supra note 111, at 882-83.

114. See id.
115. See Robert R. Bliss & Robert S. Steigerwald, Derivatives Clearing and Settlement: A
Comparison of Central Counterparties and Alterative Structures, 30 ECON. PERSPS., No. 4,
2006, at 22, 22-23.
116. See id.
117. Johnson, supra note 59, at 840.
118. See supra notes 96-100 and accompanying text.
119. See Stanislav Dolgopolov, Insider Trading and the Bid-Ask Spread: A Critical
Evaluation of Adverse Selection in Market Making, 33 CAP. U. L. REV. 83, 88-89 (2004)
(defining the bid-ask spread as “the difference between the market maker’s ‘sell’ and ‘buy’
prices,” which “represents the ‘price for immediacy’ and the ‘cost of trading and the illiquidity
of a market’” (footnotes omitted)).
120. See Merritt B. Fox, Lawrence R. Glosten & Gabriel V. Rauterberg, The New Stock
Market: Sense and Nonsense, 65 DUKE L.J. 191, 222 (2015); Definition of Price Discovery
Process, NASDAQ, https://www.nasdaq.com/glossary/p/price-discovery-process [https://perma.
cc/TDX5-8AD4].
121. See Fox et al., supra note 120, at 254.

Consequently, secondary market trading on exchanges enhances

price discovery.122
In addition to enabling price discovery, centralizing trading on an
exchange increases price accuracy.123 Consolidating aggregated
pricing information improves individual investors’ and investment
professionals’ ability to price securities.124 Market participants
increasingly rely on analytical models to predict the prices of
securities.125 In many instances, greater volumes of data permit
rapid, more accurate securities pricing.126 Accurate pricing influ-
ences other economic attributes of a well-functioning market.127
U.S. capital markets attract many issuers who seek to list their
securities and investors interested in trading because market
participants perceive the securities traded in U.S. capital markets
as liquid, meaning one can quickly identify buyers or sellers who are
willing to trade listed securities.128 Thus, in liquid markets, an
investor who submits an offer to sell a security promptly receives
confirmation that the market has identified a party interested in
buying the security.129
“Liquidity generally describes the amount of time and effort
required to identify” a counterparty who is ready and willing to
enter into “a securities trade at a relatively stable price without
sensitivity to the volume of the purchase or sale order.”130 “For
122. Nazli Sila Alan & Robert A. Schwartz, Price Discovery: The Economic Function of a
Stock Exchange, 40 J. PORTFOLIO MGMT. 124, 124 (2013) (defining an exchange according to
its primary function of price discovery).
123. See Definition of Price Discovery Process, supra note 120.
125. See id. at 881, 884.
126. See id. at 885.
127. See id. at 882-85; Merritt B. Fox, Randall Morck, Bernard Yeung & Artyom Durnev,
Law, Share Price Accuracy, and Economic Performance: The New Evidence, 102 MICH. L. REV.
331, 344-45 (2003).
128. See SAUNDERS & CORNETT, supra note 74, at 5-6.
129. Id. at 12 (defining liquidity as “[t]he ease with which an asset can be converted into
cash at its fair market value”); see Markham & Harty, supra note 111, at 882-83.
130. Johnson, supra note 59, at 841; see William C. Dudley, President & CEO, Fed. Rsrv.
Bank of N.Y., Remarks at the Federal Reserve Bank of Atlanta 2016 Financial Markets
Conference (May 1, 2016), https://www.newyorkfed.org/newsevents/speeches/2016/dud160501
[https://perma.cc/KGF8-478K] (describing market and funding liquidity). Market liquidity
refers to:
[T]he cost—both in expense and time—of buying or selling an asset for cash.
Market liquidity reflects a number of factors, including any direct transaction

highly liquid securities, one might expect that a broker who places
an order to purchase [a security] will promptly receive confirmation
that a counterparty accepts her bid (maximum price) at the stated
asking price.”131 Consequently, one might describe so-called blue
chip stocks with large market capitalizations listed on national
securities exchanges as highly liquid.132
Imagine that you wish to buy shares of Amazon.com, Inc.
(Amazon.com), common stock on the Nasdaq securities exchange. In
today’s increasingly digital market, an investor would enter her bid
to purchase shares of Amazon.com on the app of her preferred
broker-dealer on her mobile phone, computer, or personal tablet.
The app may send a confirmation message via text or email within
minutes.
In fact, the broker-dealer who submits such a request to a
national securities exchange offering to purchase shares of Ama-
zon.com at the prevailing market price may receive a confirmation
within (fractions of) a second. There is also a significant possibility
that the broker-dealer may have previously acquired shares of
Amazon.com at a price slightly below the prevailing market price
and, upon receiving the investor’s order, fill the investor’s order
from its inventory. In the latter instance, the broker-dealer collects
fees for executing the trade and receives as profit the difference (or
spread) between the price that the investor bid and the lower price
that the broker-dealer paid to acquire the shares of Amazon.com.133
The contributions of exchanges extend beyond their role as
auction houses; exchanges also regulate the broker-dealers who are
members of the exchange. Typically, exchange governance measures
expense, such as brokerage costs; the price the transaction is executed at

relative to the midpoint of the bid-ask spread; how much, if at all, the
transaction moves the market price; and the immediacy or speediness with
which the transaction can be completed.
Id. In addition, funding liquidity denotes the “ability of a financial entity to raise cash by
borrowing on either an unsecured or a secured basis.” Id.
132. See Blue Chip Stocks, NASDAQ, https://www.nasdaq.com/glossary/b/blue-chip-stock
[https://perma.cc/8YCY-H4J8] (defining blue chip stocks as “[c]ommon stocks of well-known
companies with a history of growth and dividend payments”).
133. The descriptions of the transactions here are simplified for purposes of illustrating the
basic mechanics of trading, the potential economic benefits of centralized trading, and the fees
or expenses such transactions generate.

address capital requirements, risk management policies, and dis-

pute resolution policies.134 In addition, exchanges may initiate
enforcement actions against members who violate SRO regulations
or federal or state laws.135 These regulations govern member firms’
risk decisions (enterprise risk management) as well as risks across
the market for specific asset classes.136
Risks related to trading or the operational framework for trading
might be described as member firm enterprise risks.137 Market risk
or the threat that acquired assets may suddenly decline in value
offers an example of a member firm enterprise risk.138 Trading
inherently exposes firms to market risk; in a bilateral trading
market, counterparty risk—the risk that the counterparty to a trade
may default—also creates an enterprise risk for each member
firm.139 Depending on the size of the member firm that defaults,
counterparty risk may also create systemic risk for other counter-
parties trading in the asset class.140
Acting as a centralized market intermediary, an exchange may
adopt policies or practices to mitigate certain market or trading
risks. For example, exchanges may agree to act as guarantors for
the transactions executed on their platforms.141 When an exchange
agrees to act as a guarantor for transactions executed by its

135. See id. at 887.
136. See id.
137. See Bliss & Steigerwald, supra note 115, at 22-23.
138. Id. at 22-25 (arguing that the clearinghouse will only offer these benefits in markets
that reflect conditions of complete information, but noting that market conditions,
asymmetries of information, incentives to shift costs, and distributive effects on pricing of
default risk may increase systemic risk); see also id. at 24-26 (“Credit risk, on the other hand,
is centralized in the CCP [central counterparty] itself.”). Generally, clearinghouses only enter
into matching transactions, meaning a clearinghouse will enter into an agreement with a
member (Member A) acting as a protection seller only if the clearinghouse has already
identified another member (Member B) who agrees to enter into a contemporaneous
arrangement whereby the clearinghouse assigns its rights and obligations as a protection
seller in the agreement with Member A to Member B. See id. at 24-25. By matching
transactions and substituting members into its positions in agreements clearing and settling
on its platform, the clearinghouse minimizes its exposure to counterparty default risk. Id. at
24 (“A CCP can be defined as ... ‘[a]n entity that interposes itself between counterparties to
contracts traded in one or more financial markets, becoming the buyer to every seller and the
seller to every buyer.’” (footnote omitted)).
139. See id. at 22-23.
140. See id. at 23-25.
141. See id. (explaining central counterparty-mediated securities transactions).

members, the exchange interposes itself as the counterparty in the

transaction between the buyer and the seller to ensure the perfor-
mance of both counterparties under the contract.142
For example, in the transaction described above, a trader submits
a bid to purchase Amazon.com stock at the prevailing market price.
The trader places her order using a broker-dealers app on her mo-
bile phone and, if the broker-dealer does not maintain a proprietary
inventory of Amazon.com common stock, then the broker submits
the bid to the exchange.
While the exchange matches the investor’s bid with a proposed
offer to sell at the prevailing market price, a series of back-office
settlement procedures ensure that the Amazon.com stock will be
registered in the investor’s name when the investor delivers the
anticipated funds. If either the seller or the buyer should default in
her obligations related to the sale of the Amazon.com stock, the
exchange, as a guarantor, will take on the obligations of the
defaulting party and make the counterparty whole.143 In essence,
the exchange becomes the counterparty to each party to the
transaction and accepts the contractual commitments of the
counterparty.144 If either party defaults, the exchange accepts
responsibilities of the defaulting party.145
Exchanges amass reserves of funds by collecting fees, assess-
ments, fines, and penalties from members; and exchanges use the
funds in reserve accounts to satisfy obligations that arise in the
course of their operations.146 Historically, exchanges have been
organized as private associations, trusts, and partnerships;
members shared responsibility for the losses related to operational
risks.147 Curiously, in recent years, exchanges have increasingly
adopted the corporate form. Mergers and acquisitions among the
largest securities exchanges in different parts of the world have
142. See id. at 23.

143. See id. at 23-25.
144. See id.
145. See id.
146. Fox et al., supra note 120, at 198; Craig Pirrong, The Economics of Clearing in
Derivatives Markets: Netting, Asymmetric Information, and the Sharing of Default Risks
Through a Central Counterparty 16 (Jan. 8, 2009) (unpublished manuscript), https://ssrn.com/
abstract=1340660 [https://perma.cc/ZY2D-KN8Y].
147. See Pirrong, supra note 146, at 2-3, 5, 18.

created an international conglomerate.148 And perhaps most inter-

estingly, a number of exchanges have elected to register shares of
common stock for sale in public offerings as part of IPOs.149
Notwithstanding these important shifts, classical trading
industry norms continue to characterize exchange governance.
Exchanges adopt trading and governance guidelines to ensure mem-
bers’ risk practices align with the exchanges’ risk management
policies.150 For example, exchanges may impose limits on trades that
involve leveraged or structured trading strategies, such as margin
trading, as well as enforce guidelines regarding the valuation of
assets offered as collateral.151 In the event that the exchange expe-
riences a liquidity crisis, members contribute to guarantee funds to
preserve the solvency and integrity of the exchange.152
Because exchanges are SROs, the SEC carefully monitors any
formal or informal rulemaking practices.153 While securities ex-
changes enjoy broad rulemaking and enforcement authority, their
governance and risk management policies remain subject to the
supervision of the SEC.154 As discussed above, Section 6 of the
Exchange Act requires “exchanges” to register with the SEC and
subjects these entities to mandatory regulations including rules
governing broker-dealer capitalization and broader exchange
governance.155
148. See, e.g., Markham & Harty, supra note 111, at 908-10 (discussing the various mergers
of the NYSE and Nasdaq between 2000 and 2008 in response to ECNs).
149. See Cohney et al., supra note 16, at 608-09 (describing and comparing the “traditional
IPO” with the newer ICO).
150. Markham & Harty, supra note 111, at 885-87.
151. See Bliss & Steigerwald, supra note 115, at 25.
152. See id.
153. U.S. SEC. & EXCH. COMM’N, supra note 97, at 15-16.
154. Compare Securities Act of 1933, Pub. L. No. 73-22, 48 Stat. 74, 74 (stating the Act’s
purpose is “[t]o provide full and fair disclosure of the character of securities”), with Securities
Exchange Act of 1934, Pub. L. No. 73-291, 48 Stat. 881, 881 (stating the Act’s purpose is “[t]o
provide for the regulation of securities exchanges ... to prevent inequitable and unfair
practices”).
155. Regulation of Exchanges and Alternative Trading Systems, Exchange Act Release No.
34-407605 (Dec. 8, 1998) (“The Commission believes that its regulation of markets should both
accommodate traditional market structures and provide sufficient flexibility to ensure that
new markets promote fairness, efficiency, and transparency. In adopting a new regulatory
framework for alternative trading systems today, the Commission has incorporated
suggestions and responded to requests for clarification made by commenters. The Commission
believes that this regulatory approach effectively addresses commenters’ concerns while

The statutory definition of exchange casts a wide net capturing

“any organization, association, or group of persons, whether
incorporated or unincorporated, which constitutes, maintains, or
provides a marketplace or facilities for bringing together purchasers
and sellers of securities.”156 Interpreting the statutory definition of
exchange, the SEC adopted a functional test—Rule 3b-16(a)—for
assessing whether a trading platform fits within the statutory
description of “a market place or facilities for bringing together
purchasers and sellers of securities.”157 The test evaluates whether
the entity that facilitates trading performs functions commonly
associated with a stock exchange.158
Rule 3b-16(a) articulates the SEC’s perspective that the term
exchange includes any forum, “organization, association, or group
of persons” that brings together buyers and sellers of securities (as
the term is defined by federal securities laws) and uses established,
nondiscretionary methods to facilitate trading.159 Adopted in the late
1990s to address electronic communication networks, an emerging
group of alternative trading systems, Rule 3b-16(a) extends the
reach of the SEC’s supervisory authority to alternative trading
venues that perform the functions of traditional exchanges.160
Concluding that these trading venues operate as exchanges triggers
the registration requirement in Section 5 of the Exchange Act and
subjects the trading venues to the economic and governance regu-
lations that the Exchange Act imposes on registered exchanges.161
In recent years, the origination and trading of cryptocurrency has
attracted the attention of investors, regulators, legislators, media,
and commentators.162 With increasing frequency, regulators have
carefully tailoring a regulatory framework that is flexible enough to accommodate the

evolving technology of, and benefits provided by, alternative trading systems.”).
156. 15 U.S.C. § 78c(a)(1).
157. 17 C.F.R. § 240.3b-16(a) (2019).
158. Id.; § 240.6a-1(a).
159. § 240.3b-16(a).
160. See id.
161. See 15 U.S.C. § 78e.
162. See generally, e.g., Examining Facebook’s Proposed Digital Currency and Data Privacy
Considerations: Hearing Before the S. Comm. on Banking, Hous., & Urb. Affs., 116th Cong.
(2019); Sarah Jane Hughes & Stephen T. Middlebrook, Feature, Advancing a Framework for
Regulating Cryptocurrency Payments Intermediaries, 32 YALE J. REGUL. 495 (2015); Gregory
Meyer, U.S. Derivatives Regulator Looks to Calm Cryptocurrency Fears, FIN. TIMES (Jan. 31,
2018), https://ft.com/content/db9d547e-06b4-11e8-9650-9c0ad2d7c5b5 [https://perma.cc/S5NP-

signaled that cryptocurrency bears the attributes of regulated asset

classes and, therefore, that issuers, traders and marketplaces that
facilitate trading must comply with the regulatory obligations
applicable to the distribution and trading of these assets.163
Should regulators conclude that certain cryptocurrencies are secu-
rities as defined in federal securities law, a host of questions
emerge. Issuers may face registration requirements under the
Securities Act for any forthcoming public offering of the assets.164
Even after the assets are freely trading among market participants,
the firms that facilitate secondary market trading and the trading
venues where transactions are executed may face liability for failure
to register as broker-dealers or exchanges, respectively.165
This Part has offered a brief introduction to these obligations as
well as the economic and governance benefits engendered in U.S.
secondary trading markets. While many of these benefits and limits
are well studied and well settled in capital markets, we are only
beginning to apply many of these norms, regulations, and economic
theories in cryptocurrency markets. The next Part examines the
market for this emerging asset class and begins to explore assump-
tions regarding the benefits and limits of applying federal securities
law to this asset class.
II. CRYPTOCURRENCY PRIMARY AND SECONDARY MARKET

TRANSACTIONS
The creation of cryptocurrency, an alternative medium of ex-

change, promises to alter the role of intermediaries in financial
markets. Proponents praise cryptocurrency initiatives.166 Skeptics
express deep distrust.167 Illegal Ponzi and pyramid schemes, scams,
3L9G]; Cryptocurrency Comparison, IG, https://www.ig.com/en/cryptocurrency-trading/crypto

currency-comparison [https://perma.cc/P9AL-6C8X].
163. See, e.g., Jay Clayton & J. Christopher Giancarlo, Regulators Are Looking at Cryp-
tocurrency, WALL ST. J. (Jan. 24, 2018, 6:26 PM), http://www.wsj.com/articles/regulators-are-
looking-at-cryptocurrency-1516836363 [https://perma.cc/KA98-8AAY].
166. See, e.g., DON TAPSCOTT & ALEX TAPSCOTT, BLOCKCHAIN REVOLUTION: HOW THE
TECHNOLOGY BEHIND BITCOIN IS CHANGING MONEY, BUSINESS, AND THE WORLD (2016).
167. See, e.g., Dave Michaels & Paul Vigna, Facebook Pressed on Protections for Crypto-
currency Users, WALL ST. J. (July 17, 2019, 4:44 PM), https://www.wsj.com/articles/facebook-

and misconduct have been all too prevalent in cryptocurrency coin

and token offerings.168 In response, Congress has proposed legisla-
tion.169 Regulators have issued formal guidance170 and initiated
enforcement actions.171 State attorneys general have launched
investigations.172
Creators of blockchain, the technology that permits the creation
of cryptocurrencies, posit that a permissionless or publicly accessible
ledger that relies on a network of participants to verify and record
pressed-on-protections-for-cryptocurrency-users-11563396239 [https://perma.cc/WY2X-PFUC];
Nathaniel Popper, Regulators Have Doubts About Facebook Cryptocurrency. So Do Its
Partners., N.Y. TIMES (June 25, 2019), https://nyti.ms/2X1d0qv [https://perma.cc/V8Z2-G4YS].
168. See, e.g., Defendant Charged in Fraudulent ICO Ordered to Pay $450,000, SEC Re-
lease No. 24842, 2020 WL 3447978 (June 23, 2020), https://www.sec.gov/litigation/litreleases/
2020/lr24842.htm [https://perma.cc/4P8Z-MT4L]; SEC Charges Founder of Purported Block-
chain Marketplace for Fraudulent ICO, SEC Release No. 24723 (Jan. 21, 2020), https://www.
sec.gov/litigation/litreleases/2020/lr24723.htm [https://perma.cc/PXE9-MJZ9]; SEC Charges
Former Bitcoin-Denominated Exchange and Operator with Fraud, SEC Release No. 24078,
2018 WL 992274 (Mar. 23, 2018), https://www.sec.gov/litigation/litreleases/2018/lr24078.htm
[https://perma.cc/YD4R-FGXK].
169. Jason Brett, Two New Bills in Congress Offer Clarity for Blockchain Tokens and
Crypto Exchanges, FORBES (Sept. 25, 2020, 11:06 AM), https://www.forbes.com/sites/
jasonbrett/2020/09/24/two-new-bills-in-congress-offer-clarity-for-blockchain-tokens-and-crypto-
exchanges/?sh=1d90ab6f2e00 [https://perma.cc/54YN-69CD].
170. See, e.g., SEC, Framework for “Investment Contract” Analysis of Digital Assets (Apr.
3, 2019), https://www.sec.gov/corpfin/framework-investment-contract-analysis-digital-assets
[https://perma.cc/GFG8-2DB9]; Report of Investigation Pursuant to Section 21(a) of the Se-
curities Exchange Act of 1934: The DAO, SEC Release No. 81207 (July 25, 2017) [hereinafter
DAO Report], https://www.sec.gov/litigation/investreport/34-81207.pdf [https://perma.cc/43GX-
SABR]; Public Statement, SEC, SEC Statement Urging Caution Around Celebrity Backed
ICOs (Nov. 1, 2017), http://www.sec.gov/news/public-statement/statementpotentially-unlaw
ful-promotion-icos [https://perma.cc/6UBN-U6NB]; Public Statement, SEC, Statement on
Potentially Unlawful Online Platforms for Trading Digital Assets (Mar. 7, 2018), http://www.
sec.gov/news/public-statement/enforcement-tm-statement-potentially-unlawful-online-
platforms-trading [https://perma.cc/MFL6-K8JF].
171. See 2019 SEC DIV. OF ENF’T ANN. REP. 12, https://www.sec.gov/files/enforcement-
annual-report-2019.pdf [https://perma.cc/3NAK-DSNJ]; 2018 SEC DIV. OF ENF’T ANN. REP. 7-8,
https://www.sec.gov/files/enforcement-annual-report-2018.pdf [https://perma.cc/Z95V-2QYD].
172. See, e.g., Nikhilesh De, New York AG Report Faults Crypto Exchanges for Ma-
nipulation Risks, COINDESK (Sept. 19, 2018, 7:31 PM), https://www.coindesk.com/new-york-
ags-office-takes-aim-at-crypto-exchanges-in-new-report [https://perma.cc/3TFL-BXPC]; Press
Release, N.J. Off. of the Att’y Gen., New Jersey Bureau of Securities Orders Two Online
Cryptocurrency Promoters to Stop Offering Unregistered Securities in the State (Aug. 7,
2019), http://www.nj.gov/oag/newsreleases19/pr20190807a.html [https://perma.cc/3WUX-
2KNW]; Press Release, Md. Off. of the Att’y Gen., Attorney General Frosh Announces
Coordinated Cryptocurrency Crackdown (Aug. 14, 2019), http://www.marylandattorney
general.gov/Press/2019/081419a.pdf [https://perma.cc/572K-JNJF].

data or transactions can replace the various firms and institutions

that intermediate financial market transactions.173 In some in-
stances, advocates argue, the decentralization of certain financial
arrangements may remove the transactions from the ambit of regu-
latory oversight.174
In the wake of blockchain’s development, a vibrant debate has
ensued; the debate has intensified as the futurists and visionaries
committed to publicly accessible, permissionless, or decentralized
blockchains contend with for-profit businesses. The latter increas-
ingly capture the open-source projects and divert community-
developed technology to private, permissioned blockchains.
This Part explores recently articulated infrastructure-based
classifications—centralized or decentralized—for cryptocurrency
coin or token transactions. These classifications have received a
great deal of attention from regulators, practitioners, and academ-
ics. In addition, this Part focuses on the platforms or cryptocurrency
exchanges that facilitate secondary market trading.
Based on continuing infrastructure developments, these platforms
have the capacity to adapt, reducing and possibly eliminating
intermediation in secondary market trading. The unique features of
permissionless, public blockchains that enable secondary market
trading demonstrate potential to achieve disintermediation. Careful
evaluation also reveals the perils that arise in secondary market
cryptocurrency transactions and the potential for decentralized
cryptocurrency exchanges to exacerbate these concerns.
A. Cryptocurrency Primer
Cryptocurrency is a medium of exchange.175 Market participants

may use cryptocurrencies in transactions as a cash equivalent or a
form of payment in a manner similar to long-recognized
government-issued fiat or money, such as the U.S. dollar, euro, or
Japanese yen.176 Similar to conventional forms of money or cash,
173. See, e.g., SATOSHI NAKAMOTO, BITCOIN: A PEER-TO-PEER ELECTRONIC CASH SYSTEM 1
(2008), https://bitcoin.org/en/bitcoin-paper [https://perma.cc/9JRW-93FK].
174. See infra notes 205-08 and accompanying text.
175. Kevin V. Tu & Michael W. Meredith, Rethinking Virtual Currency Regulation in the
Bitcoin Age, 90 WASH. L. REV. 271, 279 (2015).
176. Public Statement by Jay Clayton, Chairman, SEC, Statement on Cryptocurrencies and

cryptocurrencies enable market participants to purchase or sell

valuables or engage in a variety of other financial transactions.177
Unlike conventional forms of legal tender or fiat, no sovereign
government issues or guarantees the value of cryptocurrency.178
Cryptocurrencies enable parties to transact on peer-to-peer plat-
forms, creating a pathway to transfer value to anyone capable of
receiving the value anywhere in the world.179
Unlike sovereign currency or government-issued fiat, developers
create cryptocurrencies. For example, in 2008, a developer who
adopted the pseudonym Satoshi Nakamoto published a whitepaper
entitled Bitcoin-A Peer-to-Peer Electronic Cash System.180 The
developer outlined an innovative, decentralized protocol or block-
chain that facilitated the generation and distribution of the crypto-
currency known as Bitcoin.181
Admittedly, this description reveals only one of the many
functions of cryptocurrencies in financial markets. In the decade
since the introduction of Bitcoin, the universe of coins and tokens
has experienced exponential growth. Cryptocurrencies with a wide
array of functions have inundated various corners of financial
markets. The universe of cryptocurrencies is continually ex-
panding.182 Today, the classes of cryptocurrency include, among
others, a great variety of coins, alt-coins, stablecoins, and tokens.183
While entrepreneurs continue to originate a significant percentage
of cryptocurrency offerings, the universe of issuers increasingly
includes various institutions such as multinational businesses,
central banks, governments, and nonprofit entities.184
Initial Coin Offerings (Dec. 11, 2017), http://www.sec.gov/news/public-statement/statement-

clayton-2017-12-11 [https://perma.cc/5Q3C-PKZ7].
177. Id.
178. DON TAPSCOTT & ALEX TAPSCOTT, WORLD ECON. F., REALIZING THE POTENTIAL OF
BLOCKCHAIN 5 (June 28, 2017), http://www3.weforum.org/docs/WEF_Realizing_Potential_
Blockchain.pdf [https://perma.cc/N7RW-R53G]. For further description of what virtual cur-
rency is, see Hughes & Middlebrook, supra note 162, at 504-05.
179. Public Statement by Jay Clayton, supra note 176.
180. See generally NAKAMOTO, supra note 173.
181. See id.
182. See supra text accompanying notes 22-24.
183. See Capital.com Research Team, Types of Cryptocurrencies: Explaining the Major
Types of Cryptos, CAPITAL (Nov. 1, 2019), https://capital.com/types-of-cryptocurrencies [https://
perma.cc/T34P-NGBZ].
184. See Bob Mason, The Next Cryptocurrency Evolution: Countries Issue Their Own Digital

For financial market regulators, the rapid development of a

diverse spectrum of cryptocurrencies poses a notable challenge. U.S.
financial markets benefit from thoughtfully balancing principles of
federalism as well as a regulatory framework characterized by
intervention based on the type of financial product (class of assets),
transaction (activity), or market participant.185 Consequently, as
described in the previous Part, determining that an asset is a
security subjects the issuer to the registration requirements of
Section 5 of the Securities Act.186 Any subsequent resales of un-
registered securities are likely subject to resale limitations,187 and
registered securities are subject to continuous reporting obli-
gations,188 exchange listing requirements (for relevant offerings),189
and secondary market transaction restrictions imposed on regis-
tered broker-dealers or securities exchanges.190
Structuring regulation in this manner yields the many benefits
described in the previous Part.191 Mandatory disclosure may
enhance investor protection and economic efficiency;192 and the
philosophy of prioritizing issuer registration of public offerings and
registration of broker-dealers and exchanges may promote fair and
orderly markets.193 However, dogmatic attempts to apply this regu-
latory framework in cryptocurrency markets reveals its limitations.
The architects of cryptocurrency markets intentionally developed
assets and marketplaces for trading these assets that do not fit
neatly into preexisting regulatory categories.194 The diversity of
Currency, FXEMPIRE, https://www.fxempire.com/education/article/the-next-cryptocurrency-

evolution-countries-issue-their-own-digital-currency-443966 [https://perma.cc/52XZ-LSUQ].
186. See supra notes 155-61 and accompanying text; see also 15 U.S.C. § 78l(a).
187. See 17 C.F.R. § 230.905 (2019).
188. See 15 U.S.C. § 78m.
189. See U.S. Sec. & Exch. Comm’n, Listing Standards, INVESTOR.GOV, https://www.
investor.gov/introduction-investing/investing-basics/glossary/listing-standards [https://perma.
cc/846N-9Q55].
190. See, e.g., 15 U.S.C. § 78o.
191. See supra Part I.
194. See M. Todd Henderson & Max Raskin, A Regulatory Classification of Digital Assets:
Toward an Operational Howey Test for Crytpocurrencies, ICOs, and Other Digital Assets, 2019
COLUM. BUS. L. REV. 443, 444-46; see also Kristin N. Johnson, Regulating Cryptocurrency
Secondary Market Trading Platforms, U. CHI. L. REV. ONLINE (Jan. 7, 2020), https://lawreview
blog.uchicago.edu/2020/01/07/298/ [https://perma.cc/22R3-P6GS].

features of cryptocurrencies defies the taxonomy of existing

financial products, transactions, and actors.195 Thus, a one-size-fits-
all approach is unlikely to offer a solution to address regulatory
concerns in cryptocurrency markets.
The diversity of cryptocurrencies is not the only barrier to
effectively regulating this nascent market. Financial market
regulation is deeply fragmented.196 Jurisdictional limitations based
on the attributes of a regulated financial product, transaction or
activity coupled with our commitment to principles of federalism
may result in regulatory gaps creating opportunities for arbitrage
in shadow markets.197 For some cryptocurrency developers, the
regulatory gaps serve as an invitation to create an alternative
financial system that defies the existing regulatory framework.
More specifically, the blockchain protocol represents an affirma-
tive attempt to eliminate the storied intermediaries that have
centralized transactions.198 According to cryptocurrency advocates,
at best, intermediaries profit richly by extracting fees from the
unwary.199 At worst, the intermediaries prey upon the public with
impunity and, in the event of severe market disruption, externalize
the costs of self-interested misconduct.200
In response to concerns, cryptocurrency communities developed
the blockchain protocol, a peer-to-peer method of transacting
without relying on intermediation.201 For example, instead of relying
on a legacy financial institution to act as an underwriter and
orchestrate a public offering of securities, an issuer may directly
distribute to investors coins or tokens that represent an equity
investment in the issuer’s firm using blockchain’s permissionless,
open-source, distributed ledger.202 As the Bitcoin white paper and
195. See Cryptocurrency Comparison, supra note 162.

196. U.S. GOV’T ACCOUNTABILITY OFF., GAO-19-157SP, HIGH-RISK SERIES: SUBSTANTIAL
EFFORTS NEEDED TO ACHIEVE GREATER PROGRESS ON HIGH-RISK AREAS 91 (2019).
197. See id.
198. See TAPSCOTT & TAPSCOTT, supra note 166, at 5.
199. See Deniz Kahramaner, The Future of Crypto Trading: Decentralized Exchanges,
MEDIUM (Jan. 4, 2018), https://denizkahramaner.medium.com/the-future-of-crypto-trading-
decentralized-exchanges-30b41a20dd01 [https://perma.cc/F5Q6-RT28].
200. See Kahramaner, supra note 199; see also TAPSCOTT & TAPSCOTT, supra note 166, at
5; Dolgopolov, supra note 119, at 86-87.
201. See TAPSCOTT & TAPSCOTT, supra note 166, at 4-5.
202. See id. at 5.

many others explain, eliminating intermediaries in peer-to-peer

cash transfers as well as other financial market transactions, such
as capital formation and secondary market trading increases
transparency, reduces transaction costs, and engenders greater
democratic access to markets for all.203
Similar to many financial products created in the shadows of
existing financial market regulation, questions regarding the
operational architecture and functions of cryptocurrency have
prompted jurisdictional conflicts among regulators and resistance
from market participants. An early and frequent commentator on
the question of regulating cryptocurrency, the SEC has announced
its intentions to apply a well-established legal standard when
evaluating whether a cryptocurrency may be subject to federal
securities regulations.204 Other state and federal regulators with
legitimate jurisdictional claims issued similar releases, fitting
cryptocurrency into the widely adopted pre-existing regulatory
frameworks applicable to the asset classes or transactions that they
supervise.205
During a speech in the summer of 2018, the then-Director of the
SEC’s Division of Corporate Finance articulated an argument in
favor of prioritizing the architecture of an individual blockchain in
regulatory inquiries.206 In the speech, Director Hinman explained
that the blockchain protocol that enables generation of cryptocur-
rency may become “sufficiently decentralized” that its infrastructure
no longer creates the concerns that justify regulatory interven-
tion.207 More specifically, Hinman acknowledged that the role of
intermediaries may be reduced or eliminated when the underlying
blockchain protocol adopted to distribute coins or tokens is a public,
permissionless blockchain.208 Hinman referenced Bitcoin as an
example of the kind of open-source protocol that has achieved the
203. NAKAMOTO, supra note 173; TAPSCOTT & TAPSCOTT, supra note 166, at 5.
204. William Hinman, Dir., Div. Corp. Fin., Sec. & Exch. Comm’n, Remarks at the Yahoo
Finance All Markets Summit: Crypto: Digital Asset Transactions: When Howey Met Gary
(Plastic) (June 14, 2018) (arguing that ICOs may be considered securities under the Howey
“‘investment contract’ test”).
205. See, e.g., Press Release, N.J. Off. of the Att’y Gen., supra note 172; Press Release, Md.
Off. of the Att’y Gen., supra note 172.
206. See Hinman, supra note 204.
207. Id.
208. See id.

requisite on-chain transparency to eliminate the question of

whether the coins could be deemed “securities” and subject to
securities regulation.209
Unfortunately, Hinman’s explanation regarding the attributes of
a “sufficiently decentralized”210 protocol raise more questions than
it resolves. Some rejoiced, interpreting Hinman’s remarks as an
acknowledgment that “truly” decentralized platforms would be
beyond the ambit of regulation.211 Others expressed dismay.212
Developers hoping to launch initial coin offerings queried which
specific configurations might lead regulators to conclude that the
protocol facilitating an ICO is “sufficiently decentralized.”213
As questions emerged regarding the attributes of decentraliza-
tion, the SEC and CFTC initiated prosecutions alleging that de-
velopers violated federal statutes by creating protocols for secondary
market trading in securities and commodities markets.214 The
releases issued by the agencies announcing settlements related to
these claims offered little clarity regarding the factors that led to
the agencies’ conclusions that the traded assets were securities or
commodities, triggering liability for developers whose platforms
facilitated secondary market trading.215 As the market for secondary
trading platforms continues to grow, the evolution of decentralized
209. See id.

210. Id.
211. See, e.g., Guillermo Jimenez, A Brief History of the SEC’s Adventures in Cryptoland,
DECRYPT (Jan. 4, 2019), https://decrypt.co/4371/a-brief-history-of-the-secs-adventures-in-cryp
toland [https://perma.cc/G6LW-YHB7].
212. See, e.g., Olta Andoni & Donna Redel, How the Incoming Administration Can Fix
Crypto Regulation, COINDESK (Dec. 14, 2020, 10:58 AM), https://www.coindesk.com/biden-
administration-crypto-regulation [https://perma.cc/D8GY-22WF].
213. See id.; see also Johnson, supra note 194, at 36.
214. See, e.g., Nikhilesh De, ICO Project Enigma Settles SEC Charges over $45M Token
Sale, COINDESK (Feb. 9, 2020, 2:32 PM), https://www.coindesk.com/ico-project-enigma-settles-
sec-charges-over-45m-token-sale [https://perma.cc/MVJ3-DG37]; Chris Madill, Crypto Fraud-
ster CabbageTech Slapped with over $1 Million in Fines in CFTC Case, BITRATES (Aug. 26,
2018, 10:11 AM), https://www.bitrates.com/news/p/crypto-fraudster-cabbagetech-slapped-with-
over-1-million-in-fines-in-cftc-case [https://perma.cc/R2MV-NXAZ].
215. See Press Release, U.S. Sec. & Exch. Comm’n, ICO Issuer Settles SEC Registration
Charges, Agrees to Return Funds and Register Tokens as Securities (Feb. 19, 2020), https://
www.sec.gov/news/press-release/2020-37 [https://perma.cc/WV3U-LSMU]; Press Release, U.S.
Commodity Futures Trading Comm’n, CFTC Wins Trial Against Virtual Currency Fraudster
(Aug. 24, 2018), https://www.cftc.gov/PressRoom/PressReleases/7774-18 [https://perma.cc/
Z42N-8ZVH]; see also Andoni & Redel, supra note 212.

digital ledgers operating in this market reveals developers’ growing

momentum to build such an infrastructure.
B. Cryptocurrency Exchanges
Scholars collecting ethnographic data on the blockchain commu-

nity have identified differing accounts of developers’ incentives for
creating blockchains. Some trace blockchain’s philosophical under-
pinnings to the recent financial crisis and developers’ frustration
with the avarice of legacy financial institutions that act as interme-
diaries.216 Others suggest that a libertarian philosophy inspired
blockchain developers to create an alternative financial system.217
Still others claim that the recent financial crisis inspired developers
to consider pathways to create a store of value or medium of
exchange free from the influence of any single sovereign govern-
ment.218
Despite differing political or philosophical motivations, early
developers shared a common understanding of the architecture and
governance of a blockchain; the operational paradigm of blockchains
would be public or permissionless.219 The ledger would be transpar-
ent, revealing verified transactions to anyone who could access the
blockchain.220 The blockchain would be governed democratically by
the network or community engaged in the enterprise of creating and
sustaining the protocol.221
Operational challenges, governance disputes, and schisms reveal
diverging philosophies and motivations for integrating blockchain,
further frustrating regulatory analysis. In the decade since the
launch of the Bitcoin blockchain, governance questions have
plagued the blockchain community.222 Infrastructural challenges
have limited many blockchain protocols from executing transactions
216. Syed Omer Husain, Alex Franklin & Dirk Roep, The Political Imaginaries of
Blockchain Projects: Discerning the Expressions of an Emerging Ecosystem, 15 SUSTAINABILITY
SCI. 379, 380 (2020); see also Kahramaner, supra note 199.
217. See KEVIN DOWD, NEW PRIVATE MONIES: A BIT-PART PLAYER? 38-39 (2014).
218. See TAPSCOTT & TAPSCOTT, supra note 166, at 4-5.
219. Id. at 5; Walch, supra note 20, at 844.
220. Brummer & Yadav, supra note 17, at 266-67; Magnuson, supra note 20, at 1185;
TAPSCOTT & TAPSCOTT, supra note 166, at 5.
221. Walch, supra note 20, at 844-45.
222. TAPSCOTT & TAPSCOTT, supra note 166, at 3, 8.

in a completely transparent manner.223 While protocol developers’

white papers promised transparency, executing transactions “on-
chain” proved to be impractical and inefficient.224 Consequently,
developers routed certain aspects of transactions “off-chain” and
created procedures for determining which elements of transactions
might remain on-chain and which might occur off-chain.225
Mounting procedural issues revealed a governance crisis in the
blockchain community. While blockchain began as an open-source
community developing permissionless distributed digital ledgers,
software programmers affiliated with commercial enterprises and
noncommercial institutions began adapting the publicly available
code for proprietary projects.226 Financial services firms and entre-
preneurs developing financial market transactions on blockchain
promptly seized the mantle.227 Entrepreneurs and financial services
firms began adapting digital ledgers, shifting the protocols from
permissionless to permissioned, and integrating governance mecha-
nisms.228 These market participants expressly aim to reintroduce
aspects of intermediation that have generated revenues for legacy
financial institutions.229
While critical questions remained unresolved for developers
creating protocols or launching offerings associated with ICOs,230 the
growing market for secondary trading poses marked difficulties for
developers seeking to comply with legal standards or create
223. See, e.g., Walch, supra note 23, at 742-43; see also Johnson, supra note 194, at 41-42.
224. See Jake Frankenfield, Off-Chain Transactions (Cryptocurrency), INVESTOPEDIA (Oct.
31, 2019), https://www.investopedia.com/terms/o/offchain-transactions-cryptocurrency.asp
[https://perma.cc/LEQ9-WPVN].
225. Id.; see also Johnson, supra note 194, at 37-38.
226. See Walch, supra note 20, at 840-41, 849-50.
227. See id.
228. See id.
230. For developers orchestrating the launch of ICOs, regulators have declared that
adopting an operational or governance approach that centralizes authority and decision-
making aligns permissioned blockchains or the coins and tokens issued on these protocols
with the types of investment arrangements subject to registration under the Securities Act.
Applying the analysis of the seminal decision in S.E.C. v. Howey, regulators characterize ICO
issuers as promoters of “securities” in contexts when the role of coins or tokens purchasers is
analogous to passive investors who face asymmetries of information when making investment
decisions. See infra note 418 and accompanying text.

platforms that would not be subject to the registration requirements

of the Exchange Act.231
Notwithstanding Bitcoin’s promise and developers’ aspirations for
cryptocurrency to democratize access to finance, cryptocurrency
markets continue to rely on intermediation for important aspects of
secondary market trade execution and settlement. In fact, many of
the earliest and largest cryptocurrency exchanges operate as for-
profit businesses; they collect hefty fees to facilitate cryptocurrency
trading and distribute profits to the individual entrepreneurs and
investors who own the platform.232 These platforms are proprietary,
permissioned blockchain ledgers that execute transactions using
efficient operational procedures that are far from transparent.233
Coinbase, Gemini, Bittrex, and Binance are all examples of
centralized exchanges.234 Users deposit their funds directly into a
pooled wallet that is controlled by the exchange; the exchange takes
custody of traders’ deposited assets, and the exchange directly
engages in matching buy and sell orders.235
Centralized exchanges create accounts that store customer
funds.236 The exchanges maintain “hot” wallets connected to the
platform’s network to facilitate trading.237 Centralized exchanges
generally enable traders to execute, clear, and settle buy/sell
orders.238 As custodians of financial assets, centralized exchanges
must comply with state and federal laws relevant to the custody,
231. See, e.g., Press Release, Sec. & Exch. Comm’n, ICO Issuer Settles SEC Registration
Charges, Agrees to Return Funds and Register Tokens as Securities (Feb. 19, 2020), https://
www.sec.gov/news/press-release/2020-37 [https://perma.cc/WV3U-LSMU] (describing a run-in
between Enigma and the SEC).
232. See Nathan Reiff, What Are Centralized Cryptocurrency Exchanges?, INVESTOPEDIA
(June 25, 2019), https://www.investopedia.com/tech/what-are-centralized-cryptocurrency-ex
changes/ [https://perma.cc/95M4-HMK9].
233. See Johnson, supra note 194, at 37-38.
234. See, e.g., Laura M., Gemini vs Coinbase: Is Gemini a Better Coinbase Alternative?,
BITDEGREE (Sept. 9, 2020), https://www.bitdegree.org/crypto/tutorials/gemini-vs-coinbase
[https://perma.cc/R65M-CGGE].
235. Reiff, supra note 232.
236. Id.
237. See Will Kenton, Hot Wallet, INVESTOPEDIA (June 30, 2020), https://www.investopedia.
com/terms/h/hot-wallet.asp [https://perma.cc/GAQ4-6BWA].
238. See Reiff, supra note 232.

exchange, and transfer of assets including federal anti-money-

laundering and know-your-customer user-verification obligations.239
Having abandoned aspects of the public, permissionless block-
chain envisioned by early theorists and developers, centralized
exchanges relinquished the benefits of transparent, permissionless
trading. Incorporating certain aspects of intermediation, these
exchanges inherited the attendant operational challenges that have
long plagued legacy financial institutions.240
First, centralized cryptocurrency exchanges create single points
of failure. Centralized exchanges are susceptible to hacks, shut-
downs, insider trading, scams, and withdrawal latencies.241
International media coverage has chronicled the cybersecurity
breaches at Mt. Gox, Shapeshift, Bitfinix, Poloniex, QuadrigaCX,
and Bithumb.242 Hackers stole more than $4 billion in crypto-
currencies from centralized exchanges between 2011 and 2017.243
Second, similar to legacy exchanges, centralized cryptocurrency
exchanges typically charge transaction fees.244 Trading on central-
ized exchanges may be less transparent because the exchange may
permit the execution and settlement of trades off-chain, meaning
the information regarding the transaction may not be broadcast to
the entire blockchain network and may not be authenticated on the
blockchain network.245 Settling trades off-chain creates concerns,
including whether or not traders are offered the most competitive
pricing.246
239. See Tradepassionate, Decentralized Exchanges—Don’t Overlook KYC/AML Policies,

MEDIUM (Aug. 14, 2018), https://medium.com/@tradepassionate/decentralised-exchanges-
don’t-overlook-kyc-aml-policies-ef1e6b406de4 [https://perma.cc/BVH8-XYE2].
240. The following discussion draws on prior work. See Johnson, supra note 194, at 37-38.
241. See Kahramaner, supra note 199.
242. See Crypto Exchange: Hacks in Review, COINTELEGRAPH, https://cointelegraph.com/
magazine/crypto-exchange-hacks/ [https://perma.cc/K7ET-U7WK]; Erik Voorhees, Looting of
the Fox: The Story of Sabotage at ShapeShift, BITCOIN.COM (Apr. 19, 2016), https://news.
bitcoin.com/looting-fox-sabotage-shapeshift/ [https://perma.cc/U5Z5-HP4R]; Tim Copeland,
The Complete Story of the QuadrigaCZ $190 Million Scandal, DECRYPT (Mar. 13, 2019),
https://decrypt.co/5853/complete-story-quadrigacx-190-million [https://perma.cc/X883-AJ8P].
244. See Totle, Crypto Trading Fees Explained and How to Minimize Them, MEDIUM (Dec.
5, 2018), https://medium.com/totle/crypto-trading-fees-explained-and-how-to-minimize-them-
203f0938f2f1 [https://perma.cc/TZ2D-3NLE].
245. See Frankenfield, supra note 224.
246. Id.

Centralized exchanges may act as broker-dealers, maintaining an

inventory of various cryptocurrencies and satisfying customer orders
from their own inventory at the prices determined by the ex-
change.247 In the absence of a consolidated pricing index, traders
may be unaware that the executed transaction price is higher than
the average market price for the same cryptocurrency.
Finally, on centralized exchanges, retail traders also pay market-
taker fees. On legacy securities exchanges, for example, the maker-
taker structure of market pricing provides a transaction rebate to
market-markers who provide liquidity by “making” a trade.248 In
this context, the market-maker posts a trade and the taker com-
pletes the transaction.249 The market-maker receives a rebate for
introducing the transaction and the taker pays a fee to execute the
transaction.250
In recent years, developers have released white papers and
introduced a number of decentralized cryptocurrency exchanges
(DEXs).251 All transactions are authenticated by the network’s
community.252 Theoretically, DEX users execute transactions
without the assistance of intermediaries and store funds and assets
in their own wallets, transacting in a genuinely trustless manner.253
DEXs do not maintain custody of traders’ assets or wallets.254
Traders connect hardware wallets or software wallets to the DEX
smart contract to execute trading transactions.255 Depending on the
DEX framework, the trader either stores customer tokens or
releases the customer’s tokens to the DEX’s smart contract until a
particular trade is executed and settled.256

248. Andrew Bloomenthal, What Market-Taker Fees Mean for You, INVESTOPEDIA (June 22,
2020), https://www.investopedia.com/articles/active-trading/042414/what-makertaker-fees-
mean-you.asp [https://perma.cc/2DPQ-WZQ9].
249. Id.
250. Id.
251. See What Is a Dex: Decentralized Exchanges Explained, LEDGER (Oct. 9, 2020), https://
www.ledger.com/academy/crypto/what-is-a-dex-decentralized-exchanges-explained [https://
perma.cc/4E7M-AU9P].
252. Id.
253. Id.
254. Id.
255. See id.
256. See Nuke Token, How to Trade on a DEX (Decentralized Exchange), MEDIUM (June
24, 2019), https://medium.com/@NukeTokenOfficial/how-to-trade-on-a-dex-decentralized-ex

On decentralized exchanges, makers and takers act independ-

ently. The DEX protocol does not support market orders; however,
liquidity pools and automated market-maker applications may
approximate the benefits of market orders.257 DEXs create liquidity
pools.258 Rather than rely on a market-maker to create liquidity,
traders stake (lock-up) tokens in a smart contract-based liquidity
pool. When a trade is executed, the reward for creating liquidity
reverts to the pool and participants share the financial benefits of
creating liquidity pro rata based on their contributions to the pool.259
DEX traders may, however, pay higher transaction fees due to the
operational mechanics of executing all elements of a trade on-
chain.260 DEX traders pay substantially higher network fees known
as “gas” because the operational infrastructure of the exchanges
requires additional steps for verification and posting transactions
to the exchange network.261
A DEX may adopt one of the following approaches for matching
buyers and sellers: on-chain order books or off-chain order relay
with on-chain settlement. With on-chain order books, the DEX hosts
the order book on the exchange platform.262 The DEX distributes
orders across the network and the user releases custody of her
tokens to the DEX smart contract.263 Maintaining an on-chain order
book creates notable inefficiencies, imposing high friction costs and
leading to latency that enables market participants to engage in
change-2cc38054d8bb [https://perma.cc/P9B5-L5B5].
257. See, e.g., WILL WARREN & AMIR BANDEALI, OX: AN OPEN PROTOCOL FOR DECEN-
TRALIZED EXCHANGE ON THE ETHEREUM BLOCKCHAIN 1 (2017), https://0x.org/pdfs/0x_white_
paper.pdf [https://perma.cc/ASX2-EBX2].
258. See, e.g., Nikolai Kuznetsov, DeFi Liquidity Pools, Explained, COINTELEGRAPH (Jan.
28, 2021), https://cointelegraph.com/explained/defi-liquidity-pools-explained [https://perma.cc/
99GK-HEXF].
259. See id.
260. See Leslie Ankney, No More Trading or Listing Fees? Decred Releases New DEX
Proposal, FORBES (Feb. 4, 2019, 11:00 AM), https://www.forbes.com/sites/leslieankney/2019/
02/04/no-more-trading-or-listing-fees-decred-releases-new-dex-proposal/#3929f8b235d9
[https://perma.cc/89FV-M69Y].
261. See What Is Gas?, ETH GAS STATION (July 31, 2019), https://ethgasstation.info/blog/
what-is-gas/ [https://perma.cc/9L6D-DNVV].
262. See Richard Chen, A Comparison of Decentralized Exchange Designs, MEDIUM (Apr.
18, 2019), https://thecontrol.co/a-comparision-of-decentralized-exchange-designs-1deef249f56a
[https://perma.cc/84A2-WDY3].
263. See id.

predatory trading behavior.264 Modifying and cancelling trades

present significant challenges.265 Higher trading volumes consume
a large amount of network bandwidth.266
A second approach involves DEX using off-chain order relay with
on-chain settlement. Under this approach, the trader allows the
DEX contract to access their token balance.267 The trader then
creates an order specifying a desired exchange rate, expiration time,
and cryptographically signs their exchange order with their private
key.268 The order is not broadcast across the network. The order is
sent across a communication medium; relayers, such as Relay
Radar, are used to find, match, and fill orders as they go across a
communication medium.269 Relayers do not execute trades; rather,
relayers recommend a best available price to a trader who then
decides whether to take the order.270 A trader who intercepts the
message and decides to fill the order, submits the signed order to
the DEX smart contract.271 The DEX smart contract authenticates
the trader’s signature, makes sure the order has not expired,
verifies that the order has not already been filled, and then
transfers the tokens for value and settles the exchange on-chain.272
DEXs may provide increased security, and the automated market
maker features in these platforms may increase fairness and incor-
porate circuit-breakers to better govern trading dynamics. Unlike
a centralized exchange, a DEX is not a single point of failure and is,
264. See id.

265. See Jack Yeu, Are Decentralized Exchanges Built Equal?, MEDIUM (Dec. 4, 2019),
https://medium.com/switcheo/are-decentralized-exchanges-built-equal-213e70a95a03
[https://perma.cc/5ULL-5UAG].
266. See id.
267. See Usman Fazil, Diving Deep into Ox Protocol, MEDIUM (Apr. 26, 2018), https://
medium.com/coinmonks/diving-deep-into-0x-protocol-547efb83ffed [https://perma.cc/3GM7-
B576].
268. See id.
269. See Radar Relay, On Radar and Relayers, MEDIUM (Aug. 24, 2017), https://medium.
com/@RADARRELAY/on-radar-and-relayers-30423f506587 [https://perma.cc/2B4M-QLR2].
270. See Radar Relay, RADAR RELAY, The First Open Order Book Relayer, Relaunches
Decentralized Exchange with a Modern Swap Interface, PR NEWSWIRE (May 11, 2020, 8:00
AM), https://www.prnewswire.com/news-releases/radar-relay-the-first-open-order-book-relay
er-relaunches-decentralized-exchange-with-a-modern-swap-interface-301056312.html [https://
perma.cc/N33M-EDE8].
271. See Fazil, supra note 267.
272. See id.

therefore, far less susceptible to the various security and risk-

management concerns that plague centralized exchanges.273
Consider the example of Uniswap:
Uniswap is the largest decentralized cryptocurrency exchange

by volume and a leader in decentralized finance (DeFi). The
Uniswap platform is supported by a protocol that uses Auto-
mated Market Makers (AMMs) and liquidity pools to facilitate
peer-to-peer trading. Liquidity providers add tokens to Uniswap
pools and are rewarded with a fee proportional to their share of
the pool. In September 2020, Uniswap launched its UNI
governance token and airdropped 400 UNI—worth approxi-
mately $1,400 at the time of transfer—to every platform user.
... Cryptocurrency exchanges emulate this marketplace
dynamic, offering a trading venue for digital assets[.]
... [C]oncerns over individual user autonomy are reportedly
driving the development of decentralized exchanges (DEXs).
These emerging alternatives are built with blockchain technol-
ogy and use smart contracts to execute transactions between
buyers and sellers in an automated fashion.
... DEXs have faced growing pains, being bound by the
limitations of blockchain technology. Network scalability,
segmented liquidity, and disjointed user experience have posed
significant hurdles to widespread DEX adoption. To address
these shortcomings, protocols like Uniswap are developing tools
to improve the functionality of DEXs....
Uniswap is a decentralized exchange protocol that operates on
the Ethereum blockchain. The platform enables peer-to-peer
(P2P) trades that execute without order books or an intermedi-
ary.... Anyone can swap tokens, contribute tokens to a pool and
earn fees, or list a token on Uniswap. Almost any ERC-20 token
is exchangeable using Uniswap, and there are no listing fees.
... There are more than 22,000 Uniswap pools, which mini-
mize this misalignment between buyer and seller market orders
by creating a deep reservoir of assets to trade, which ensures
liquidity. Uniswap’s Automated Market Maker technology
273. See Jan Wozniak, Thoughts on Decentralized Exchanges and Real World Usage of
Their Own Tokens, MEDIUM (Sept. 18, 2018), https://medium.com/trivial-co/thoughts-on-decen
tralized-exchanges-and-real-world-usage-of-their-own-tokens-d0a6a16f5d3d [https://perma.
cc/A52S-MYT4].

algorithmically analyzes liquidity pools to offer the most

appropriate prices for specific trades.
... The key innovation that makes the Uniswap protocol work
is Automated Market Maker (AMM) technology. An AMM is a
smart contract that manages the Uniswap pools that furnish the
tokens to effectuate a trade. When a trade is made, the AMM
algorithm determines the price based on supply and demand
between tokens in these liquidity pools.274
The developing definitions for each of the two classes of exchanges

described in this Part may offer a path for governing cryptocurrency
secondary market trading. Distinguishing between these two classes
of exchanges, however, may be insufficient to articulate a set of
formal rules governing cryptocurrency secondary market trading
platforms. There may be a need to create new rules that recognize
the distinctions between centralized and decentralized exchanges
and to distinguish these types of exchanges from traditional
securities and commodities exchanges.
Reflecting on Director Hinman’s comments, are decentralized
exchanges that execute transactions on chain “sufficiently decentral-
ized?”275 Even if the operational mechanics of these publicly
accessible, permissionless, censorship resistant, and trustless
trading venues may prompt answers in the affirmative, there may
be good reason to continue to evaluate the benefits of regulatory
oversight. The next Part identifies risk management concerns that
create challenges for market participants and the exchanges that
enable conventional secondary market trading. Curiously, many of
these concerns persist in cryptocurrency markets, even when the
exchanges facilitating trading may be characterized as decentral-
ized.
274. Cryptopedia Staff, What Is Uniswap? A Breakdown, CRYPTOPEDIA (Mar. 13, 2021),
https://www.gemini.com/cryptopedia/uniswap-decentralized-exchange-crypto-defi [https://
perma.cc/PLK9-EN2S].

III. MARKET EVOLUTION AND FRAGILITY
Similar to the market for conventional financial products, crypto-

currency secondary markets and the firms that operate in these
markets face notable and endemic risks. Within each class of risks,
there are ancillary concerns that may individually or in the
aggregate become enterprise risks. As noted in Part I, exchanges
incur market risk by acquiring securities and maintaining a
proprietary portfolio of assets to satisfy orders executed on their
platform;276 thus, decisions regarding which securities to acquire,
how long to maintain the securities in an exchange’s inventory, and
whether to extend credit to counterparties trading on their plat-
forms create risks.277
Cryptocurrency exchanges also facilitate a diversity of transac-
tions that create risks. For example, traders executing transactions
on cryptocurrency exchanges may act as broker-dealers, acquiring
cryptocurrency for their proprietary portfolios. Firms operating as
broker-dealers on cryptocurrency exchanges may execute or permit
clients to structure leveraged transactions or complex derivatives
transactions. Such policies may create enterprise risks for individ-
ual broker-dealers and, in the event that the exchange guarantees
trades executed on its platform, solvency risks for the exchange.278
In addition to risks that arise from leveraged or structured deriva-
tive transactions, the business model for these exchanges requires
the platforms to facilitate the exchange of a diversity of coins or
tokens creating endemic exchange rate risks.279
276. Market risk describes the possibility that an investor may experience losses resulting
from a sharp decline in the value of assets (shares of stock, commodities, or derivatives) in the
investor’s portfolio. See James Chen, Market Risk, INVESTOPEDIA (Jan. 31, 2020), https://www.
investopedia.com/terms/m/marketrisk.asp [https://perma.cc/3XQ3-9W9N].
277. Credit risk refers to the possibility that a lender will default on an outstanding debt
obligation. See The Causes and Effects of the AIG Bailout: Hearing Before the H. Comm. on
Oversight and Gov’t Reform, 110th Cong. 37 (2008) (statement of Eric R. Dinallo,
Superintendent, New York Insurance Department) (“For a large, large, large percentage of
credit default swaps, you’re required to have absolutely no collateral or capital behind them.”);
Frank Partnoy, Financial Derivatives and the Costs of Regulatory Arbitrage, 22 J. CORP. L.
211, 219 n.48 (1997).
279. See generally DAVID W. PERKINS, CONG. RSCH. SERV., R45427, CRYPTOCURRENCY: THE
ECONOMICS OF MONEY AND SELECTED POLICY ISSUES 23 (2020) (“[T]he existence of multiple

Cryptocurrency exchanges navigate this diverse array of risks.

The aggregation of these enterprise risks may, however, undermine
a firm’s operational integrity and lead to a solvency crisis. In 2013,
for example, Mt. Gox—the world’s largest cryptocurrency exchange
at the time—declared bankruptcy.280 Swarmed by hackers and
subject to stunning acts of fraud, theft, and mismanagement, Mt.
Gox lost over 850,000 Bitcoins worth more than $8.5 billion today.281
As financial markets expand to include a greater diversity of
intermediaries, the interconnectedness between and among inter-
mediaries may influence individual firm enterprise risk and market
stability. This Part examines three common intermediary risk-
management concerns that threaten market stability in emerging
cryptocurrency markets. Each of these concerns poses a threat to
the operational infrastructure of cryptocurrency exchanges. This
Section argues that enterprise or systemic risk that results from the
failure of a systemically significant cryptocurrency broker-dealer or
the interconnectedness among market intermediaries may disrupt
cryptocurrency markets and lead to spillover effects that destabilize
broader financial markets.
The next three Sections begin to outline risk management con-
cerns and responses to risk management concerns in emerging
cryptocurrency markets. In truth, certain of the trading strategies
described below are still quite novel in conventional securities and
commodities markets.282 Thus, the discussion is developing as the
market for cryptocurrencies matures.
A. Automating Risk
Following the Flash Crash in 2010, algorithmic trading is one of

the most rapidly expanding and closely monitored financial markets
trading strategies in the world.283 In a quiet revolution, computer-
currencies adds difficulty to buyers and sellers making exchanges; all buyers and sellers must
be aware of and continually monitor the value of different currencies relative to each other.”).
280. Floyd, supra note 13.
281. Id.
282. See infra Part III.A.
283. See Charles R. Korsmo, High-Frequency Trading: A Regulatory Strategy, 48 U. RICH.
L. REV. 523, 526-28 (2014).

based trading programs are rapidly replacing human traders.284

“These changes mark the end of the era of specialists and physical
execution of trades on legacy exchanges.”285 Moreover, computer-
based trading programs have had a significant impact on the
volume and speed of securities market transactions.286
Due to the efficiencies and reduced costs, algorithmic trading has
seized an increasingly dominant role in financial markets.287
Historically, executing trades required relaying orders to buy or sell
a security to an intermediary such as a broker-dealer; the broker-
dealer would manually enter the solicited trade and, based on the
asset price reflected in the exchange order book, identify a counter-
party willing to execute a trade for the solicited asset.288
Today, investors may program trading platforms to execute auto-
mated trading strategies.289 These trading bots have the capacity to
evaluate vast volumes of data and respond in fractions of a second
to the release of information in markets.290 Algorithmic trading
automates trade execution, reducing if not eliminating the role of
intermediaries, and calculates market, credit, and other risks of
conventional and complex, structured, or leveraged trades.291 The
introduction of artificial intelligence (AI) and algorithmic trading
strategies has led to even more sophisticated automated trading
programs.292
284. See The Stockmarket Is Now Run by Computers, Algorithms and Passive Managers,
ECONOMIST (Oct. 5, 2019), https://www.economist.com/briefing/2019/10/05/the-stockmarket-is-
now-run-by-computers-algorithms-and-passive-managers [https://perma.cc/WSH3-49H4].
286. See The Stockmarket Is Now Run by Computers, Algorithms and Passive Managers,
supra note 284.
287. Id.
288. See What Is an Automated Market Maker?, COINMARKETCAP, https://coinmarketcap.
com/alexandria/glossary/automated-market-maker-amm [https://perma.cc/5VH5-RZBD]; The
Stockmarket Is Now Run by Computers, Algorithms and Passive Managers, supra note 284;
RISHI K. NARANG, INSIDE THE BLACK BOX: A SIMPLE GUIDE TO QUANTITATIVE AND HIGH FRE-
QUENCY TRADING 42-45 (2d ed. 2013).
289. See NARANG, supra note 288, at 43-45 (describing various questions and concerns that
programmers must consider when designing and training data-driven algorithms for trading).
290. See id.
291. See Yesha Yadav, How Algorithmic Trading Undermines Efficiency in Capital
Markets, 68 VAND. L. REV. 1607, 1611-12 (2015).
292. AI methodologies rely on supervised and unsupervised learning. See generally ETHEM
ALPAYDIN, INTRODUCTION TO MACHINE LEARNING (3d ed. 2014). In supervised learning, the
algorithm is trained with well-labeled and classified data, whereas there are no training data

Similar to legacy securities exchanges, centralized and decentral-

ized exchanges may permit automated or algorithmic trading.293
These platforms may also continue to rely on order books or an
electronic equivalent to determine asset prices for the orders
submitted for execution on the exchange.294
A number of decentralized exchanges are, however, experiment-
ing with automated order books described as automated market
makers. Financial market participants first introduced the notion
of automated market makers (AMM) in the early 1990s.295 Introduc-
ing an AMM renders manual order books obsolete and accelerates
the execution of trades, making price discovery more efficient and,
arguably, more accurate.296 AMMs also reduce the potential for
human error that plagues manual order entry.297 Unfortunately,
early AMM systems were also susceptible to manipulation.298
An increasing percentage of decentralized exchanges endeavoring
to transition operational mechanics on chain have identified AMM
as a possible replacement for off-chain, centralized order books.299
Developing AMM systems, decentralized exchanges increase
transparency and reduce the transaction risks that arise from
intermediation.300 In addition, AMM systems may serve as liquidity
pools that may be pre-funded on-chain.301 Thus, for decentralized
in unsupervised learning. For accessible explanations of supervised and unsupervised

learning, see Bernard Marr, Supervised v Unsupervised Machine Learning—What’s the Dif-
ference?, FORBES (Mar. 16, 2017, 3:13 AM), http://www.forbes.com/sites/bernardmarr/2017/
03/16/supervised-v-unsupervised-machine-learning-whats-the-difference/ [http://perma.cc/
F7KG-424B]; Devin Soni, Supervised vs. Unsupervised Learning, MEDIUM (Mar. 22, 2018),
http://towardsdatascience.com/supervised-vs-unsupervised-learning-14f68e32ea8d [https://
perma.cc/T5ZZ-7WHX]. Unsupervised learning infers information from the data set and can
be highly resource intensive, as the data set is tested against a massive number of potential
patterns. See Marr, supra; Soni, supra.
293. While centralized exchanges function through the use of third-party intermediaries,
such intermediaries can be human or algorithmic. Reiff, supra note 232 (explaining that the
primary difference between centralized and decentralized exchanges is the presence or
absence, respectively, of a middleman).
294. See, e.g., Radar Relay, supra note 270.
295. What Is an Automated Market Maker, supra note 288.
296. See id.
297. See id.
298. Id.
299. Id.
300. See id.
301. See id.

exchanges the users of the exchange may provide the liquidity pool
for executing transactions.302 Users may even earn passive income
by providing the deposits that create the liquidity pool.303 Uniswap,
for example, has implemented an AMM that “allows its users to
both supply liquidity to earn passive income or exchange between
various assets.”304 As the next Section explains, certain classes of
cryptocurrency traders may gain significant benefits as they adopt
automated trading strategies in cryptocurrency markets.305 Others
discover that these practices enable sophisticated trading counter-
parties to target and profit from the trading of less sophisticated
market participants.306
B. Accelerating Risk
The advent of high frequency trading strategies increases the

speed for order execution in secondary markets.307 While there is no
universal definition for the specific activities that constitute high
frequency trading, theorists and regulators identify several common
attributes.308 As a recent SEC report explains, common functional
characteristics of HFT strategies include:
(1) the use of extraordinarily high speed and sophisticated

programs for generating, routing, and executing orders; (2) use
of co-location services and individual data feeds offered by
exchanges and others to minimize network and other latencies;
(3) very short time-frames for establishing and liquidating
positions; (4) the submission of numerous orders that are
302. Id.
303. Id.
304. Id.
305. See infra Part III.B.
306. See Marr, supra note 292; Soni, supra note 292.
307. See Korsmo, supra note 283, at 528; see also GARY SHORTER & RENA S. MILLER, CONG.
RSCH. SERV., R43608, HIGH-FREQUENCY TRADING: BACKGROUND CONCERNS, AND REGULATORY
DEVELOPMENTS 10 (2014), https://fas.org/sgp?%20crs/misc/R43608.pdf [https://perma.cc/SF9H-
FCX8] (noting that firms using HTF can “execute trades within microseconds or milli-
seconds”).
308. There is no formal, universally adopted definition of high frequency trading. See
SHORTER & MILLER, supra note 307, at 5. Acknowledging the definitional ambiguity, the SEC
describes HFT traders as “professional traders acting in a proprietary capacity that engage
in strategies that generate a large number of trades on a daily basis.” Concept Release on
Equity Market Structure, 75 Fed. Reg. 3594, 3606 (proposed Jan. 21, 2010).

cancelled shortly after submission; and (5) ending the trading

day in as close to a flat position as possible (that is, not carrying
significant, unhedged positions overnight).309
One might ask what attracts investors to high frequency trading

strategies. Coupling algorithmic trading practices with high fre-
quency trading strategies generates significant profits.310
Firms that adopt HFT strategies may submit significant num-

bers of orders for a small quantity of securities [(one hundred or
two hundred shares)] over a relatively short window of time.
After submitting the orders, HFT strategists quickly cancel the
orders and benefit from the small discrepancies in the price[s] of
the securities from the time of the submission of the orders to
the moment when the HFT firm cancels the order[s]. Estimates
report that HFT transactions now account for two-thirds of
trading activity in the U.S. financial market. There are several
different HFT strategies.311
Traders who employ HFT strategies successfully reduce laten-

cy.312 HFT strategies that rely on “algorithms submit and route
309. Concept Release on Equity Market Structure, 75 Fed. Reg. at 3606.

310. See SHORTER & MILLER, supra note 307, at 5, 10-11.
311. Johnson, supra note 59, at 856; Concept Release on Equity Market Structure, 75 Fed.
Reg. at 3606, 3609; Graham Bowley, Clamping Down on Rapid Trades in Stock Market, N.Y.
TIMES (Oct.8, 2011), http://www.nytimes.com/2011/10/09/business/clamping-down-on-rapid-
trades-instock-market.html [https://perma.cc/2TFY-QF6V] (High frequency “trading ... now
accounts for two of every three stock market trades in America.”). HFT firms employ market-
making, arbitrage, structural, and directional strategies. Market-making strategies passively
capitalize on liquidity rebates; arbitrage takes advantage of discrepancies in rates, prices, and
other market conditions; structural strategies, like co-location, capture profits based on
structural market vulnerabilities; and directional strategies rely on more traditional in-
vestment principles such as anticipating price movement based on the conclusion that the
stock price for a security does not represent the fundamental value of the security. See PWC,
AN OBJECTIVE LOOK AT HIGH-FREQUENCY TRADING AND DARK POOLS 5 (2015), http://www.pwc.
com/us/en/pwc-investor-resource-institute/publications/assets/pwc-high-frequency-trading-
dark-pools.pdf [https://perma.cc/WV55-C9FC].
312. Michael J. McGowan, The Rise of Computerized High Frequency Trading: Use and
Controversy, 16 DUKE L. & TECH. REV. 1, 11 (2010) (“Some of the most popular HFT strategies
include automated market making, low latency arbitrage, and liquidity rebate trading.
Additionally, the practice of issuing ‘flash orders’ to high-frequency traders and the use of
certain Alternative Trading Systems (ATSs) by those competing with HF traders have come
under increasing scrutiny in recent months. These computerized ‘neural networks’ and
‘genetic algorithms’ permit computers to create new rules and automatically change

trades at exponentially faster speeds than human traders negotiat-

ing the purchase or sale of securities on an exchange trading floor.
HFT strategies may execute hundreds of trades in the space of
milliseconds or microseconds.”313 Others adopt strategies such as
algorithmic trading programs, direct market access, and co-
location.314
Co-location service arrangements enable HFT firms to place their
proprietary servers in close physical proximity to securities ex-
changes’ servers; closer proximity reduces the time required to
match bids or asks, leading to lower latency.315
Media reports suggest that centralized cryptocurrency exchanges
are permitting HFT trading on their platforms. According to one
media account, “[a] handful of cryptocurrency exchanges are rolling
out the red carpet for high-frequency traders.”316 Gemini, a popular
cryptocurrency exchange created in 2014 by Cameron and Tyler
Winklevoss, is currently offering co-location to traders operating
near its data centers in the New York and Chicago areas.317
underlying assumptions about the markets. They then evolve by letting different rules
compete, and combining the most successful outcomes.”); see also Andrew J. Keller, Robocops:
Regulating High Frequency Trading After the Flash Crash of 2010, 73 OHIO STATE L.J. 1457,
1464-69 (2012) (describing various HFT strategies).
313. Johnson, supra note 59, at 856; see Charles Duhigg, Stock Traders Find Speed Pays,
in Milliseconds, N.Y. TIMES (July 23, 2009), https://www.nytimes.com/2009/07/24/business/
24trading.html [https://perma.cc/6YSH-7WK5].
314. See id.; Korsmo, supra note 283, at 563-64 (“A second HFT-related market practice
that has come under fire as ‘unfair’ is co-location. In seeking to reduce latency, HFTs will
often seek to place their computers as physically close to an exchange’s data center as
possible. Doing so minimizes the distance data needs to travel between computers, and
thus—due to the finite speed of electronic signals—the communications delay. Many trading
centers rent ‘rack space’ on-site, so that HFTs and other proprietary traders can locate their
computers at the exchange, right next to the exchange’s own servers. Exchanges must receive
SEC approval for offering co-location services, and the SEC requires that ‘terms of co-location
services must not be unfairly discriminatory, and the fees must be equitably allocated and
reasonable.’” (footnotes omitted)).
315. See PWC, supra note 311, at 2, 4; Concept Release on Equity Market Structure, 75
Fed. Reg. at 3608 (“Some proprietary firm strategies may exploit structural vulnerabilities
in the market or in certain market participants. For example, by obtaining the fastest delivery
of market data through co-location arrangements and individual trading center data feeds ...
proprietary firms theoretically could profit by identifying market participants who are offering
executions at stale prices.”).
316. Anna Baydakova, High-Frequency Trading Is Newest Battleground in Crypto Exchange
Race, COINDESK (July 8, 2019, 3:48 PM), https://www.coindesk.com/high-frequency-trading-is-
new-battleground-in-crypto-exchange-race [https://perma.cc/J5HR-CV2C].
317. Id.

In a report exploring the gaps in regulating cryptocurrency

secondary market trading, Timothy Massad describes increasing
interconnectedness among cryptocurrency exchanges permitting
concerning HFT practices:
The same firms that co-locate at a cryptointermediary may co-

locate at our major securities or derivatives intermediaries.
Banks and brokers may engage in transfers of customer funds
to and from crypto intermediaries. Technology vendors that
work for crypto intermediaries may also work for other ex-
changes, trading platforms, banks or brokers.318
Even in established securities and commodities markets, HFT

tactics may pose risk management and other concerns. The use of
HFT strategies to engage in tactics such as front-running or
318. TIMOTHY G. MASSAD, IT’S TIME TO STRENGTHEN THE REGULATION OF CRYPTO-ASSETS,

ECONOMIC STUDIES AT BROOKINGS 24 (2019), https://www.brookings.edu/wp-content/uploads/
2019/03/Timothy-Massad-Its-Time-to-Strengthen-the-Regulation-of-Crypto-Assets-2.pdf
[https://perma.cc/M5ZN-VKSC].

spoofing319 exacerbates the likelihood that HFT strategies may de-

stabilize highly volatile cryptocurrency secondary markets.
Pinging, another technique used by HFT firms, involves placing

small test orders in the market at a number of different price
levels and then quickly canceling orders that are not filled. At
first, the trader may suffer a small loss, but will then adjust
their position and earn a larger profit. Some scholars refer to
pinging as a form of “high-speed front running,” and liken it to
the use of a radar or sonar system—hence the term pinging.320
319. Spoofing refers to a bluffing tactic whereby traders submit and cancel a series of bids
for the purpose of gaining an advantage in the market price. See Lindsay Whipp & Kara
Scannell, ‘Flash-Crash’ Trader Navinder Sarao Pleads Guilty to Spoofing, FIN. TIMES (Nov.
9, 2016), http://www.ft.com/content/a321031a-a6cb-11e6-8898-79a99e2a4de6 [https://perma.cc/
FMU2-G2S3] (discussing a futures trader’s part in the Flash Crash); see also Yun-Yi Wang,
Strategic Spoofing Order Trading by Different Types of Investors in the Futures Markets, 2016
EUR. FIN. MGMT. ASSN. 2, https://www.efmaefm.org/0EFMAMEETINGS/EFMA%20ANNUAL
%20MEETINGS/2016-Switzerland/papers/EFMA2016_0171_fullpaper.pdf [https://perma.cc/
D2MQ-QWAS] (“‘Spoofing orders’ are orders that are submitted into the market, with no
intention of the order being executed, as a means of injecting misleading information with
regard to the demand or supply of an asset, with the ultimate aim of coercing other traders
to trade in a particular way. ‘Spoofers’, that is, those submitting spoofing trading orders, will
subsequently submit their real orders, in order to take advantage of the price changes
resulting from trading by other market participants in response to their earlier spoofing
orders.”); Richard Satran, Spoofing or Just Fast Trading? Chicago Case Helps Unwrap
Mystery, REUTERS (Nov. 19, 2015), http://blogs.reuters.com/financial-regulatory-forum/
2015/11/19/spoofing-or-just-fast-trading-chicago-case-helps-unwrap-mystery/ [https://perma.
cc/7NZ5-5JJH] (“Spoofing involves traders entering and quickly canceling large orders in an
attempt to manipulate prices.”); Larry Schneider, “Spoofing” and Disruptive Futures Trading
Practices, N.Y. INST. OF FIN., https://perma.cc/TYS2-4LLF; Bradley Hope, As ‘Spoof’ Trading
Persists, Regulators Clamp Down, WALL ST. J. (Feb. 22, 2015, 10:34 PM), http://www.wsj.com/
articles/how-spoofing-traders-dupe-markets-1424662202 [https://perma.cc/JP2G-C3VP]; see
also Steven McNamara, The Law and Ethics of High-Frequency Trading, 17 MINN. J.L. SCI.
& TECH. 71, 114-15 (2016) (“‘Spoofing’ would involve making an offer to buy (a bid) at $15.12,
then executing the opposite transaction, selling the security at this price, after other players
in the market have raised their bids in response to the higher offer. Finally, the original offer
to buy at $15.12 will be cancelled before other parties can act on it.” (footnotes omitted)).
320. Johnson, supra note 59, at 879-80; see Gregory Scopino, The (Questionable) Legality
of High-Speed “Pinging” and “Front Running” in the Futures Markets, 47 CONN. L. REV. 607,
612-13 (2015). While some see pinging as a legitimate tactic in modern trading, many
complain that it takes advantage of the market and those who do not have access to such
techniques. See id. at 625-26. For example, a primary issue is that computer programs,
effectively algorithms and artificial platforms, bait institutional and traditional investors into
placing large numbers of orders and then canceling the vast majority of them quickly. Id. at
624.

Regulators are concerned that these tactics may also enable

insider trading.321 These concerns include scenarios in which
traders, engaging in nefarious trading practices, frequently inun-
date cryptocurrency exchanges and clearinghouses with fictitious
trades to manipulate the price of listed cryptocurrencies.322 Such
practices would undermine the price discovery and price accuracy
processes.323 Furthermore, algorithmic trades often have substantial
correlations; thus, “shocks that hit a small number of very active
HFT traders could detrimentally affect the entire market.”324
Regulators are also concerned that cryptocurrency exchanges may
have experienced rapid but short-lived price declines because of
errors or malfunctions arising from market participants’ reliance on
automated trading.325
Notwithstanding, the case for regulatory oversight will not appeal
to everyone. Many may not applaud regulatory intervention that
reduces fraud and manipulation. Some reject regulation as inconsis-
tent with the antiestablishment principles that motivate the
creation and development of cryptocurrency.326 Others may be
attracted to cryptocurrency secondary markets because they desire
to engage in conduct that would be prohibited in the secondary
markets for traditional legacy asset classes.327
The operational mechanics of the protocols for decentralized
exchanges further exacerbates concerns. Censorship resistance is a
key feature of these public, permissionless exchange networks.328
Recall traders executing transactions on decentralized exchanges
321. See Commerce, Justice, Science, and Related Agencies Appropriations for 2015:
Hearing Before the Subcomm. on Com., Just., Sci. & Related Agencies of the H. Comm. on
Appropriations, 103th Cong. 195 (2014) (statement of Eric Holder, Jr., Att’y Gen. of the
United States); SHORTER & MILLER, supra note 307, at 20-21.
322. See SHORTER & MILLER, supra note 307, at 41.
323. Id. at 8-9.
324. Id. at 27.
325. See Matt Egan, Flash Crash: Could It Happen Again?, CNNMONEY (May 6, 2014, 3:58
PM), http://money.cnn.com/2014/05/06/investing/flash-crash-anniversary/ [https://perma.cc/
7LNY-FTXA].
326. See TAPSCOTT & TAPSCOTT, supra note 166, at 5-6; Walch, supra note 20, at 871.
328. Cyrus Younessi, An Introduction to Censorship-Resistant Store of Value, MEDIUM
(June 18, 2018), https://medium.com/scalar-capital/an-introduction-to-censorship-resistant-
store-of-value-c5f4a24ca8a0 [https://perma.cc/F4LH-6ACV].

generally retain custody of their funds.329 Censorship resistance

reinforces the notion that only the accountholder may access any
funds or assets that may be used to trade on the exchange.330 This
feature prevents third parties such as financial market intermediar-
ies, banks, or exchanges facilitating secondary market trading from
confiscating the assets of platform users.331
Censorship resistance and the operatoinal mechanisms of trust-
lessness create latency in cryptocurrency secondary market
trading.332 As noted above, for traders implementing high frequency
trading strategies, latency provides opportunities for deploying
front-running trading tactics.333 In the fall of 2020, an academic
study revealed that high frequency traders have leveraged a
combination of commonly used tactics to introduce a front-running
and back-end attack that sandwiches targeted trading victims’
transactions.334 According to the study,
To make their sandwich, a predatory trader first observes a

blockchain P2P network for a victim transaction and then
rushes to squeeze it by placing one order just before the transac-
tion (i.e. front-run) and one order just after it (i.e. back-run). If
the target transaction is going to increase (decrease) the price of
an asset, the adversary can place an order before which buys
(sells) the asset in question, and an order afterward which sells
(buys) the asset again.335
Referring to the Uniswap decentralized exchange, the authors

underscore that decentralized exchanges that rely on automated

330. Younessi, supra note 328.
331. Id.
332. In the absence of the centralized exchange acting as an intermediary, the mechan-
isms for confirming sufficient available funds and distributing funds in exchange for crypto-
currency on DEXs is a multistage process that creates latency. See Frank Edwood, Why Low
Latency Is Important for Cryptocurrency Exchanges, Explained, COINTELEGRAPH (Oct. 23,
2020), https://cointelegraph.com/explained/why-low-latency-is-important-for-cryptocurrency-
exchanges-explained [https://perma.cc/5H8X-GTCC].
334. Liyi Zhou, Kaihua Qin, Christof Ferreira Torres, Duc V Le & Arthur Gervais, High-
Frequency Trading on Decentralized On-Chain Exchanges, CORNELL UNIV. (Sep. 29, 2020),
https://arxiv.org/abs/2009.14021 [https://perma.cc/GG7A-PDN5].
335. Id.

market makers (AMM) for liquidity offer empirical evidence of the

proliferation of these practices.336 Transactions executed on
decentralized exchange protocols supported by smart contracts that
rely on AMMs for liquidity and integrate censorship-resistant
features that eliminate intermediation seem to fit neatly into SEC
Director Hinman’s definition of “sufficiently decentralized,”337
however, these platforms may also facilitate unfair trading conduct
that undermines the normative ethos of trading markets and under-
cut cryptocurrency theorists’ promises to democratize finance.
C. Cyber-Risks
During the ten-year period since Bitcoin’s creation, hackers have

launched fifty-six reported cyberattacks against cryptocurrency
exchanges, initial coin offerings, and other digital currency plat-
forms around the world.338 These incidents have resulted in over
$1.63 billion in losses.339 In January 2018, Coincheck, one of Japan’s
leading cryptocurrency trading exchanges, suffered a loss of $530
million in customer virtual currency assets after a successful cyber-
attack.340 Unfortunately, for cryptocurrency market participants,
these losses are not unprecedented.341 Concerns regarding cyber-
security incidents are mounting.342
Cryptocurrency exchanges often lack the infrastructure of
traditional financial institutions.343 Without internal governance
processes, compliance policies, and risk management guidelines,
cryptocurrency exchanges are more attractive to hackers and more
336. Id.
338. Steven Russolillo & Eun-Young Jeong, Cryptocurrency Exchanges Are Getting Hacked
Because It’s Easy, WALL ST. J. (July 16, 2018, 1:14 AM), https://www.wsj.com/articles/why-cryp
tocurrency-exchange-hacks-keep-happening-1531656000 [https://perma.cc/D8MV-V7G2].
339. Id.
340. Takashi Mochizuki & Paul Vigna, Cryptocurrency Worth $530 Million Missing from
Japanese Exchange, WALL ST. J. (Jan. 26, 2018, 4:48 PM), http://www.wsj.com/articles/cryp
tocurrency-worth-530-million-missing-from-japanese-exchange-1516988190 [https://perma.
cc/5MAT-U3QK].
341. As noted above, when hundreds of millions of dollars disappeared from Mt. Gox’s
coffers, the cryptocurrency exchange filed for bankruptcy protection. Id.
342. See Jolana Kubicek, Complications of Cyptocurrency: Financial and Cybersecurity
Risk in the Age of Bitcoin 30 (Apr. 2018) (M.S. dissertation, Utica College) (Proquest).
343. See id.

likely to suffer cybersecurity attacks.344 While it is beyond the scope

of this Article, it is worth noting that unregulated cryptocurrency-
exchange customers may have limited protection under federal
banking regulation. Both regulators and cryptocurrency exchanges
have indicated that the cash (U.S. dollars, euros, and so on) placed
in the custody of cryptocurrency exchanges may be eligible for pro-
tection under the federal banking scheme supervised by the Federal
Deposit Insurance Corporation.345 There is also near agreement that
the cryptocurrency assets that exchanges may hold in their custody
are not likely to receive protection under federal banking insurance
policies.346
Simply stated, centralized exchanges are “vulnerable to attack.”347
In fact, as described above, third-party cryptocurrency services and
individual wallets are “especially appealing” to hackers and “have
become points of failure for the system.”348
Centralized cryptocurrency exchanges are “like sitting ducks”
because cryptocurrency exchanges store currencies for their cus-
tomers.349 If malicious actors attack, their ability to penetrate the
cryptocurrency exchange platform provides unfettered access to
customers’ assets if the assets are stored in hot wallets that connect
to the platform through the internet.350
The cold wallet accountholder maintains a private key required
to access the cryptocurrency stored in the wallet.351 The cold wallet
is offline when cryptocurrencies are not being transferred (deposited
or debited) to and from the wallet.352 However, there are notable
costs associated with cold wallets. First, in order to execute trades
holders of cold wallets must connect to the platform and submit
orders.353 Consequently, cold wallet transactions operate on an
inherent delay and internet outages may disrupt access to cold
344. See id.

345. Cf. id. at 15.
346. Id. at 30.
347. Id. at 57.
348. Id. at 58.
349. See Russolillo & Jeong, supra note 338.
350. See id.
351. See Kubicek, supra note 342, at 44-45.
352. See id.
353. Id. at 45.

wallets.354 Accessing a cold wallet may require significant planning

and transactions may be delayed up to twenty-four hours.355 Cold
wallet holders also risk the loss of all value in the cold wallet.356 If
cold wallet users cannot authenticate their identification creden-
tials, misplace passwords, or forget the responses to security
imposed guardrails, their funds may be lost.357
D. Systemic Risk
The risks described above are not unique to cryptocurrency mar-

kets; automation, acceleration, and cyber risks are ubiquitous and
plague broker-dealers, exchanges, and clearinghouses servicing
diverse asset classes across the financial services industry. This
Section classifies the risks described above as enterprise risks and
explains how enterprise risks may lead to endogenous or exogenous
shocks that create systemic risks concerns. When risks threaten the
stability or solvency of an individual firm, the threat is an enter-
prise risk. When an individual firm experiences an enterprise risk
management failure, substantial losses occur.358
Financial markets provide an important infrastructure resource

that facilitates the efficient and effective transfer of money and
assets throughout the economy. When an event disrupts finan-
cial markets, the resulting negative externalities may spill over
and affect broad segments of the economy. For example, market
disruptions that cause financial market intermediaries to limit
lending activities can affect commercial and individual borrow-
ers across the country and create uniquely significant conse-
quences for traditional commercial banks.359
354. Id.
355. Id. at 44-45.
356. See id.
357. Id.
358. Kristin N. Johnson, Macroprudential Regulation: A Sustainable Approach to Reg-
ulating Financial Markets, 2013 ILL. L. REV. 881, 903; see Stephen M. Bainbridge, Caremark
and Enterprise Risk Management, 34 J. CORP. L. 967, 969 (2009); MILTON FRIEDMAN & ANNA
JACOBSON SCHWARTZ, A MONETARY HISTORY OF THE UNITED STATES 1867-1960, at 308-09
(1963).
359. See FRIEDMAN & SCHWARTZ, supra note 358, at 309.

When a run on the bank occurs, depositors concerned about the

bank’s future solvency may demand that the bank return their cash
deposits.360 As economists Milton Friedman and Anna Schwartz
explain, a national market disruption may create “a contagion of
fear” and lead to a series of bank failures.361
Commentators use the term systemic risk to describe the con-

cern that one systemically significant financial institution may
become insolvent and initiate a cascade of losses or insolvencies
across financial markets. Systemic risk concerns arise because
the banking industry is inextricably interconnected. Traditional
commercial banks hold deposit balances for other banks, lend to
and borrow from each other, and make payments to one another
through an interbank clearing system.362
Due to the interconnected contractual and economic nature of the

relationships among the largest market participants, “one financial
institution’s default on its obligations adversely affects the financial
institution’s trading partners, hindering their ability to meet their
obligations” and “so on down the chain of banks and beyond.”363
“Systemic risk may also occur if an exogenous shock to the financial
system causes widespread, contemporaneous losses across financial
markets that trigger the collapse of one or more systemically signif-
icant financial institutions or a series of financial institutions.”364
To mitigate the classic run on the bank scenario, regulatory ef-

forts have historically focused on prudential measures such as
boards’ risk oversight, safeguarding financial institutions’ sol-
vency by imposing mandatory capital requirements, limiting the
size or types of assets held by the bank, and limiting the classes
of permissible transactions. While regulators established these
mandates, authorities delegated primary risk-management
oversight to market participants.365
360. See id.

361. Id.
362. Johnson, supra note 358, at 903-04; see Steven L. Schwarcz, Systemic Risk, 97 GEO.
L.J. 193, 196, 199 (2008).
363. Johnson, supra note 358, at 904; Schwarcz, supra note 362, at 199 (quoting George G.
Kaufman, Bank Failures, Systemic Risk, and Bank Regulation, 16 CATO J. 17, 20-21 (1996)).
364. Johnson, supra note 358, at 904; Schwarcz, supra note 362, at 202.
365. Johnson, supra note 358, at 904; Schwarcz, supra note 362, at 210-11.

Some commentators and regulators “question the decision to permit

market participants to regulate activities that contribute to sys-
temic risk concerns using internal governance mechanisms; others
tout the benefits of self-regulation.”366
The failure of a systemically significant firm or the failure of
several important firms in rapid succession may create disruption
across financial markets.367 In other words,
localized economic shocks have the potential to crescendo into

broader systemic crises. First, a firm’s financial integrity and its
exposure to the risk of low-probability adverse events may lead
to economic shocks. Second, the inter-institutional correlation
among financial firms and markets may trigger events that
disrupt a local, regional, or national economy.368
The failure of the American International Group (AIG) is one of

the most infamous examples of an enterprise risk management
failure leading to a market shock and engendering systemic risk
concerns. In June 2008, AIG was a large diversified financial
services firm with slightly more than $1 trillion in assets;369 by the
fourth quarter of 2008, AIG reported over $61.7 billion in losses—
the largest single quarter loss reported in the history of financial
markets.370 In the years leading up to its solvency crisis, AIG’s
366. See Schwarcz, supra note 362, at 212 n.105.

367. Id. at 204. As Steven Schwarcz explains, such an event or series of events may lead
to systemic risk, or
the risk that (i) an economic shock such as market or institutional failure trig-
gers (through a panic or otherwise) either (X) the failure of a chain of markets
or institutions or (Y) a chain of significant losses to financial institutions, (ii)
resulting in increases in the cost of capital or decreases in its availability, often
evidenced by substantial financial-market price volatility.
Id.
368. Kristin N. Johnson & Steven A. Ramirez, New Guiding Principles: Macroprudential
Solutions to Risk Management Oversight and Systemic Risk Concerns, 11 U. SAINT THOMAS
L.J. 386, 394 (2014); see Iman Anabtawi & Steven L. Schwarcz, Regulating Systemic Risk: To-
wards an Analytical Framework, 86 NOTRE DAME L. REV. 1349, 1351 (2011).
369. Regulatory Reform: American International Group (AIG), Maiden Lane II and III, FED.
RSRV. SYS. (Feb. 12, 2016), https://www.federalreserve.gov/regreform/reform-aig.htm [https://
perma.cc/5SGM-6Z56].
370. AIG Enters Record Books with $61.7 Billion Loss, REUTERS (Mar. 2, 2009, 6:29 AM),
https://www.reuters.com/article/us-aig-results-sb/aig-enters-record-books-with-61-7-billion-

Financial Products unit had amassed a $450 billion credit deriva-

tives portfolio—an irresponsible bet that nearly caused the firm’s
collapse.371 According to Federal Reserve Chair Ben Bernanke, AIG
“exploited a huge gap in the regulatory system” and operated as an
unregulated hedge fund.372
When the market moved against its large unhedged credit
derivatives position, AIG lurched toward insolvency. The firm’s
unhedged exposure in the credit derivatives market led to an
enterprise risk management failure.373 Due to the interconnected
web of transactions among AIG and many of the largest financial
institutions in the nation, had AIG failed and filed for bankruptcy
protection, its counterparties would have suffered staggering losses
and some may have faced their own individual solvency crisis.374 To
avoid this outcome, the Federal Reserve granted AIG access to a
$152 billion credit facility.375 The Office of Thrift Supervision (OTS)
criticized AIG’s “risk-management, corporate oversight, and finan-
cial reporting,” and later issued a Supervisory Letter downgrading
AIG’s examination rating.376
Enterprise and systemic risk concerns arise, in part, due to the
endemic asymmetries of information. One might assume that in-
vestors or customers who utilize cryptocurrency secondary markets
have basic information regarding the fintech firms that execute
loss-idUSTRE5211X520090302 [https://perma.cc/UA44-VUCQ]. AIG underwrote $450 billion

of credit default swaps that obligated it to pay on pools of securities in the event that the
primary obligees failed to pay. Lilla Zuill & Kristina Cooke, AIG Failure Would Be Disastrous
for Global Markets, REUTERS (Mar. 2, 2009, 3:59 AM), https://www.reuters.com/article/a-
failure-would-be-distrarous-for-global-markets-idUKLNE52101620090302 [https://perma.cc/
H7S8-E7W8]. The government pumped $150 billion into AIG. Id.
371. See Zuill & Cooke, supra note 370.
372. Economic and Budget Challenges for the Short and Long Term: Hearing Before the S.
Comm. on the Budget, 111th Cong. 19 (2009) (statement of Ben Bernanke, Chairman, Bd. of
Governors of the Fed. Res. Sys.).
373. See Zuill & Cooke, supra note 370.
374. Robert O’Harrow, Jr. & Brady Dennis, Downgrades and Downfall, WASH. POST (Dec.
31, 2008), https://www.washingtonpost.com/wp-dyn/content/article/2008/12/30/AR200812300
3431.html?sid=ST2010062905395 [https://perma.cc/N9HH-WQ7E].
375. See id.
376. American International Group’s Impact on the Global Economy: Before, During, and
After Federal Intervention: Hearing Before the Subcomm. on Capital Markets, Ins., and Gov’t
Sponsored Enters. of the H. Comm. on Fin. Servs., 111th Cong. 215 (2009) (statement of Scott
M. Polakoff, Acting Dir., Off. of Thrift Supervision).

their trading transactions. In fact, most customers have exception-

ally limited information regarding the firms upon which they rely.
Although economic models assume perfect information, consum-
ers often lack information that they need to assess the quality of
goods and services prior to purchasing them.377 Because goods and
services vary based on the amount of information that consumers
possess, economists group goods and services into three categories
based on their attributes: (1) search goods and services; (2) experi-
ence goods and services; and (3) credence goods and services.378 For
search goods and services, quality may be easily discerned prior to
consumption.379 Financial markets offer credence goods and ser-
vices, distinct from the markets for other goods and services;
consequently, there are fewer straightforward methods to resolve
information gaps. An illustration may be useful.
A consumer in the market for a used car, for example, distrusts
the used car salesman’s representations regarding the quality of the
car. The used car salesman has more information about the car and
has incentives to misrepresent, or at least remain silent about the
car’s defects. If the buyer wants to reduce the asymmetries of in-
formation, she can hire a mechanic to evaluate the car. She might
also limit her search to a reputable used car showroom.
For customers entering into cryptocurrency trading transactions,
there are far fewer tools to assess the quality of broker-dealers,
clearinghouses, and exchanges. First, evidence from the recent
financial crisis demonstrates that even reputation information may
prove a challenging measuring stick for customers.380 During the
recent financial crisis, several of the most storied broker-dealers
377. See George A. Akerlof, The Market for “Lemons”: Qualitative Uncertainty and Market
Mechanism, 84 Q.J. ECON. 488, 490-92 (1970); see also Henry N. Butler & Jason S. Johnston,
Reforming State Consumer Protection Liability: An Economic Approach, 2010 COLUM. BUS.
L. REV. 1, 59-60.
378. Butler & Johnston, supra note 377, at 59-60.
379. Phillip Nelson, Information and Consumer Behavior, 78 J. POL. ECON. 311, 312 (1970);
see also Butler & Johnston, supra note 377, at 59. Experience goods and services can be
accurately evaluated only after they have been purchased and experienced. Credence goods
have qualities that cannot be observed. These goods and services require expert opinions.
380. See Noah Smith, The Dirty Little Secret of Finance: Asymmetric Information,
BLOOMBERG (Aug. 11, 2016, 7:00 AM), https://www.bloomberg.com/opinion/articles/2016-08-
11/the-dirty-little-secret-of-finance-asymmetric-information [https://perma.cc/DPE2-LQNS].

suffered debilitating losses due to their firms’ excessive risk taking

or enterprise risk management failures.381
Second, asymmetries of information are more problematic in
financial services markets because information is often the product
that financial market services consumers seek to acquire. As one
commentator explains:
People want cars and bananas and microwave ovens because

those things are immediately useful. But most people who buy
and sell financial assets have no intrinsic desire for the asset
itself—they only care about how its value to other people will
change in the future. That means that while information is im-
portant for many products, when it comes to financial markets,
information is the product.382
If information is the asset, then there are even fewer tools available
to financial market consumers than other types of consumers to
mitigate asymmetries of information.
Third, asymmetries of information enable arbitrage. As described
above, high frequency traders profit from latency, which is to say a
delay between the time information is available regarding a pending
trade and the execution of the trade.383 Traders who employ HFT
strategies learn information regarding institutional investors’
pending large block orders and enter into a series of smaller trades
to purchase and sell the same securities ahead of the execution of
the institutional investors’ trade.384 This strategy increases the price
of the security at little risk for the high frequency trader.385
IV. (RE-)ENVISIONING INTERMEDIARY REGULATION
The proliferation of innovative developments and technology in

fintech is not surprising. Fintech entrepreneurs are persistent, in
part, because of their attractive and highly lucrative incentives:
381. See id.

382. Id.; see also Sanford J. Grossman & Joseph E. Stigliz, On the Impossibility of
Informationally Efficient Markets, 70 AM. ECON. REV. 393, 393 (1980).
383. See supra Part III.B.

provide an alternative to costly and burdensome intermediation and

displace traditional financial institutions marred by opportunistic
behavior, avarice, and misconduct.
Facebook’s distribution of the White Paper detailing the creation
of Diem, a managed stablecoin, in 2019 illustrates this drive.386
During his testimony before Congress, the head of Diem and chief
executive officer of Calibra, David Marcus, stated that Diem will de-
mocratize finance and increase access to banking for the thirty-three
million unbanked and underbanked households in the United
States387 and the 1.7 billion individuals globally who lack access to
basic financial services.388 According to Marcus, Diem will enable
frictionless and less expensive remittances between families in the
U.S. and among friends, relatives, and other intimate relations in
countries all over the world.389
While lawmakers and consumer advocates’ skeptical response has
(temporarily) stymied domestic and international adoption of
Diem,390 it is worth noting that neither Facebook nor any of the
myriad fintech firms competing to eliminate financial services inter-
mediation, are sitting idle. On November 12, 2019, Facebook an-
nounced the launch of Facebook Pay on its original and WhatsApp
applications.391 In fact, Diem and Facebook Pay mark the fourth and

387. See FED. DEPOSIT INS. CORP., 2017 FDIC NATIONAL SURVEY OF UNBANKED AND
UNDERBANKED HOUSEHOLDS 1 (2018), http://www.fdic.gov/householdsurvey/2017/2017report.
pdf [https://perma.cc/Y65A-5YGR].
388. ASLI DEMIRGÜÇ-KUNT, LEORA KLAPPER, DOROTHE SINGER, SANIYA ANSAR & JAKE HESS,
WORLD BANK GRP., THE GLOBAL FINDEX DATABASE 2017: MEASURING FINANCIAL INCLUSION
AND THE FINTECH REVOLUTION 4 (2018), http://documents1.worldbank.org/curated/en/332
881525873182837/pdf/126033-PUB-PUBLIC-pubdate-4-19-2018.pdf [https://perma.cc/SM2J-
YUM9] (“[A]bout 1.7 billion adults remain unbanked—without an account at a financial
institution or through a mobile money provider.”).
389. Alex Katsomitros, Facebook’s Foray into Financial Services Is Struggling to Gain
Momentum—Here’s Why, WORLD FIN. (Jan. 6, 2020), https://www.worldfinance.com/special-
reports/facebooks-foray-into-financial-services-is-struggling-to-gain-momentum-heres-why
[https://perma.cc/RUE7-2ZW8].
390. See id.
391. Deborah Liu, Simplifying Payments with Facebook Pay, FACEBOOK NEWS (Nov. 12,
2019), http://about.fb.com/news/2019/11/simplifying-payments-with-facebook-pay/ [https://
perma.cc/8ZZV-TJJW]; see also Tom Warren, Facebook Pay Is a New Payment System for
WhatsApp, Instagram, and Facebook, VERGE (Nov. 12, 2019, 12:33 PM), https://www.the
verge.com/2019/11/12/20961447/facebook-pay-whatsapp-instagram-messenger-features
[https://perma.cc/5Z3H-7MEU].

fifth, respectively, financial services platforms that Facebook has

readied for launch.
This Part explores the need for federal intervention in crypto-
currency secondary market transactions. It argues that federal
intervention should address enterprise and systemic risk concerns
by correcting asymmetries of information in secondary market
transactions and ensuring compliance with emerging industry
norms. This Part evaluates three popular proposals and concludes
that none of them successfully addresses both the asymmetries of
information and risk management concerns. This Part concludes by
proposing that financial regulators must collaborate to develop and
deploy an ex ante registration process for fintech products and
services enabling secondary market trading on distributed digital
ledger technology platforms.
A. Ordering Markets: Proposed Reforms
A survey of the proposed responses to fintech’s growing signifi-

cance in financial markets reveals all-too-common responses to
market regulation. Disillusioned by the financial services industry,
fintech proponents contend that efforts to regulate are a by-product
of industry capture. As such, some cryptocurrency proponents de-
mand a laissez-faire approach. They argue that the code is law and
criticize regulators’ irreverent, clumsy, and underinformed inter-
ventions.
According to advocates, regulators may be unduly influenced by
the industries that they regulate.392 As a consequence, democratic
processes are co-opted and financial services special interest groups
exert significant influence over the development and implementa-
tion of financial services legislation and regulation.393 Consequently,
capture may lead to policy choices that benefit industry participants
rather than the public good.394 Examples following the recent fi-
nancial crisis punctuate these claims.395 The question is not which
392. See Victor Fleischer, Regulatory Arbitrage, 89 TEX. L. REV. 227, 283-84 (2010).
393. See id.
394. See id.
395. See id. at 283-85.

example but how many examples may be required to prove the

point.396
At the opposite end of the spectrum, detractors demand a formal
prohibition preventing the origination, distribution, or secondary
market trading of cryptocurrencies. In the wake of the exponential
growth of cryptocurrencies in markets during the last several years,
this approach is tantamount to willful blindness. Not only are
cryptocurrency markets flourishing but, as Part II explained, a
secondary market infrastructure now supports the market for native
tokens.397 In other words, the horse is out of the gate.
An express prohibition is unlikely. The SEC has advocated for a
more measured approach that may serve as an equally useful
limiting rule. First, the SEC has clearly articulated its position. If
the economic realities of a cryptocurrency are analogous to those of
traditional securities—stocks or bonds—then the cryptocurrencies
may be deemed securities and subject federal securities laws.398
Consistent with its mission to protect investors and the integrity
of markets, the SEC published the DAO report, an investigative
report offering guidance on the application of Section 5 of the
Securities Act to ICOs issued by decentralized, autonomous orga-
nizations.399 Section 5 of the Securities Act requires market par-
ticipants to register “securities” with the SEC prior to offering them
for sale unless an exemption applies.400 Section 2(a)(1) defines the
term “security” by enumerating a list of financial arrangements that
Congress expressly intended to capture within the purview of the
396. Congress and the SEC’s mismanagement of proposed changes to the standards
governing broker-dealers’ and investment advisers’ interactions with customers offers a less
controversial example. For years prior to the adoption of the Dodd-Frank Act, advocates
lobbied for either Congress to codify or the SEC to adopt regulations imposing fiduciary duties
on broker-dealers and investment advisers. To its credit, Congress adopted Section 913 of the
Dodd-Frank Act and tasked the SEC with studying whether the legal standard of care
applicable to broker-dealers and investment advisers was appropriate. Dodd-Frank Wall
Street Reform and Consumer Protection Act, Pub. L. No. 111-203, § 913, 124 Stat. 1376, 1824-
25 (2010). To consumer advocates’ chagrin, the statutory provision did not enact a standard
nor did it require the SEC change the existing standard. Id. The SEC’s election not to change
the standard deflated advocates’ campaign and generally marked the defeat of their efforts.
See Hilary J. Allen, Regulatory Sandboxes, 87 GEO. WASH. L. REV. 579, 611 & n.187 (2019).
397. See supra Part II.
398. Henderson & Raskin, supra note 194, at 455.
399. DAO Report, supra note 170, at 1-2.
400. Securities Act of 1933 § 5, 15 U.S.C. § 77e(a).

statute.401 A digital asset may be deemed a “security” and be subject

to federal securities laws if the asset is one of the enumerated
examples of “securities.”402 Unsurprisingly, blockchain-based coins
and tokens are not expressly listed among the enumerated examples
of “securities” in Section 2(a)(1).403 However, alongside the enumer-
ated examples of asset classes commonly referred to as securities,
Congress included, but did not define, a catch-all term: “investment
contract.”404
In SEC v. W.J. Howey Co., the Supreme Court articulated the
legal standard for determining when a financial arrangement may
be deemed an “investment contract” and, therefore, a “security.”405
As Howey and its progeny explain, a financial arrangement is an
“investment contract” if the arrangement involves (1) an investment
of money (2) in a common enterprise (3) with a reasonable expecta-
tion of profits (4) to be derived from the entrepreneurial or manage-
rial efforts of others.406
The DAO Report confirms the SEC’s intentions to apply this well-
established legal standard to coin offerings and signals that coin or
token offerings with transactional attributes that satisfy the ele-
ments articulated in Howey will be deemed “investment contracts”
and therefore “securities” subject to the registration requirements
established under Section 5 of the Securities Act.407
Second, a marked uptick in SEC enforcement actions buttresses
the agency’s proclamation regarding cryptocurrencies.408 Unless an
exemption applies, failure to register an offering of financial
products that bears the attributes of the instruments enumerated
in the definition of a “security” triggers strict liability under
Sections 5(a) and (c)409 and a host of remedies, including an inves-
tor’s right to rescind her purchase under Section 12.410 In recent
401. Securities Act of 1933 § 2, 15 U.S.C. § 77b(a)(1).

402. See id.
403. Id.
404. Id.
405. 328 U.S. 293, 298-99 (1946).
406. Id. at 301.
407. See DAO Report, supra note 170, at 10-11.
408. See, e.g., Munchee Inc., Securities Act Release No. 10445, 2017 WL 10605969, at 2
(Dec. 11, 2017).
409. 15 U.S.C. § 77e(a), (c).
410. Id. § 77l.

enforcement actions against cryptocurrency broker-dealers and

exchanges, the SEC has reiterated this perspective.411
While applying federal securities laws to cryptocurrency origina-
tion and secondary distribution is far from an express prohibition,
the effects of imposing the onerous registration process indisputably
introduces a speed bump for issuers, investors, broker-dealers, and
exchanges.412 In fairness to market participants, neither of the
approaches adopted by the SEC—informal guidance and regulation
by enforcement—is a substitute for the public rulemaking process.413
Moreover, the DAO Report announces the application of federal
securities laws, yet fails to address concerns regarding the applica-
tion of the standard.414 Specifically, the DAO Report does not ex-
plain which attributes of a cryptocurrency offering satisfy the final
two elements of the Howey test.415 One may assume that the first
two prongs of the Howey test—(1) an investment of money (2) in a
common enterprise—are easily satisfied; in most instances, in-
vestors exchange money (government-issued fiat or other forms of
cash, including other digital currencies) for cryptocurrencies.416
Cryptocurrencies pool investors’ money, establishing the horizontal
or vertical commonality required under Howey and its progeny.417
Thus, liability for ICO issuers rests on whether there is evidence of
investors’ reasonable expectation of profits derived from the mana-
gerial efforts of others.418 Reasonable minds may disagree regarding
the evidence that satisfies these final elements in the standard.419
411. See, e.g., Munchee Inc., Securities Act Release No. 10445 at 2, 10.
412. See § 77e (describing liability for failure to register product as a “security”).
413. See, e.g., Commission Rulemaking Explained, COMMODITY FUTURES TRADING COMM’N,
https://cftc.gov/LawRegulation/CommissionRulemakingExplained/index.htm [https://perma.cc/
KK32-M7Y5] (describing public notice and comment rulemaking process used by CFTC).
414. See DAO Report, supra note 170, at 1-2.
415. See id. at 11-12.
416. See id. at 11.
417. See, e.g., SEC v. Edwards, 540 U.S. 389, 392-93, 397 (2004); SEC v. ETS Payphones,
Inc., 408 F.3d 727, 732 (11th Cir. 2005); SEC v. Infinity Grp. Co., 212 F.3d 180, 187-88 (3d Cir.
2000).
418. See Henderson & Raskin, supra note 194, at 455, 458, 461-62.
419. Compare SEC v. Glenn Turner Enters., 474 F.2d 476, 482 (9th Cir. 1973) (stating that
the critical inquiry is “whether the efforts made by those other than the investor are the
undeniably significant ones, those essential managerial efforts which affect the failure or
success of the enterprise”), with Miller v. Cent. Chinchilla Grp., 494 F.2d 414, 417-18 (8th Cir.
1974) (holding chinchilla-raising investment opportunity was a pyramid scheme and
concluding that promoters were liable based on the marketing materials’ suggestion that only

As market participants and regulators observe, the operational

mechanics of different coins and tokens create noteworthy varia-
tions among cryptocurrencies.420 Consequently, notwithstanding the
DAO Report, market participants and issuers continue to lack
clarity regarding which operational attributes establish that digital
assets are investment contracts and therefore securities subject to
the registration requirements imposed by Section 5 of the Securities
Act.421 Moreover, market participants have become increasingly
indignant as continued guidance, court decisions, and subsequent
enforcement actions reflect inaccuracies regarding how cryptocur-
rencies operate,422 conflicting suggestions regarding the structures
that satisfy the final elements of the Howey standard, and muddled
or incomplete information regarding what triggers liability in
secondary market transactions.423
Reflecting on Facebook’s Diem, Katharina Pistor poignantly
observed during congressional hearings that “[e]xisting experience
with attempts to regulate cryptocurrencies suggests that regulating
Diem with the tools currently available would not be easy and might
even be impossible.”424
Finally, moderate commentators acknowledge the perils of an
unregulated cryptocurrency market and the challenges of applying
existing regulation to cryptocurrency markets.425 In a diverse set of
proposals that all encourage light-touch regulation, proponents
encourage various intermediate approaches to regulation, including
minimal efforts were required by potential investors to breed chinchillas).

420. See generally Cryptocurrency Comparison, supra note 162.
421. See Securities Act of 1933 § 5, 15 U.S.C. § 77e.
422. In the SEC’s first enforcement action alleging a violation of Section 5 of the Securities
Act related to the sale of a cryptocurrency, both the federal district court’s opinion and the
SEC’s briefs include several incomplete or erroneous descriptions of blockchain technology
and the financial products distributed by the defendant Bitcoin Savings and Trust. See SEC
v. Shavers, No. 4:13-CV-416, 2014 U.S. Dist. LEXIS 130781, at *3-4 (E.D. Tex. Sept. 18, 2014);
see, e.g., Plaintiff’s Motion for Summary Judgment or, in the Alternative, for Default
Judgment at 19-21, SEC v. Shavers, 2014 U.S. Dist. LEXIS 130781.
423. See James J. Park, When Are Tokens Securities? Some Questions from the Perplexed,
HARV. L. SCH. F. ON CORP. GOVERNANCE (Dec. 20, 2018), https://corpgov.law.harvard.edu/2018/
12/20/when-are-tokens-securities-some-questions-from-the-perplexed/ [https://perma.cc/8A8R-
K55Y].
424. Statement of Katharina Pistor, supra note 16, at 9.
425. See Daniel Araya, The Challenges of Cryptocurrency Regulation, REGUL. REV. (Oct. 9,
2018), https://www.theregreview.org/2018/10/09/araya-challenges-cryptocurrency-regulation/
[https://perma.cc/25CQ-KHMN].

allowing cryptocurrency market participants to qualify for regis-

tered offering and secondary market trading exemptions426 or
creating regulatory sandboxes to permit regulators to engage in
regulatory experimentation.427
B. Self-Certification
In recent years, developers, investment bankers, hedge funds, and

venture capital firms began engineering two new classes of
blockchain-based assets—derivatives and exchange traded funds
(ETFs).428 Creators posit that transforming cryptocurrencies or
digital gold429 into these types of assets expands the ecosystem of
financial products, platforms, and services; enhances price discovery
and liquidity; and mitigates volatility.430 Yet, recent experience in
financial markets suggests that even the most straightforward
iterations of these two complex financial products—derivatives and
ETFs—may create concerns for financial market integrity and
stability.431
Similar to the creation of cryptocurrencies, cryptocurrency
exchanges, and clearinghouses, cryptocurrency ETFs present a
notable challenge for federal financial markets regulators.432
Financial markets statutes and regulations expressly establish
transaction-centered mandates for federal regulatory agencies.433
These mandates apply to specific transactions with the under-
standing that regulators exercise authority over certain classes of
426. See, e.g., Johnson, supra note 194, at 26, 30.

427. Allen, supra note 396, at 580-81.
428. Cf. AJ Horch, Here’s Why Investors Started Pouring Trillions into Exchange-Traded
Funds, CNBC (May 29, 2020, 10:09 AM), https://www.cnbc.com/2020/05/29/why-investors-are-
pouring-trillions-into-exchange-traded-funds.html [https://perma.cc/2DNH-MCV3] (describing
reasons for the growth of ETFs in the 2010s).
429. NATHANIEL POPPER, DIGITAL GOLD, at x-xii, 8-11 (2015) (providing a carefully detailed
narrative of the development of Bitcoin and its subsequent adoption by Cypherpunks).
430. See Horch, supra note 428 (describing ETFs as “typically low cost, low risk” funds).
431. See MARIA DEMERTZIS & GUNTRAM B. WOLFF, BRUEGEL, THE ECONOMIC POTENTIAL
AND RISKS OF CRYPTO ASSETS: IS A REGULATORY FRAMEWORK NEEDED? 10-11 (2018), https://
www.bruegel.org/wp-content/uploads/2018/09/PC-14_2018.pdf [https://perma.cc/9NHQ-9XZN].
432. Cf. id. at 5, 11 (discussing the challenge of classifying cryptoassets and the financial
instability such assets may cause).
433. See, e.g., Securities Exchange Act of 1934 § 5, 15 U.S.C. § 78e.

entities, financial products, and transactions.434 New classes of

cryptocurrency assets, however, may be fluid and defy this
transaction-based regulatory approach.435
Notwithstanding the attractiveness of this approach in other
asset classes, it is unlikely to serve regulators well in cryptoasset
markets where assets may be more fluid or dynamic.436 Espousing
a transaction-based approach in a market where financial products
are rapidly evolving fails to acknowledge the convertible nature of
the assets and exchanges in these shadow markets.437
Additionally, contentious conflicts regarding jurisdiction create
frictions in the relationships among regulators.438 Territorial
disputes among regulators and posturing may impede adoption of
universally accepted terminology, delaying regulatory certainty.439
Regulators fiercely defend the scope of their authority and aggres-
sively dissuade incursions.440 As described below, regulatory com-
petition can undermine regulators’ efforts to achieve the normative
goals that motivate financial market regulation.441
To enhance regulatory oversight of cryptocurrency exchanges and
clearing platforms, this Article proposes that regulation should
designate these assets as dynamic intermediaries and empower the
developers of these assets to self-designate which federal regulatory
authority they believe should supervise their market activities.
Market participants would designate their preferred regulator
through a process known as “self-certification” under the
434. See id.

435. See Araya, supra note 425 (explaining that cryptoassets “can simultaneously function
across multiple categories”).
436. See Statement of Katharina Pistor, supra note 16, at 2, 9.
437. See Fleischer, supra note 392, at 229-30 (introducing “the first comprehensive theory
of regulatory arbitrage, identifying the conditions under which arbitrage takes place and the
various legal, business, professional, ethical, and political constraints on arbitrage”).
438. See Kevin Wack, Regulatory Competition Is Hot Again—and That’s Worrisome, AM.
BANKER (Jan. 6, 2019, 10:00 PM), https://www.americanbanker.com/news/regulatory-competi
tion-is-hot-again-and-thats-worrisome [https://perma.cc/NM6C-LM5U].
439. See id.
440. See id.; see also Marcelo Rezende, The Effects of Bank Charter Switching on Super-
visory Ratings 20 (Fed. Rsrv. Bd. Div. of Rsch. & Stat. & Monetary Affs. Working Paper No.
2014-20, 2014), https://www.federalreserve.gov/pubs/feds/2014/201420/201420pap.pdf [https://
perma.cc/7ZWK-DYKP] (demonstrating that banks “almost surely receive good [supervisory]
ratings after they switch charters”).
441. See infra Part V.B.

regulations imposed by the CFTC under the Commodity Exchange

Act (CEA) adopted by Congress in 1936.442 Because this Article
anticipates that multiple federal regulators will simultaneously
create self-designation processes, outlining a detailed description of
the operational language may not be particularly useful.
Regulators would implement this comprehensive self-designation
process through a formal notice and comment rulemaking process.443
Under such a coordinated approach, each regulator, empowered by
one of the several statutes in the patchwork of laws that govern
financial markets would proceed according to its mandate.444 Even
operating within this coordinated regulatory scheme, the ethos and
regulatory culture of each agency will influence the details of the
development, adoption, and implementation of the self-designation
process. Thus, rather than attempt to propose specific operational
language, this Section offers a soft definition of dynamic intermedi-
aries, identifies the agencies that will create self-designation
processes, and provides a general illustration of the CFTC’s recent
use of its self-certification process in cryptocurrency markets.
Because the concerns regarding cryptocurrency markets traverse
the fragmented financial markets regulatory framework, this Article
proposes a macroprudential solution.445 By imposing uniform,
principles-based regulation on cryptocurrency exchanges operating
442. See U.S. COMMODITY FUTURES TRADING COMM’N, CFTC BACKGROUNDER ON SELF-
CERTIFIED CONTRACTS FOR BITCOIN PRODUCTS (2017), https://www.cftc.gov/sites/default/
files/idc/groups/public/@newsroom/documents/file/bitcoin_factsheet120117.pdf [https://perma.
cc/TYE8-2Q62] [hereinafter CFTC BACKGROUNDER].
443. See Commission Rulemaking Explained, supra note 413.
444. Cf. Shelagh Dolan, How the Laws and Regulations Affecting Blockchain Technology
and Crypocurrencies, Like Bitcoin, Can Impact Its Adoption, BUS. INSIDER (Jan. 27, 2021, 3:36
PM), https://businessinsider.com/blockchain-cryptocurrency-regulations-us-global [https://
perma.cc/36GU-X5JN] (describing state agencies empowered by law to regulate cryptocur-
rency).
445. Macroprudential policies mitigate the herding associated with prudential policies. See
supra notes 365-68. Exploring macroprudential policy enables us to consider increasing
capital requirements when the economy performs well or introducing techniques such as
dynamic provisioning and capital buffers to moderate procyclical activities or create a fund
to serve during economic downturns. See Kadija Yilla & Nellie Liang, What Are
Macroprudential Tools?, BROOKINGS INST. (Feb. 11, 2020), https://www.brookings.edu/blog/up-
front/2020/02/11/what-are-macroprudential-tools/#:~:text=Macroprudential%20policies%20
are%20fubabcuak%20policies,necessary%20for%20stable%20economic%20growth [https://
perma.cc/7B3J-TEFM]. Macroprudential tools may reduce incentives to adopt excessive lev-
erage during periods of prosperity or to deleverage during economic downturns. See id.

in the marketplace, self-designation fills a risk oversight gap and

addresses endogenous and exogenous enterprise and systemic risk
as well as moral hazard concerns.
In response to the systemic risk concerns that led to the recent
financial crisis, Congress adopted the Dodd-Frank Wall Street
Reform and Consumer Protection Act in 2010.446 Acknowledging
that fragmented regulatory oversight may invite market partici-
pants to engage in opportunistic behavior, Congress orchestrated
market-wide regulatory intervention447 and created the Financial
Stability Oversight Council (FSOC).448
The FSOC establishes a forum for the senior regulatory officials
of the most significant financial markets regulators to act as a super
regulator.449 Congress tasks the FSOC with identifying and miti-
gating systemic risk concerns that arise in individual asset classes
as well as intermarket risks that emerge based on the interconnec-
tedness among systemically significant financial institutions.450 Led
by the U.S. Department of the Treasury, the FSOC has ten voting
members and five nonvoting members.451 The voting members
446. Dodd-Frank Wall Street Reform and Consumer Protection Act, Pub. L. No. 111-203,
124 Stat. 1376 (2010) (codified as amended in scattered sections of 7, 12, and 15 U.S.C.).
447. See Michael Barr, The Dodd-Frank Act, One Year On, BROOKINGS INST. (June 27,
2011), https://www.brookings.edu/on-the-record/the-dodd-frank-act-one-year-on/ [https://
perma.cc/L4W8-VK6X].
448. See 12 U.S.C. § 5321 (2018) (establishing the FSOC); see also Alan Beattie & Sarah
O’Connor, Bernanke Calls for Powerful Regulator, FIN. TIMES (Mar. 10, 2009), https://www.ft.
com/content/6d4f943a-0d6e-11de-8914-0000779fd2ac [https://perma.cc/5EKY-LQ5G] (high-
lighting Bernanke’s support of a new overarching regulator to oversee all systemically harm-
ful institutions); Hilary J. Allen, Putting the “Financial Stability” in Financial Stability
Oversight Council, 76 OHIO STATE L.J. 1087, 1088-89 (2015) (arguing that the FSOC should
be made a more effective financial regulator by making it less susceptible to politics).
449. See FINANCIAL STABILITY OVERSIGHT COUNCIL, 2019 ANNUAL REPORT, at i (2019),
https://home.treasury.gov/system/files/261/FSOC2019AnnualReport.pdf [https://perma.cc/
H7S9-PZ4A].
450. Id.
451. The voting members are:
• the Secretary of the Treasury, who serves as the Chairperson of the Council;
• the Chairman of the Board of Governors of the Federal Reserve System;
• the Comptroller of the Currency;
• the Director of the Consumer Financial Protection Bureau;
• the Chairman of the Securities and Exchange Commission;
• the Chairperson of the Federal Deposit Insurance Corporation;
• the Chairperson of the Commodity Futures Trading Commission;
• the Director of the Federal Housing Finance Agency;
• the Chairman of the National Credit Union Administration; and

include the Chairpersons of the SEC, the CFTC, and the Federal
Reserve.452
Congress established the FSOC with supervisory authority and
a mandate to mitigate systemic risk concerns.453 Notwithstanding
this mandate, the FSOC’s 2019 annual report mentions Bitcoin in
passing but does not reference cryptocurrency, virtual currency,
initial coin offerings, or cryptocurrency exchanges.454 The report
does include a handful of references to “digital assets” and a passing
recommendation to “federal and state regulators [to] continue to
examine risks to the financial system posed by new and emerging
uses of digital assets and distributed ledger technologies.”455
The FSOC serves as the best platform for initiating a system-wide
financial markets procedure to monitor and mitigate systemic risk
concerns in cryptocurrency primary and secondary market trad-
ing.456 Specifically, the FSOC may orchestrate a coordinated effort
among regulatory agencies to initiate development of self-designa-
tion policies. Given the unlikelihood that the FSOC would craft
granular details and implementation process, this Article proposes
the creation of a Financial Services Office of Innovation (FSOI).
Each relevant federal regulatory agency would create an FSOI or
indicate an existing authority among its offices and divisions that
would act as the FSOI equivalent.457 Among other mandates, the
• an independent member having insurance expertise who is appointed by the

President and confirmed by the Senate for a six-year term.
The non-voting members, who serve in an advisory capacity, are:
• the Director of the Office of Financial Research;
• the Director of the Federal Insurance Office;
• a state insurance commissioner designated by the state insurance commis-
sioners;
• a state banking supervisor designated by the state banking supervisors; and
• a state securities commissioner (or officer performing like functions)
designated by the state securities commissioners.
Id.
452. See id.
453. See id.
454. See id. at 96.
455. Id. at 7.
456. Cf. id. at 4 (“[FSOC] [m]ember agencies have also taken actions to reduce system risk
in the financial system.”).
457. In 2016, Republican Congressman Patrick McHenry introduced a bill proposing the
creation of an FSOI within each federal financial markets regulatory agency. See Financial
Services Innovation Act of 2016, H.R. 6118, 114th Cong. § 4 (2016).

FSOI would develop a self-designation form that would permit a

cryptocurrency primary and second market participant to affirma-
tively indicate the financial market regulator that it believes should
supervise its activities. Self-designation processes may permit par-
ticipants to indicate more than one regulator; however, the process
should require market participants to designate one agency who will
serve as the primary regulator of their relevant activities.
Submission of a self-designation form would not be determinative.
Based on the procedures developed collaboratively by the FSOI of-
fices, self-designation processes would constitute a type of preregis-
tration. Further, the self-certification process would only be effective
once the FSOI for the firm’s preferred regulator acquiesces. While
the firm awaits confirmation by its preferred regulator, the firm
may operate under the assumption that the self-designation process
will conclude as anticipated. In the event that the preferred
regulator does not acquiesce, the preferred regulator will issue a
formal notice granting the firm ninety days to resubmit its self-
designation to another regulatory agency. The FSOC will oversee
individual agency procedures for evaluating self-designation forms
to avoid attempts by market participants to manipulate the process
and mitigate disputes among regulatory agencies.
For primary market offerings, this process will ensure that the
SEC—assuming the cryptocurrency is a security—is on notice that
the offering is in progress even if it is not a registered offering. If the
agency concludes that the offering should be, however, a registered
offering, then the issuer will have an opportunity to submit regis-
tration of the offering, essentially tolling the registration process.
This approach enables the issuer to benefit from informal guidance
that may alleviate the harsh consequences of discovering that an
offering is subject to Section 5 of the Securities Act after a distribu-
tion of the securities.
For cryptocurrency secondary market participants, the process
complements the SEC’s no action letter policy.458 Regulators may
adopt policies that permit application to remain under review and
choose not to publicly release the same for some minimum period
while the submission is under consideration or in the event that
458. See No Action Letters, SEC (Mar. 23, 2017), https://www.investor.gov/introduction-

investing/investing-basics/glossary/no-action-letters [https://perma.cc/K2U3-MY4W].

resubmission is required. In the event that the self-certification

application applies to a public offering, there are other tools in the
SEC’s toolbox to address these concerns.
Self-designation must also facilitate the existing process for plat-
forms that seek to operate as regulated entities. For example, the
process may put the SEC on notice of a platform’s intentions to
register as a broker-dealer; the SEC will have an opportunity to
guide the platform in its efforts to register as a broker-dealer and
become a member of an SRO, such as the Financial Industry
Regulatory Authority (FINRA).459
How should regulators address a market participant that rejects
the notion that it is subject to regulatory oversight? In such an
instance, assuming investors in the United States or investors using
U.S.-based accounts, the entity would be required to submit a self-
designation form to the Office of Financial Research in the U.S.
Department of the Treasury indicating the rationale for its conclu-
sion. Such an approach enables regulators to, at a minimum,
identify the platforms that may be operating in U.S. financial
markets.
C. Collaborative Market Governance
Under the CEA, a designated contract market (DCM) is a board

of trade that agrees to comply with the core principles described in
7 U.S.C. § 7(d) and any requirement that the CFTC imposes by rule
or regulation.460 A board of trade is an organized exchange or other
trading facility.461 Once designated as a contract market, the board
of trade becomes a registered entity subject to oversight by the Com-
mission.462
The CEA permits DCMs to list a new contract for trading a
commodity or derivative upon the DCM by providing the Commis-
sion with either (1) a written certification that the new contract
complies with the CEA and existing regulations (self-certification),
459. See Financial Reports and Policies, FINRA (July 1, 2020), https://www.finra.org/about/
annual-reports [https://perma.cc/KM53-EZGR] (discussing FINRA’s financial policies as a not-
for-profit SRO).
460. 7 U.S.C. § 7(d)(1)(A)(i)-(ii).
461. See id. § 1a(6).
462. See id. § 1a(40).

or (2) a request that the Commission grant approval to the new

contract (prior approval).463 If the DCM elects to self-certify the new
contract, the submission to the Commission must include a copy of
the product’s rules, as well as a “concise explanation and analysis
of the product and its compliance with ... core principles” and ex-
isting regulations found in 17 C.F.R. § 38.464 Absent a finding by the
Commission “that a new product would violate the CEA or Commis-
sion regulations, the DCM may list the new product no sooner than
one full business day following the self-certification.”465 There is no
statutory or regulatory requirement that DCMs receive public input
from market participants for product self-certifications.466 DCMs
must, however, “establish, monitor, and enforce compliance” with
existing rules and other federal financial markets regulations.467
Recent activity in the Bitcoin futures market illustrates the use
of the self-certification process and the need for collaborative gov-
ernance in certain asset classes. On December 1, 2017, the Chicago
Mercantile Exchange Inc. (CME) and the CBOE Futures Exchange
(CFE) self-certified new contracts for Bitcoin futures products, and
the Cantor Futures Exchange (Cantor Exchange) self-certified a new
contract for Bitcoin binary options.468 On December 14, 2017, the
North American Derivatives Exchange, Inc. (Nadex) self-certified a
new contract for weekly Bitcoin spread contracts, and on February
27, 2018, Nadex self-certified a new contract for monthly mini
Bitcoin spread contracts.469
463. Id. § 7a-2(c)(1), (4); see also CFTC BACKGROUNDER, supra note 442.
464. 17 C.F.R. § 40.2(a)(3) (2019).
465. CFTC BACKGROUNDER, supra note 442; see also 17 C.F.R. § 40.2(a)(2).
466. J. Christopher Giancarlo, Chairman, U.S. Commodity Futures Trading Comm’n,
Remarks Before the Market Risk Advisory Committee Meeting (Jan. 31, 2018), http://www.
cftc.gov/PressRoom/SpeechesTestimony/giancarlostatement013118 [https://perma.cc/BC2D-
A6CW].
467. 7 U.S.C. § 7(d)(2).
468. CFTC BACKGROUNDER, supra note 442.
469. JAIME WALSH, NADEX, SELF-CERTIFICATION OF RULE AMENDMENTS: NADEX ADDS
BITCOIN VARIABLE PAYOUT CONTRACT—SUBMISSION PURSUANT TO COMMISSION REGULATION
§ 40.2(A), at 1 (2017), https://www.cftc.gov/sites/default/files/filings/ptc/17/12/ptc121517nadex
dcm001.pdf [https://perma.cc/DP55-4NSP]; Nadex Adds Mini-Bitcoin Monthly Contract, MAR-
KETSCREENER (June 5, 2018, 9:02 AM), https://www.marketscreener.com/news/latest/Nadex-
Adds-Mini-Bitcoin-Monthly-Contract--26716813/ [https://perma.cc/DL85-25JC].

CME, CFE, Cantor Exchange, and Nadex filed self-certifications

with the Commission as DCMs.470 Before self-certifying and thus
listing their Bitcoin contracts, CME, CFE, and Cantor Exchange
provided SEC staff with advanced draft contract terms and condi-
tions to facilitate review of compliance with the CEA and CFTC
regulations and to assess the “potential risk of defaults in these
futures contracts on the DCOs.”471
As described below in Part V, self-certification poses notable
challenges. However, self-certification offers a useful pathway for
regulators to discover who is operating in markets. Academic
commentators have previously proposed the creation of ex ante
preapproval regulatory processes for financial products similar to
the processes employed by the Food and Drug Administration, for
example.472
While interesting, these proposals raise questions that are
difficult to resolve and for which there is often little political will. As
CFTC Commissioner J. Christopher Giancarlo recently explained,
“Congress framed the self-certification process deliberately so that
development of new and innovative derivatives products would not
be hampered by cautious regulators conscious of the political risks
of approving new products.”473 The self-designation process may
prove equally valuable for regulators across the financial markets
ecosystem.
470. CFTC BACKGROUNDER, supra note 442; see WALSH, supra note 469, at 7-8.
471. CFTC BACKGROUNDER, supra note 442.
472. See Eric A. Posner & E. Glen Weyl, An FDA for Financial Innovation: Applying the
Insurable Interest Doctrine to Twenty-First-Century Financial Markets, 107 NW. U. L. REV.
1307, 1307 (2015) (“We propose that when firms invent new financial products, they be
forbidden to sell them until they receive approval from a government agency designed along
the lines of the FDA, which screens pharmaceutical innovations. The agency would approve
financial products if they satisfy a test for social utility that focuses on whether the product
will likely be used more often for insurance than for gambling.”); Saule T. Omorova, License
to Deal: Mandatory Approval of Complex Financial Products, 90 WASH. U. L. REV. 63, 66
(2012).
473. J. Christopher Giancarlo, Chairman, U.S. Commodity Futures Trading Comm’n,
Remarks to the ABA Derivatives and Futures Section Conference (Jan. 19, 2018), http://www.
cftc.gov/PressRoom/SpeechesTestimony/opagiancarlo34 [https://perma.cc/C4N4-6GYA].

V. BENEFITS AND LIMITATIONS OF SELF-DESIGNATION
The self-certification (know-your-regulator) proposal outlined in

Part IV creates a collaborative regulatory dialogue between regu-
lators and regulated entities. The open dialogue increases transpar-
ency and engenders a number of benefits. Consequently, markets
are better poised to protect investors from the risk of losses arising
from threats such as cybersecurity attacks and predatory trading
practices.
Admittedly, self-certification processes rely heavily on market
participants’ willingness to align themselves with regulatory norms
and goals.474 This approach is, in essence, a self-regulatory ap-
proach, and self-regulation is not a panacea.475 Market participants’
incentives may not align with regulatory goals, and even if many
market participants refrain from misconduct, intermediary risk may
still lead to several of the enterprise and systemic risks described
above.
A. Benefits
Adopting a self-certification process has a number of notable

benefits. First, in the absence of a regulatory dialogue with regu-
lated market participants, regulators may lack the opportunity and
incentive to investigate emerging fintech products and services.
Introducing self-certification will enhance transparency in crypto-
currency primary and secondary markets. The process of declaring
their preferred regulatory authority is, in part, a disclosure process.
Market participants’ filings will reveal the participants in the
market, the size of their operations, and the specific financial
services and products that they originate and distribute. The
disclosure process will initiate a regulatory dialectic that will enable
regulators to raise important questions regarding market partici-
pants’ risk management procedures.
474. See David P. Doherty, Arthur S. Okun, Steven F. Korostoff & James A. Nofi, The
Enforcement Role of the New York Stock Exchange, 85 NW. U. L. REV. 637, 641 (1991).
475. See generally id. at 637-38.

Second, initiating a dialogue provides regulators with greater

access to information across the financial services industry and
improves regulators’ ability to identify and detect cybersecurity
threats to consumers and market integrity. Similarly, greater access
to information better positions regulators to identify and monitor
misconduct, including market manipulation. Regulators’ ability to
police trading markets for disconcerting automated or HFT prac-
tices and cybersecurity risks will also improve.
Third, gathering data across markets will assist regulators in
their efforts to develop and implement meaningful reforms. For
example, the need for well-structured compliance programs that
introduce anti-money laundering, rigorous know-your-customer,
and consumer privacy protections cannot be overstated.476 Access to
general information regarding the entities operating in markets and
their governance structures is the first step to developing policies
and practices to achieve these regulatory goals.
B. Remaining Questions
While self-certification may offer an expedient solution to the

challenge of identifying market participants, assessing risks,
protecting customers, ensuring fairness in trading transactions, and
preserving market integrity, this approach has a number of
noteworthy limitations. For example, while the Bitcoin futures
exchange certification process described above initiates a robust
dialogue between market participants and the CFTC, operating
challenges and muddled administrative directives have plagued the
fledgling market.477
After CME made its self-certification filings, market participants
began to recognize that the clearing organizations “will bear the
brunt of the risk associated with ... their guarantee fund contribu-
tions and assessment obligations”; consequently, the members
476. See Alon Kaufman, How Privacy-Enhanced Technologies Can Make Financial Crime
Compliance More Effective, AM. BANKERS ASS’N (June 11, 2020), https://bankingjournal.aba.
com/2020/06/how-privacy-enhanced-technologies-can-make-financial-crime-compliance-more-
effective/ [https://perma.cc/79NG-JQR8].
477. See Oscar Williams-Grut, There’s an Argument Brewing over the Launch of Bitcoin
Futures, BUS. INSIDER (Dec. 7, 2017, 5:26 AM), http://www.businessinsider.com/fia-complains-
to-cftc-about-bitcoin-futures-2017-12?r=UK&IR=T [https://perma.cc/RK5R-LBYJ].

became increasingly concerned and critical of the self-certification

process.478
In an open letter to CFTC Chairman J. Chistopher Giancarlo,
Walt Lukken, CEO of the Futures Industry Association (FIA),
stated that “the launching of these innovative products through the
1-day self-certification process did not allow for proper public
transparency and input.”479 Lukken found “that this expedited self-
certification process for these novel products does not align with the
potential risks that underlie their trading” and that “[a] more
thorough and considered process would have allowed for a robust
public discussion among clearing member firms, exchanges and
clearinghouses to ascertain the correct margin levels, trading limits,
stress testing and related guarantee fund protections and other
procedures needed in the event of excessive price movements.”480 On
a similar note, Kristen Walters of BlackRock “suggested a more
formal review was appropriate given the ‘extreme volatility’ of
cryptocurrencies.”481
In response to the criticism, Commissioner Giancarlo acknowl-
edged the CFTC’s need for “heightened review” of compliance by the
DCMs with core principles.482 In order to implement risk mitigation
and oversight measures, the CFTC must improve oversight of
margin requirements and solicit information-sharing agreements
among the Bitcoin trading platforms.483 These measures may enable
the CFTC to gain better insights into the U.S. Bitcoin futures mar-
ket and enable the CFTC to better detect and pursue bad actors.484
In addition, Commissioner Giancarlo explained that DCMs must
disclose “what steps they have taken in their capacity as self-
478. See id.

479. Walt Lukken, Open Letter to CFTC Chairman Giancarlo Regarding the Listing of
Cryptocurrency Derivatives, FUTURES INDUS. ASS’N (Dec. 7, 2017), https://fia.org/resources/
open-letter-cftc-chairman-giancarlo-regarding-listing-cryptocurrency-derivatives [https://
perma.cc/BV8P-F9KE].
480. Id.
481. Gregory Meyer, U.S. Derivatives Regulator Looks to Calm Cryptocurrency Fears, FIN.
TIMES (Jan. 31, 2018), https://www.ft.com/content/db9d547e-06b4-11e8-9650-9c0ad2d7c5b5
[https://perma.cc/S5NP-3L9G].
482. See Giancarlo, supra note 466.
483. Jay Clayton & J. Christopher Giancarlo, Regulators Are Looking at Cryptocurrency,
WALL ST. J. (Jan. 24, 2018, 6:26 PM), http://www.wsj.com/articles/regulators-are-looking-at-
cryptocurrency-1516836363 [https://perma.cc/KA98-8AAY].
484. Id.

regulatory organizations to gather and accommodate appropriate

input from concerned parties.”485
These regulatory, administrative, and operational challenges are
disturbing. They are not, however, surprising. The Bitcoin futures
market is indisputably in its infancy.486 These types of limitations
of the self-certification process are sharpest at the inception of the
market for a financial transaction or asset class.487 Over time,
experimentation will likely soften the processes.
Moreover, it appears that regulators may eliminate many of the
administrative and regulatory limitations that stymied the CFTC
self-certification process by introducing procedural guardrails.488 In
truth, some elements of the self-certification process will remain
experimental and unresolved as regulators navigate the markets for
nascent financial products such as Bitcoin futures.489 As Commis-
sioner Giancarlo explained, “[t]he CFTC’s current product self-
certification framework is consistent with public policy that
encourages market-driven innovation that has made America’s
listed futures markets the envy of the world.”490 The product self-
certification process has served the markets for decades and will
likely continue to do so.491
Addressing the procedural concerns described above requires
making sufficient resources available to any administrative agency
and, if the development of the self-designation process involves rep-
resentatives of multiple agencies, it is all the more likely that the
procedural elements adopted will facilitate efficient, frictionless reg-
istration. There are, however, two endemic limitations identified
below that may prove difficult to address.
485. Giancarlo, supra note 466.

486. See Jason Williams, Why Adoption Is Critical for the Future of Crypto—GlobalBlock
Insights, FINTECH TIMES (Mar. 2, 2019), https://thefintechtimes.com/crypto-adoption/ [https://
perma.cc/494Y-UGUA].
487. See supra notes 27-28.
488. See Henry Engler, U.S. Derivatives Regulator Tightens Review for Virtual Currencies;
Defends ‘Self-Certification’ Rules, REUTERS (Jan. 31, 2018, 2:52 PM), https://www.reuters.com/
article/bc-finreg-cftc-virtual-currency/u-s-derivatives-regulator-tightens-review-for-virtual-
currencies-defends-self-certification-rules-idUSKBN1FK2XL [https://perma.cc/7DLA-M2JC].
489. Rostin Behnam, Comm’r, Commodity Futures Trading Comm’n, Opening Statement
Before the Market Risk Advisory Committee (Jan. 31, 2018), https://www.cftc.gov/PressRoom/
SpeechesTestimony/behnamstatement013118 [https://perma.cc/T4TB-UKK6].
490. Giancarlo, supra note 466.
491. See id.

***
Victor Fleischer identifies one endemic concern that will chal-

lenge regulators in cryptocurrency markets for many years to
come—regulatory arbitrage.492 According to Fleischer, “[r]egulatory
arbitrage is a consequence of a legal system with generally applica-
ble laws that purport to define, in advance, how the legal system
will treat transactions that fit within defined legal forms.”493 When
legal definitions fail to “track the underlying economic relationship
between the parties, gaps arise,” creating an invitation for opportu-
nistic behavior.494
As discussed above, Facebook and other cryptocurrency origina-
tors aspire to introduce financial services and products that displace
legacy financial intermediaries.495 Many of the developers have
expressly acknowledged that one central motivation for developing
cryptocurrencies is to identify a gap in market regulation and profit
by drawing transactions and financial resources to the unregulated
area. Operating outside the ambit of federal regulations eliminates
the costs of complying with federal law.496
The securities and commodities market regulatory regimes
impose significant, extensive, and onerous legal obligations and
costs on financial market participants. Launching a registered,
initial public offering through traditional channels (elite investment
banking firm, top-flight accountants, Wall Street law firm) is a
costly undertaking. The average IPO costs almost $1 million or
more.497 Uber paid their underwriters—Morgan Stanley, Goldman
Sachs, and Bank of America Merrill Lynch among others—over
$100 million in fees for facilitating their offering.498 This figure fails
492. See Fleischer, supra note 392, at 227.

493. See id. at 243.
494. See id.; see also Partnoy, supra note 277, at 219 n.48.
495. See supra notes 25-27.
496. See DEMERTZIS & WOLFF, supra note 431, at 8.
497. Patricia Ntiamoah, 2018-2019 IPO Accounting and Legal Fees, AUDIT ANALYTICS
(Feb. 20, 2020), https://blog.auditanalytics.com/2018-2019-ipo-accounting-and-legal-fees/
[https://perma.cc/8T67-NWQB]; Caleb Christensen, The Costs of Going Public, IPO HUB (Mar.
27, 2018), https://www.ipohub.org/costs-going-public/ [https://perma.cc/RPH5-MP9K].
498. Mamta Badkar & Nicole Bullock, Uber Underwriters Bring in $106.2m in Revenues,
FIN. TIMES (May 13, 2019), https://www.ft.com/content/79df7d28-75af-11e9-bbad-7c18c0ea
0201 [https://perma.cc/KD6L-KKT7].

to capture the costs that issuers incur beyond fees paid to profes-
sional services providers.499
An interesting literature explores the debate regarding the value
of cost-benefit analysis in financial regulation.500 Without entering
that thicket, this Article seeks to balance the normative goals
underlying securities and commodities market regulation—
consumer protection, fairness, and market stability—with calls for
efficient regulation.
While creating a self-designation process will create immediate
costs for market participants, these costs are far less onerous than
formal registration processes or the liability that follows from failing
to register. Finally, as noted above in Part III, enterprise and
systemic risk management failures may create costs that market
participants externalize.501 Notably, cryptocurrency platforms not
affiliated with regulated banking entities may lack any form of
deposit insurance protection.502 Regulators must be careful to ensure
that adopted regulatory approaches do not create moral hazard
concerns that lead to market participants relying on a taxpayer-
funded safety net for actors operating in these nascent, mercurial,
and highly volatile markets.
A second endemic concern characterizes the relationship between
fintech firms and legacy financial institutions. As Rory Van Loo
explains, regulatory competition creates consumer protection and
systemic risk concerns.503 According to Professor Van Loo, “[t]he
advent of fintech changes the analysis and raises the stakes for
getting competition right” because “digital innovation faces
additional entry barriers” and “increases systemic risk in securities
trading, by creating new mechanisms for sudden and coordinated
mass market movements.”504
499. Christensen, supra note 497.

500. See, e.g., John C. Coates, IV, Cost-Benefit Analysis of Financial Regulation: Case
Studies and Implications, 124 YALE L.J. 882, 885-87 (2015).
501. See supra Part III.D.
502. Crypto Market’s Traders Get Something New: FDIC Protection, AM. BANKER (May 14,
2019, 2:55 PM), https://www.americanbanker.com/articles/crypto-markets-traders-get-some
thing-new-fdic-protection [https://perma.cc/2WKB-DZFK].
503. Van Loo, supra note 20, at 232.
504. Id. at 234-35.

Consequently, it is critical for regulators to operate in collabora-

tion in their efforts to understand and regulate the fintech platforms
that integrate distributed ledger technology. Acting in concert,
regulators can address regulatory gaps and minimize market
participants’ ability to engage in regulatory arbitrage. The Office of
the Comptroller of the Currency’s decision to extend bank charters
to fintech firms illustrates the perils of unilateral, deregulatory
action.505
CONCLUSION
Global financial markets are in the midst of a transformative era.

While it is not yet clear whether the integration of cryptocurrencies
and related secondary market transactions marks mere evolution or
a market revolution,506 it is undeniable that these innovative
distributed digital ledger technologies have altered the financial
markets ecosystem. As markets expand to encompass the origina-
tion and distribution of cryptocurrency assets and the secondary
market platforms—broker-dealers, clearinghouses, and exchanges—
regulatory uncertainty persists.
As cryptocurrencies and trading institutions transition and
mature, cryptocurrency market activity and practices reveal many
of the endemic enterprise and systemic risk management concerns
that have plagued conventional financial markets and legacy
financial institutions. Automated and accelerated trading leave
individual, unsophisticated investors vulnerable to predatory
trading practices.
Cybersecurity attacks threaten individual investors, cryptocur-
rency clearinghouses, and exchanges with significant losses. In
some instances, these attacks lead to insurmountable losses. When
hackers swarm or light-fingered founders shift the firm or clients’
assets into their personal wallets, clearinghouse and exchange plat-
forms find themselves anemic, insolvent, and seeking bankruptcy
505. Yuka Hayashi, Judge Denies Federal Agency’s Authority to Issue Fintech Bank
Charters, WALL ST. J. (Oct. 22, 2019, 1:53 PM), https://www.wsj.com/articles/judge-denies-
federal-agencys-authority-to-issue-fintech-bank-charters-11571766837 [https://perma.cc/
H4B6-BSEG].
506. See generally TAPSCOTT & TAPSCOTT, supra note 166.

protection. These challenges grow in tandem with the increasing

size and scope of cryptocurrency markets. Although federal regula-
tors’ preliminary market guidance and increased enforcement ac-
tions are an excellent first step in dealing with risk management
concerns in cryptocurrency markets, important questions remain
unresolved.
Introducing a self-certification process may properly incentivize
cryptocurrency market participants to disclose material information
regarding their operations such as their incorporation of centralized
cryptocurrency clearing practices. This approach will minimize
asymmetries of information in cryptocurrency markets, may miti-
gate cybersecurity risks, and will shine a spotlight on predatory
automated (algorithmic) and HFT strategies. Finally, with the self-
certification process, cryptocurrency exchanges may benefit from
governance and risk management guidance. Each of these policy
changes is necessary to protect investors, promote fairness and
efficiency, and ensure market stability.

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DECENTRALIZED FINANCE: REGULATING

Global financial markets are in the midst of a transformative

Electronic copy available at: https://ssrn.com/abstract=3831439

risk-management threats that have plagued conventional financial

Electronic copy available at: https://ssrn.com/abstract=3831439

Electronic copy available at: https://ssrn.com/abstract=3831439

Despite federal and state regulators’ warnings and mounting civil

Electronic copy available at: https://ssrn.com/abstract=3831439

“shadow banks.”5 For example, Bitfnex initially routed customer

Electronic copy available at: https://ssrn.com/abstract=3831439

customer funds, blatant theft, garden-variety fraud, and exploitative

Electronic copy available at: https://ssrn.com/abstract=3831439

Legacy financial institutions and other market participants’

“Business of Banking,” 63 U. MIAMI L. REV. 1041, 1041 (2009).

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most innovative technologies in the financial markets ecosystem.23

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cryptocurrency designed to displace existing government-issued fiat

Electronic copy available at: https://ssrn.com/abstract=3831439

proper timing, scope, and emphasis of regulatory intervention are

of departure for analysis).

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primary market regulation—chiefly mandatory disclosure—as the

33. See infra notes 244-46.

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The limitations of existing regulation leave customers, markets,

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of the operational infrastructure of the exchange. Regulators must

Electronic copy available at: https://ssrn.com/abstract=3831439

This proposal parallels the existing Commodity Futures Trading

I. INTERMEDIATION: A FUNCTIONAL ANALYSIS

Mandatory disclosure serves as a theoretical and practical

Electronic copy available at: https://ssrn.com/abstract=3831439

financial health—current and forecasted earnings and revenues—of

35. See COLLINS, supra note 34, at 22.

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U.S. capital markets promote an efficient allocation of capital.40

Electronic copy available at: https://ssrn.com/abstract=3831439

Sensational investigative hearings revealed that more than half

48. H.R. REP. NO. 73-85, at 2 (1933).

Electronic copy available at: https://ssrn.com/abstract=3831439

register with the SEC and submit to the agency’s regulatory

55. Id. §§ 78a-78qq.

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private fundraising cannot compete with the breadth and depth of

Public Company, 68 HASTINGS L.J. 445, 447 (2016).

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Most issuers who seek to launch a public offering will engage a

67. HILL & PAINTER, supra note 65, at 5.

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serve as a matchmaker, facilitating the introduction of the issuer

INSTITUTIONS 251-52 (5th ed. 2012).

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An underwriter’s reputational contribution may be one of its most

83. See Tuch, supra note 69, at 161.

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Securities exchanges are a critical infrastructure resource and the

B. Governance and Economics of Secondary Market Trading