Binance, Kraken, and Gate.io Referred to DFS for Possible Violation of New York Law

Yesterday, the New York Office of the Attorney General released a scathing report against thirteen cryptocurrency exchanges. After the release of the report, the New York State Attorney General (NY AG) referred three exchanges – Binance, Kraken, and Gate.io – to the New York Department of Financial Services to investigate a possible violation of New York regulatory law.

The report explored how thirteen different cryptocurrency exchanges do business. The authors of the report began their research in April 2018. They asked cryptocurrency exchanges various questions about their business model, including how they operate, how they make money, and how they protect investors.

Of the thirteen exchanges investigated in the report, 10 responded to the New York Office of the Attorney General. The three exchanges that did not respond were Binance, Kraken, and Gate.io, all of which claimed to not accept trading activity from New York. During their report, the NY AG found that this was not true, and that all three exchanges did accept trades from New York. That’s why those three exchanges are now in trouble.

A fourth exchange, South Korea-based Huobi, was also named in the report. However, Huobi legitimately blocks trading activity from New York, which is why their case wasn’t referred to the DFS.

https://twitter.com/NewYorkStateAG/status/1042098555849265152

You can view the full 42-page report here. Some are calling the NY AG report “the most comprehensive investigation that has been released thus far by a regulator.” It provides unique insight into how cryptocurrency exchanges operate.

Even the more “regulatory-friendly” exchanges like Coinbase and Gemini were mentioned in the report. Gemini appears to operate cleanly, but Coinbase reported that 20% of trading volume on its exchange was from Coinbase itself. That means a significant amount of Coinbase’s liquidity is self-generated. It also brings up uncomfortable questions like: what happens when bitcoin markets plummet and Coinbase halts 20% of its trading activity until markets settle?

Will Binance, Kraken, and Gate.io Face Any Punishment?

Binance, Kraken, and Gate.io are all specifically mentioned in the NY AG report. Out of the thirteen exchanges that cater to traders in New York, only Binance, Kraken, and Gate.io refused to respond to the NY AG’s investigation.

Binance, Kraken, and Gate.io declined to answer questions from the NY AG about how they operate in New York. In fact, all three exchanges claimed they didn’t operate in New York. During the NY AG investigation, this was found to be false, and investigators were able to make trades on all three exchanges from New York.

Because these exchanges failed to provide information, the NY AG has referred all three exchanges to the New York Department of Financial Services (DFS) for potential violations of state cryptocurrency regulations.

It’s hard to tell if anything will come out of referring the three exchanges to the DFS. The NY AG isn’t claiming that the three exchanges are violating the law. The three exchanges just declined to answer the NY AG’s questions.

If the three exchanges respond to DFS questions and the answers are satisfactory, then Binance, Kraken, and Gate.io may escape punishment.

Nevertheless, it doesn’t look good for the three cryptocurrency exchanges. 10 of the 13 cryptocurrency exchanges mentioned in the report willingly provided all requested information to the NY AG – even when that information painted the exchanges in a bad light. Coinbase, for example, voluntarily claimed that 20% of its trading volume was from Coinbase itself. That doesn’t make Coinbase look good, but they still voluntarily offered the information.

Cryptocurrency Exchanges Need a BitLicense to Operate in New York

The real problem with Kraken, Gate.io, and Binance is that all three exchanges accept traders from New York even though they don’t have a BitLicense.

Under the New York State Administrative Procedure act, any organization that seeks to provide crypto exchange services within New York State as a customer-facing business must seek a BitLicense. This regulation applies to out-of-state businesses that accept traders from New York.

Here’s how the report explained the problematic lack of a BitLicense:

“The OAG investigated whether those platforms accepted trades from within New York State. Based on this investigation, the OAG referred Binance, Gate.io, and Kraken to the Department of Financial Services for potential violation of New York’s virtual currency regulations.”

Conclusion

Ultimately, cryptocurrency markets do not appear to have moved significantly based on the news from the New York Office of the Attorney General. Bitcoin is down about 0.5% over the past 24 hours since the release of the report.

The report indicates serious problems within the world’s largest cryptocurrency exchanges, including fabricated liquidity, conflicts of interest, and a willingness to sidestep regulations. However, it appears that markets were already well aware of these issues, and there has been little reaction.

The next step is to see how Kraken, Gate.io, and Binance handle the upcoming investigation from the New York Department of Financial Services.

Not all of the exchanges took the news very well:

Thanks to the NY taxpayer for funding this research — saved our Product team a lot of time, and we got some interesting non-public info on our competitors. Excellent overview of issues, and a nice list of 'Questions Customers Should Ask' on pg 32. https://t.co/S5XxopBEyC

— Kraken Exchange (@krakenfx) September 19, 2018

We must, however, object to the highly unprofessional/malicious implication that because we did not respond to the voluntary information request, we *might* be operating illegally. We told you we don't operate in NY. AG trying cases in court of public opinion now?

— Kraken Exchange (@krakenfx) September 19, 2018

Is it a coincidence that this was published the day before the expiration of the @CBOE futures contract? Who traded on insider information and what is being done to prevent manipulation by @NewYorkStateAG employees? Quis custodiet ipsos custodes? https://t.co/XwrW46ywdf

— Kraken Exchange (@krakenfx) September 19, 2018

Though I would agree the report is too procedure-focused and had I been tasked to lead the project I would have focused more on "if an average user has $100 of BTC, and trades for ETH (or whatever other coin), how much do they *actually* get on each exchange"

— vitalik.eth (@VitalikButerin) September 20, 2018

Kraken-CEO-Jesse-Powell-Mocks-New-York-Regulators-on-Twitter-After-Report