Comparing Crypto Exchanges is Similar to Apples vs. Oranges

Lately, it feels as if part of crypto is being split into two camps – “TradFi crypto” versus the crypto native or “crypto incumbent” exchanges. It was not lost on some that Cboe Digital gained a long-awaited margin approval from the CFTC, complete with supportive statement from CFTC Commissioner Romero, in the same week the SEC sued Binance and Coinbase.

One of the best parts of participating in the crypto ecosystem, however, is the “we’re all in this together” mentality. In my experience, no one wants to see frauds, hacks, thefts, or other wrongdoing within crypto, because it does a disservice to the good. Legitimate entities in crypto agree that this is a nascent industry and to grow it, we hope that other projects worth supporting find a path forward—even when they present competition.

That being said, there are some natural differences across crypto. In fact, that alone is one of the most complicated aspects of regulating or legislating digital assets. Regulators and legislators must consider exchanges, NFTs, DeFi, Central Bank Digital Currencies, altcoins, tokenization, layer 1s, and more—apples, oranges, bananas, and pineapples. And what, exactly, constitutes “DeFi”? What about futures versus options, or tokenized asset trading versus crypto tokens? Finally, given the diversity of the ecosystem and variance in the approach to building in a space where there are not clearly drawn lines in the law or precedent, even the spread amongst apples can be stark.

Some may not realize that “Cboe Digital” is actually more than one legal entity. Cboe Digital operates a CFTC-registered designated contract market, but it also separately operates a CFTC-registered clearinghouse. Finally, Cboe Digital operates a digital asset commodity spot market licensed as a money service business and registered with the Financial Crimes Enforcement Network. The salient point is the fact that there is more than one (registered) entity performing these functions. Many other crypto exchanges do not separate out these functions; the exchange function and the clearinghouse function are all done as part of the same framework. This allows for instant settlement, facilitates direct peer-to-peer trading, and ideally works with the decentralized nature of crypto. But it also bypasses the steps necessary to establish a regulatory-compliant clearinghouse, which include certain disclosures and rules designed to protect investors.

At its core, crypto strives to create efficiencies, and part of that can often include the elimination of certain financial intermediaries. A clearinghouse’s primary (intermediary) function is to facilitate smooth settlement. On Cboe Digital, participants enter orders and trade on the exchange and the exchange sends those trades to the clearinghouse to clear and settle. We’ve structured it this way purposefully to intentionally look like the structure in other U.S. financial markets. We believe our clearinghouse enables us to have best-in-class risk management, as clearinghouses provide transparency, reduce counterparty risk and adhere to strict guidelines around recordkeeping and financial reporting, among other things.

Other crypto native exchanges disagree. In many cases, when retail users trade a digital asset, the platform itself matches buy and sell orders in-house, so trades are executed directly between participants. (Some crypto exchanges vary this structure for institutional trading and may offer clearing services for institutional investors.) But as there’s little regulatory vetting or standards for these different functions, individual investors may not have transparency into the security of transactions or fee structure/flow of funds, among other things. The entity is also not subject to the same degree of ongoing, external scrutiny which prompts best practices in important aspects like risk.

Further, some major crypto exchanges and crypto market participants have a different attitude than Cboe Digital. Cboe Digital works with its regulators within the bounds of current market structure because we prioritize trusted markets. With innovation comes risk; when technology outpaces law, gaps can emerge, and those gaps can hurt retail investors.

The purest intent of crypto as an asset class is to further tenets like financial privacy, efficiency, access to banking and alpha, and democratization of finance. Certainly, without registration, there are efficiencies—no one is arguing that licensing, registration, and the related compliance infrastructure imposes a burden, especially on young companies. But the risks of forgoing certain protections can outweigh any benefit. Many in the crypto community would prefer a landscape ruled by crypto native entities, but TradFi will have a place in digital asset trading, and with it comes many good, battle-tested practices.

Sometimes it feels as if fitting crypto into current market structure is like fitting a foot into a shoe one (or two) sizes too small. But Cboe Digital is willing to bear that burden because the benefits and efficiencies inherent in digital asset trading must be balanced against the potential for bad actors. We can untether digital assets from an illicit finance label by combining the ingenuity of crypto with the stability of capital markets. Bad actors have left a stamp—investors need to have the assurance that where they trade has proper governance, is appropriately regulated, has their best interest in mind, and ensures their funds are safe. Cboe Digital strives to be the trusted partner for major institutions seeking economic benefits and premier risk management, and we are dedicated to working with regulators to develop long-term solutions.

Katherine Kirkpatrick is Chief Legal Officer of Cboe Digital, leading digital asset legal strategy and related regulatory initiatives.

^{There are important risks associated with transacting in any of the Cboe Company products or any digital assets discussed here. Before engaging in any transactions in those products or digital assets, it is important for market participants to carefully review the disclosures and disclaimers contained at: https://www.cboe.com/us_disclaimers/.} 

^{These products and digital assets are complex and are suitable only for sophisticated market participants.}

 ^{These products involve the risk of loss, which can be substantial and, depending on the type of product, can exceed the amount of money deposited in establishing the position.}

 ^{Market participants should put at risk only funds that they can afford to lose without affecting their lifestyle.}

^{Cboe Clear Digital, LLC is licensed to engage in virtual currency business activity by the New York State Department of Financial Services.}