Cryptocurrency Compliance: The Importance of Internal Investigations

Matt Stankiewicz, Senior Associate at The Volkov Law Group, rejoins us for another posting on cryptocurrency compliance.  Matt can be reached at [email protected].

For those still new to the sector, Coinbase has established itself as one of (if not the) most prominent cryptocurrency exchanges operating in the U.S. Coinbase, to the delight of compliance officers everywhere, has been mostly diligent in attempting to comply with the various regulatory frameworks governing cryptocurrency exchanges. To this end, the exchange has been very slow to expand its coin offerings for fear of offering a currency that could be construed as a “security” and potentially violating SEC regulations. Despite the thousands of different cryptocurrencies offered on non-U.S.-based exchanges, Coinbase merely lists four coins.

However, news broke recently that Coinbase would indeed be adding a new coin to its roster – Ethereum Classic, a fork of one of its other offerings, the much more heralded Ethereum. The specific cryptocurrency is ultimately irrelevant for this discussion; however, this is a very useful event to help highlight some important compliance concepts and also to highlight why the compliance field will be so integral to ensuring the growth of the cryptocurrency industry.

In December 2017, Coinbase abruptly added Bitcoin Cash to its lineup, a fork of the well-known Bitcoin. Coinbase was one of (and arguably still is) the most important cryptocurrency exchange at the time, so adding a coin to its offerings would undoubtedly raise the price of that coin in a dramatic spike. Now while Coinbase maintained a policy prohibiting insider trading at the time, it appeared that one or many individuals failed to heed that policy. Leading up to the addition of the coin, the price for Bitcoin Cash continued to rise rapidly, despite no public announcements of the addition. Large buy orders were placed and were quickly sold off shortly following the announcement as the general public rushed to get involved, resulting in a 700% gain within an hour. Lawsuits have since been filed.

Coinbase apparently had an inside trading policy in place, but a policy isn’t worth the paper it’s written on without necessary support. Cryptocurrency companies are still in their infancy and many could benefit from some of the basic compliance elements that mature companies in traditional industries have already developed. This is especially so considering that various issues have placed this industry squarely in the targets of various regulators.

No doubt, Coinbase messed up. But now what? Before they could fix anything, they needed to understand exactly what went wrong. So Coinbase sought to do exactly that. The company immediately commenced an internal investigation to determine the who, what, where, when, why, and how. And as compliance officers know, that’s the important first step. Conducting a thorough and proper investigation is key in any mature compliance program. It allows a company to find, fix, and then prevent further misconduct. Further, considering Coinbase is under the microscope as a leading cryptocurrency exchange and the regulatory heat bearing down on the industry, the company now has information that may help appease regulators. Coinbase can now say: this is the bad action and these are the resulting damages of those actions, but here’s also where we found the problem to stem from and here are the steps that we’re taking to ensure this will never happen again.

This leads to the latest listing of Ethereum Classic. In addition to cleaning up its internal procedures, Coinbase is also easing the listing into the public, as opposed to suddenly flipping the switch. The first announcement was merely announcing the company’s intention to list the coin at a future date. A subsequent announcement will detail the time frame, and then once the switch is flipped to place it live, no one will be caught by surprise and hopefully no unwary investor will lose their shirt.

This is not to encourage the use of any one exchange over another. Cryptocurrency is volatile and come with a significant amount of risks, so doing your own research is always necessary. But certainly, in a sea of schemes and price manipulation, positive efforts should be called out.

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