Crypto exchange irregularities prompt regulation concerns

Pressure is building on regulators to increase oversight of cryptocurrency trading following a $15bn crash in bitcoin and irregularities at one of the world’s largest virtual trading platforms.

A recent incident at Hong Kong-based OKEx has prompted questions on how the Securities and Futures Commission can respond to trading problems in the cryptocurrencies market.

Central banks and securities watchdogs around the world are contemplating how to rein in the industry where billions of dollars worth of digital currencies are traded daily outside the purview of official oversight.

Hong Kong’s SFC said this month that it could soon allow some cryptocurrency exchanges to apply for licences — a major step that would bring some aspects of virtual asset trading under its jurisdiction. The regulator said that it “notes with concern the growing investor interest in gaining exposure to virtual assets via funds and unlicensed trading platform operators in Hong Kong”.

Focus on regulation has shifted to Hong Kong following an incident that rocked traders and caused estimated losses of $400m.

A change in the protocols used by the currency bitcoin cash last week led to confusion in the market and in turn helped wipe $15bn from the market capitalisation of the original bitcoin. In the midst of the volatility, traders say OKEx changed the rules of the underlying settlement index, leading to trades suddenly being settled against entirely different indices

“A comparable scenario would be Chicago Mercantile Exchange announcing that the S&P 500 E-Mini Futures contracts will settle and deliver tomorrow, but against the Shanghai Composite Index instead of the S&P 500, in the midst of trading,” according to Amber AI, a cryptocurrency hedge fund. Amber estimates traders took up to $400m in losses.

OKEx also forced earlier than expected settlement of bitcoin cash contracts and eventually blocked orders from all traders using the platform. “There were instances where participants could not buy at market prices even when prices were moving lower,” said one trader who experienced the situation.

OKEx said its system was overloaded during the change and apologised. But at least one cryptocurrency fund has made a complaint against the exchange to the SFC, and several others have considered such action, according to people familiar with the matter.

It is unclear how, or if, the SFC will respond to such complaints. The SFC regulates securities trading but cannot make enforcements in the market for bitcoin and other cryptocurrencies.

“There has been a lot of uncertainty in crypto markets in the past week,” said Henri Arslanian, chairman of the FinTech Association of Hong Kong. He said the bitcoin cash situation had been “messy, public and has divided key figures of the crypto community”.

“For exchanges that only trade cryptocurrencies, and not securities, it’s going to be very difficult for the SFC to give redress to traders and customers,” said Etelka Bogardi, a partner at Norton Rose Fulbright in Hong Kong.

The SFC has declined to comment on the OKEx case but published a framework for regulating virtual asset exchanges earlier this month. Under that, the SFC would allow exchanges that trade securities-like tokens to apply for licences, moving them out of the grey area that most exchanges trade in.

However, exchanges that trade bitcoin and other non-securities virtual assets are not included in the SFC’s proposal.

“SFC is improving its engagement with digital assets — but there’s a fair few aspects in the framework that may discourage exchanges from applying for SFC supervision without further discussions,” Hoi Tak Leung, counsel at Ashurt in Hong Kong, said in a note.

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