Do exchanges actually possess all of the crypto reserves (liquidity) they claim to have? Covered: Exchanges Not Bound to SEC Security Regulations Error: Withdrawals Disabled Exchanges Not Bound to SEC Security Regulations Whenever someone purchases crypto on a centralized exchange, they assume withdrawing that crypto can occur without a hitch. This is not the case. […] The post Are Exchanges Manipulating Their Liquidity? appeared first on CryptosRus.

Are Exchanges Manipulating Their Liquidity?

Do exchanges actually possess all of the crypto reserves (liquidity) they claim to have?

Covered:

  • Exchanges Not Bound to SEC Security Regulations
  • Error: Withdrawals Disabled

Exchanges Not Bound to SEC Security Regulations

Whenever someone purchases crypto on a centralized exchange, they assume withdrawing that crypto can occur without a hitch. This is not the case. Because the crypto asset class is nascent, exchanges can skirt federal, regulatory requirements. In the United States, for example, the Investment Company Act of 1940 contains rules and regulations which require equity funds to be sufficiently liquid. This simply means that funds need to possess the requisite liquidity to allow shareholders to withdraw or redeem their positions.

Title 17, Chapter 2, Part 270 states: “The money market fund must hold securities that are sufficiently liquid to meet reasonably foreseeable shareholder redemptions in light of the fund’s obligations under section 22(e) of the Act (15 U.S.C. 80a-22(e)) and any commitments the fund has made to shareholders.” Noted in an SEC report explaining asset manipulation: “The 40-Act definition of an illiquid asset is one which cannot be disposed of in the ordinary course of business within 7 days for its carrying value.”

Essentially, the Investment Company Act of 1940, ratified after the Stock Market Crash of 1929, provides investor protection and ensures that equity funds and brokers possess the actual liquidity which allows redemption, or, liquidation of positions. In accordance with the Investment Company Act of 1940, “investment companies must register with the SEC before they can offer their securities in the public market.” As you likely know, most crypto’s have been deemed securities by the SEC.

So, according to the 1940 Act, exchanges must register with the SEC before offering securities in order to be subject to these regulations, such as the 1940 Act. Currently, exchanges have been operating outside SEC parameters. A new SEC rule proposed in February seeks to address this. The rule would include “cryptocurrency exchanges and other communication protocol systems using DeFi.” Under this rule, exchanges would have to “register with the SEC and be subject to new reporting and regulatory requirements.”

However, as the report notes: “substantial uncertainty in this area remains.” Because crypto is a nascent asset class, the jury is still out on the regulatory parameters to govern it. It is even more complicated due to the decentralized framework that is intended to embody crypto assets. As it stands today in the US, crypto exchanges can presumably be illiquid, and not actually “hold securities that are sufficiently liquid” to ensure shareholder ‘redemption’, as required in the 1940 Act.

Due to this loophole, crypto exchanges time and time again simply shut off withdrawals. Excuses can be given, such as maintenance. In the US, under the 1940 Act, if this occurs for more than 7 days, the exchange would be in violation of a federal statute. There are far too many instances of exchanges “turning off” withdrawals of crypto to document here. We will address the most topical example: Binance, which has been a flagrant offender in this regard.

Error: Withdrawals Disabled

Because Binance simply has a page updating the status of crypto in terms of withdrawal and deposit ability, it is hard to keep track of the past events where withdrawing is halted. However, there are numerous screen grabs of halted withdrawals, especially for Monero ($XMR). So much so that on Monday, in a widely covered event, the Monero community organized to address this issue. By coordinating a mass withdrawal of $XMR to “test” exchange liquidity (reserves), they hoped to highlight the importance of self-custody.

The Monero community pointed the finger at “Binance, Huobi, and Poloniex expressly”, according to coverage by CryptoSlate. Because of Monero’s hardcore privacy primitives, Reddit sleuths have accused exchanges of exploiting this to manipulate their reserves: “Monero’s obfuscated ledger has enabled a number of exchanges to misrepresent their reserves, and sell XMR that they don’t actually have, knowing that all too many of us will never withdraw, and no one can see onchain the evidence of their misdeeds.”

According to Binance’s maintenance page, the withdrawals for Monero are up and running. However, users reported that they were blocked for the last 4 days from withdrawing $XMR. This was not the musings of crypto conspiracy theorists. Prominent Monero developer and privacy advocate SethforPrivacy echoed these claims on April 13th, stating: “Looking more and more like exchanges are paper trading Monero and lying about how much they have to customers.”

Because Monero’s ledger is not public, obfuscating holdings becomes a much easier process. The community response to cause a “bank run” on exchanges, dubbed “Monerun“, is an example of how distrust in centralized exchanges is not only valid, but necessary. It caused the Monero price to spike 10% in a wretched market and cast a spotlight on the importance of trying to ‘audit’ the centralized entities hoarding most crypto liquidity, which are exchanges. This is not new to crypto, and has been happening in the Gold Markets for decades.

Monero devs and contributors have devised a way to address this transparency problem, magnified in privacy protocols like Monero. In a recent white-paper titled “MProve+: Privacy Enhancing Proof of Reserves Protocol for Monero”, the authors proposed a “proof-of-reserve” solution. “Proof of reserves protocols enable cryptocurrency exchanges to prove solvency, i.e. prove that they have enough reserves to meet their liabilities towards their customer.’

Ultimately, the crypto asset class faces the conundrum: reap the benefits of SEC exchange registration (manipulation provisions) or embrace the status quo, which can result in manipulated reserves. Such is the case with crypto, it is a “damned if you do, damned if you don’t” proposition. With the crypto asset class there is no easy way out. Luckily, transparent ledgers that exist in nearly every chain, sans Monero, provide visibility into exchange movements, holdings, and liquidity, which can prevent skullduggery.

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