Cryptocurrencies: Is Your Compliance Team Ready to Monitor the New Wave of Trading?

Daniel Fernandez, Analytics Product Manager, Communications Compliance

It’s impossible to peruse any news website these days without seeing Bitcoin in the headlines. The digital currency has skyrocketed to popularity over the last year, with no sign of slowing down. If you were lucky enough to purchase a Bitcoin in 2010 for $150, today that very same Bitcoin would be worth well over $17,000. That’s one remarkable ROI. Consider also that cryptocurrencies have reached a combined market cap of over half a trillion dollars and it’s clear Bitcoin is here to stay.

So what is Bitcoin anyway?

For those unfamiliar with Bitcoin, here’s a brief primer. Created in 2009 by an unidentified software developer and inventor who goes by the pseudonym of Satoshi Nakamoto, Bitcoin is a form of digital currency that’s created and held electronically. Bitcoins aren’t printed like traditional currency; instead they’re produced by a network of ‘miners’ who create Bitcoins using a complex algorithm. The network of miners and machines (servers) operate independent of any central authority, government, or middle man. The miners receive Bitcoins as a reward for creating them. As they’re created and purchased, the coins are stored in a digital wallet and can be used for transactions, which are then tracked through Distributed Ledger Technology, also known as the Blockchain.

Why all the hype?

Bitcoin made its first appearance on Wall Street on December 1, 2017, when Bitcoin futures were traded for the first time ever on the Chicago Board Options Exchange (Cboe). In its impressive debut, Bitcoin’s price rallied, surging 26 percent, even causing a temporary shutdown of trading.

On December 18, 2017, Bitcoin took its place on an even bigger stage when the Chicago Mercantile Exchange (CME), the world’s largest derivatives exchange, rolled out trading of Bitcoin futures, which is likely to attract the attention of major institutional investors.

Today, Bitcoin is classified and taxed as a property by the IRS (not a traditional asset like gold or stocks), but CME Group’s Chairman Emeritus Leo Melamed stated that he sees Bitcoin eventually emerging as a new legitimate asset class and business line for investment banks, with futures trading being the first step toward Bitcoin’s mainstream acceptance.

Other firms jumping onboard the cryptocurrency craze include Goldman Sachs, which has said it’s exploring the possibility of creating a trading operation exclusively dedicated to Bitcoin and other digital currencies, and Fidelity which is rolling out a new digital assets business that “enables Bitcoin and blockchain users to track their investments alongside their more traditional investment categories, like stocks and mutual funds.”

The Future of Digital Currency: The Implication for Investment Banks

Even though Bitcoin is not yet an official financial instrument subject to U.S. trading regulations, it’s fair to say that futures trading and growing investor interest in digital currencies will eventually drive new regulations.

Whether this happens in the next year or a few years down the road, investment banks that trade in Bitcoin futures will also need to invest in technology to monitor communications around these new transactions, to identify and prevent market abuse, fraud and collusion. Even absent regulations and fines, the reputational damage that can result from nefarious actions is reason enough that firms should start making preparations today to equip compliance teams to monitor future communications around cryptocurrency transactions.

That said, cryptocurrencies such as Bitcoin could pose a great challenge for compliance teams around the world if they eventually become an official exchange-traded asset class.

While cryptocurrency trading is designed to be electronic and transactions are clearly reflected in an open ledger and verifiable via the blockchain, extensive verbal communications may also be necessary for trades to take place given the complexity of some cryptocurrencies including Bitcoin. Investment advisors are especially relevant given recommendations for buying and selling cryptocurrencies like bitcoin are not available in the traditional research departments. And herein lies the problem. Beyond retail investors, the new digital currency ecosystem also includes a complex web of competing miners who work outside of the purview of financial firms, and today, outside of any regulations. This means that automated, systematic means of surveillance of these communications will be all the more critical to preventing market abuse.

Another factor to consider – financial firms have strict guidelines and commonly accepted methods for sharing market news online about equities and other financial instruments. But there are no such guidelines around cryptocurrencies, despite the fact that many retail Bitcoin investors routinely follow social media for commentary, investment news and information.

Still, misinformation spread via tweets, etc., could unduly impact cryptocurrency market prices. This means that financial firms who trade in cryptocurrency will also need to take extra caution by imposing new guidelines, and implementing new tools, to monitor various types of communications, including social media. To do so, firms will need solutions that can natively connect to social media sources, ingest information and correlate it with other communications and trade data.

With the groundswell of interest around Bitcoin and other cryptocurrencies, preparing for this new wave of trading is something that firms should consider sooner, rather than later.

Reg BI is Not Going Anywhere – How Firms Should Move Forward

April 8th, 2020
David T. Ackerman, Subject Matter Expert, Communications Compliance Line of Business

3 Take-Aways from SIFMA’s Reg BI Forum

January 30th, 2020
David T. Ackerman, Subject Matter Expert, Communications Compliance Line of Business
Speak to an Expert