FTX’s collapse has sparked a debate on the segregation of activities in the cryptoasset industry, particularly between operating an exchange and a custodian. The recent failure of FTX highlighted the importance of separating market making activities from running an exchange and a custodian. This has led to discussions on the risks involved in commingling assets and the need for stricter regulations in the industry.
The issue of custody in the cryptoasset market is a complex one, involving managing information security risks and ensuring the protection of private keys. Many early cryptoasset exchanges bundled custody with execution for their retail clients, creating stickier client relationships. However, since FTX’s collapse, there have been efforts to change this model, with the adoption of ‘Off Exchange Settlement’ by large exchanges and regulatory measures calling for the use of Qualified Custodians for clients’ assets.
Drawing parallels from the US grain industry in the late nineteenth century, the tension between custodians and exchanges is evident. The development of grain exchanges, like the Chicago Board of Trade, illustrates the challenges of commingling assets and the risks involved in custodians trading on their own account. The commingling of grain allowed warehousemen to engage in unscrupulous practices, leading to conflicts of interest and market abuse.
The key takeaway from the history of the grain industry is the importance of managing conflicts of interest and ensuring the segregation of client assets from those of the exchanges. While technology and economies of scale bring benefits, they also introduce new risks that need to be managed effectively. The lessons learned from the grain industry can be applied to the cryptoasset market to ensure the protection of investors and the integrity of the market.
Overall, the debate on custody and exchange activities in the cryptoasset industry is ongoing, with a focus on implementing stricter regulations and safeguards to protect investors and prevent market abuse. The lessons from history serve as a reminder of the importance of managing conflicts of interest and ensuring the segregation of assets in the industry.
