Centralized Exchanges Asset Operational Strategy
SYNPOSIS
头部交易所资产营运策略分析
Below provides a general overview of Centralized Cryptocurrency Exchanges (CEXs) which facilitate public access to digital assets as well as some of CEXs’ best practice in relation to the asset operational strategies
BACKGROUND
Cryptocurrencies are without doubt the fastest growing asset class in 2020 and 2021, and the market continues to attract both institutional investor and retail investors. If we take a step back, during the early days of the digital asset age, public expectation was high but purchasing crypto such as Bitcoin and Ethererum was not straightforward
It took manually wire transfers followed by an indeterminate waiting period before the digital asset transported into the owner's blockchain wallet Over the years, service providers have been strived to improve the process through various methods including physical vending machines but the breakthrough only came in the form of the introduction of a third-party intermediary or Centralized Exchanges in the trading process.
WHAT ARE CENTRALIZED EXCHANGES’ ROLES?
Centralised Exchanges (CEX) set an important milestone for accelerating the development of digital assets like Bitcoin and Ethererum It provides the seamless exchange of fiat and digital asset through its platform and efficiently in transaction process These exchanges provide more user friendly access and offer better liquidity for crypto coins In summary, digital asset exchange can act as the tool for asset distribution and trades, it can also service multiple functions as they serve as marketplaces, brokers custodians and even proprietary asset managers. Major types are as follows:
o Primary sale – It acts as the gateway for ICO
o Secondary sales- It facilitates trading of assets already issued
o Air drop- The digital asset exchange allocates assets to users without payment as a reword or incentive to attract customers
Like traditional stock exchanges, Crypto centralized exchange screen digital assets prior to 'listing' and provide similar overall trading experiences by utilising order books, providing/procuring liquidity, custodising assets as well as tending to trade settlement Newer features include margin, options and derivatives trading. CEXs may also issue a native token to serve as a medium of exchange as part of the trade settlement process. E.g. Huobai Global.
CEXs have also prioritised the development of robust security measures to protect the digital assets they store. CEXs may also issue a native token to serve as a medium of exchange as part of the trade settlement process
Centralized Exchanges Asset Operational Strategy
WHY IS CEX ASSET OPERTING STRATEGY IMPORANT AND WHAT ARE THE BEST PRACTICES?
In my view, the following reasons demonstrate the importance of a sustainable and robust operating strategy of CEXs
● Increasing cryptocurrency hacks Hack and fraud have reached a record high in 2021 At least 30+ incidents of hacks and fraud for a total value of around $3bn have taken place so far in 2021. For example:
✔ Defi hack: In 2021 Aug, Poly Network , decentralized finance platform was attacked by an anonymous white hat hacker, causing over $610 million in digital crypto assets at the price of that date to be transferred to hacker-controlled addresses And this is also the largest crypto incidents that occurred this year and in history so far
✔ CEX hack: in 2019, Binance was stolen for $40million of bitcoin alone with two-factor user code and API tokens.
● We don’t adopt it quickly enough as the application is still developing in speed of light
● Technology is difficult to understand
● Openness can be a liability, i.e. there is no protection by 3rd party institutions or central authorization. Over 140 hacker incidents identified for the past few years, breaches of wallets and exchanges are the most common type of attacks, followed by breach of Ethereum smart contracts In my view, the exchange will become the easy target due to the large market cap in next few years
WHAT ARE THE BEST PRACTICES ON ASSET OPERATIONAL STRATEGIES?
Market practice on the centralized crypto exchange are still evolving, I address some items to be taken into account in operational strategies:
● Exchange should establish clear and focus market position in following areas
✔ Type of exchange
✔ Product and jurisdiction serviced
✔ Customer type
✔ Main business focus, revenue engine
● Standardized and clear Listing process:
Exchanges should maintain distinct listing requirements to attract high quality issuers:
✔ Well defined listing process procedure – An exchange should make its listing process and application clear, transparent and available Listing requirements should be as specific as possible.
✔ Consider business and governance risks I e Follow guidelines published by MAS if you're doing business in Singapore.
Centralized Exchanges Asset Operational Strategy
✔ Reputational risk considerations If the token associate with negative news and illegal activities
✔ Legal framework: Ensure the exchange has obtained robust written legal advice to confirm the issuer’s validity.
● Addressing AML issues and controls: Ensure a strong AML program is in place and effective and all staff are adequately trained with frequency of at least once a year
● Strong KYC process in place.
✔ ID verification of users at early stage of on-boarding
✔ Screening and monitoring process need to be up to date and ensure to screen customers against OFAC, World check and The FATF grey list.
● Obtain Legal Opinion from a Singapore Law firm:
Cryptocurrencies are either regulated or unregulated under Singapore’s Payment Services Act 2019 (PSA). That said, due to the wide range of features and attributes, some crypto could fall outside of the ambit of the PSA. And some are fall within the Singapore’s Securities and Futures Act (SFA)’s purview Before conducting any cryptocurrency-related activities in Singapore, CEXs and any crypto activities should obtain a legal opinion from Singapore Law firm to determine whether and how such activities would be regulated under Singapore law.
● High standard Cybersecurity Requirement and implement strong operating risk controls.
o Apply Zero Trust security. Some experts speculated that such a hack took time and planning. If so could this have been an inside job from Poly Network? Traditional IT network security trusts anyone and anything inside the network. A Zero Trust architecture trusts no one and nothing Huobi can deploy strict multi-factor identity verification for every person and device trying to access resources on a private network, regardless of whether they are sitting within or outside of the network perimeter
o Enhance identity and access management.
o Test internal staff with security exercises
o Consider business and governance risks
o Invest into fraud and AML detection tools that specialize in blockchain
o Highlight smart contract security and the potential coding bug
o Request constant and timing progress update from coin issuers listed on Huobi’s exchange i e Review Whitepaper and status update to identify early risk warnings
o Ask all coin issuers on Huobi for regular updates on its security, technology, application development, and regulatory requirements
o Closely monitor tokens/ turnaround time if they encounter technical or security issues
o Educate Huobi’s end users by applying security tips and increase their awareness
Use separate wallet addresses for DeFi activities
Centralized Exchanges Asset Operational Strategy
Use 2 factor authentication (2FA) and strong passwords
Check wallet approvals regularly Revoke the access rights for that project to the wallets if no longer required
Be mindful and warn of malicious software and phishing scams
Use a centralized exchange like Huobi to add more layers of security projection
Enhance ID management Educate users to ensure the private key is securely stored as the owner’s signature is verified directly within the blockchain
o Emphasis on software updates given the open source and decentralised environment make software update difficult
CONCLUSION
Cryptocurrency will continue to gain traction and become the revolutionary technology impacting the traditional finance service industry and it will naturally benefit the Crypto Exchanges segment
The Crypto Exchanges will also embrace DeFi functions in order to better serve their users.
The above mentioned operating strategies are not exhaustive, there are multiple features and new market applications to be created in the near future. There will be new tokens to be offered, and in which digital asset exchanges will involve in different capacity.
At this point in time in Singapore, it is crucial to comply with the key regulatory drives from MAS In such cases, the digital asset exchange will need to revisit their operational strategies and direction more frequently to ensure the sustainability of the exchange.
