How centralized exchanges can work globally and stay compliant?

December 8, 2022
TABLE OF CONTENTS

How centralized exchanges can work globally and stay compliant?

December 8, 2022

Web3 founders who have decided to launch a cryptocurrency exchange or are exploring entering new markets with their existing exchange will need to think about compliance. Given that centralized exchanges operate in a quite regulated environment, an important step in evaluating potential markets will be to understand which regulations will apply to the exchange and how to comply with them. This article is written specifically for founders and in-house lawyers working on centralized crypto exchanges. 

For this guide 8 jurisdictions are evaluated, including 5 high-reputable jurisdictions: the US, Switzerland, UAE, Malta, and Gibraltar; and 3 offshore options: the Bahamas, the Seychelles, and the Cayman Islands. The latter have legal frameworks created specifically for virtual assets. These 8 jurisdictions are the primary focus of this article as they demonstrate the benefits of a legally structured and compliant Web3 business, including: 

  • the trust of users and investors;
  • access to fiat currency-based payment methods, and;
  • a clearly indicated set of activity regulations, including AML/KYC. 

To learn more about the legal structuring requirements and regulations that apply to centralized exchanges, check out this article.

Reputable on-shore jurisdictions for establishing virtual asset exchanges

Jurisdictions with a strong reputation and well-formed regulations on virtual asset exchanges include the U.S., Switzerland, UAE, Malta, and Gibraltar. It’s key to understand the different regulations that founders might need to comply with and a good place to start is by evaluating which exchanges are already registered or have licenses in each jurisdiction. 

The United States of America (Coinbase, dYDx, CEX.io)

There is no distinct legal framework of activity in the sphere of virtual assets in this jurisdiction, but there are some general law concepts (like the Howey test) and guidelines and regulations with respect to virtual asset businesses, with which Web3 entrepreneurs should comply. 

In compliance with the guidance issued by Financial Crimes Enforcement Network, the U.S. Department of the Treasury’s Office of Foreign Assets Control, and the U.S Securities and Exchange Commission, virtual asset exchanges should comply with additional requirements on both federal and state levels. These requirements should be reviewed individually for each project, taking into account the project’s specific features.

In most of the states, centralized exchanges will be qualified as money-transmitting businesses, therefore, they would need to obtain federal Money Service Business authorization in addition to Money Transmitter licenses in each separate state.

Switzerland (SIX)

Switzerland also does not propose a legal framework specially for a virtual assets business. Instead, there are existing regulatory requirements that may apply to exchanges taking into account the characteristics of each individual business. Swiss authorities issued detailed guidelines with respect to regulations, applicable to virtual assets exchanges in each specific situation (including DEXs).

The United Arab Emirates (BitOasis)

Building a virtual assets exchange in the UAE will differ from jurisdiction to jurisdiction, as the regulation of the activity varies substantially. Web3 entrepreneurs may choose to structure their business in a free zone, such as the Dubai Multi Commodities Centre (DMCC) or the Abu Dhabi Global Market (ADGM). The ADGM has its own very detailed virtual assets legal framework, whilst the Emirate of Dubai has a special law regulating virtual assets in the Emirate, which apply to all zones across the Emirate, including special development zones and free zones but excluding the Dubai International Financial Centre (DIFC).

Malta (Crypto.com)

Malta has a special legal framework, regulator, and guidelines for the regulator. All these things make the process of structuring understandable and attractive to Web3 entrepreneurs.

Gibraltar (CEX.io, Valereum)

Gibraltar is in the same position as Malta: it has its own special regulation and a regulator, therefore, the process is straightforward. CEX.io has both US and Gibraltarian licenses, whereas Valereum has multiple different licenses, including Gibraltarian.

Off-shore jurisdiction options for CEXs

There are some offshore jurisdictions that offer a more definite legal framework: the Cayman Islands, the Bahamas, and the Seychelles. It’s crucial to understand what the legal requirements for these projects may be and to evaluate some of the existing exchanges that are already registered there. 

The Cayman Islands (BitMart)

This offshore jurisdiction was one of the first to pass a Virtual Asset (Service Providers) Law, which, among other things, regulates the activity of virtual assets exchanges. Under the law, a person who intends to provide the services of virtual assets exchange must obtain a license from the Cayman Islands Monetary Authority

The Bahamas (FTX

FTX, before the exchange’s collapse, had many licenses, including a license in the Bahamas. Bahamas has also an exhaustive framework for virtual assets exchange activity, under the management of the Securities Commission of the Bahamas.

The Seychelles (KuCoin, OKX)

The Seychelles has no special regulation for exchanges as for now, but it intends to implement it in the near future

Work on global markets in a compliant way without the regulatory risks

Are you a Web3 founder who has chosen the markets you want to scale your exchange to and are now wondering how you go about obtaining the right licenses and complying with regulations in each jurisdiction? 

The best way could be to partner with specialists who know the ins-and-outs of all these jurisdictions and are able to help you find the local specialists in each, and manage all the work and communications for you.

At Legal Nodes, we help Web3 founders and in-house lawyers do just that by pairing them with the best-in-class Virtual Legal Officers. These professionals know the best practices of legal structuring of Web3 projects and work with the Legal Nodes network of legal providers from 20+ crypto-friendly countries. They’re in a unique position to help founders create the best legal structure for their projects, select local legal providers to implement the structure, and manage all the legal works in a single place. In the same way, Virtual Legal Officers can help in-house lawyers who need more resources or need help in a specific jurisdiction. 

Book a free intro call to talk with Legal Nodes and learn how we can help legally structure your Web3 project.

Disclaimer: the information in this guide is provided for informational purposes only. You should not construe any such information as legal, tax, investment, trading, financial, or other advice. Mentioning any of the assets in this article is not an endorsement to purchase them.

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Taras is a Web3-focused Virtual Legal Officer at Legal Nodes. Since 2018, he has had various projects under his belt, ranging from M&A transactions and ICO management to handling matters concerning Ukrainian laws on virtual assets. Taras loves writing helpful guides on Web3 legal topics and draws his inspiration from doing sports and reading books (his passion is the history of the 20th century).

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