AuthorJohnson, Kristin N.

TABLE OF CONTENTS INTRODUCTION 1914 I. INTERMEDIATION: A FUNCTIONAL ANALYSIS 1924 A. Traditional Intermediaries 1926 B. Governance and Economics of Secondary Market Trading 1933 II. CRYPTOCURRENCY PRIMARY AND SECONDARY MARKET TRANSACTIONS 1943 A. Cryptocurrency Primer 1945 B. Cryptocurrency Exchanges 1951 III. MARKET EVOLUTION AND FRAGILITY 1960 A. Automating Risk 1961 B. Accelerating Risk 1964 C. Cyber-Risks 1971 D. Systemic Risk 1973 IV. (RE-) ENVISIONING INTERMEDIARY REGULATION 1978 A. Ordering Markets: Proposed Reforms 1980 B. Self-Certification 1985 C. Collaborative Market Governance 1991 V. BENEFITS AND LIMITATIONS OF SELF-DESIGNATION 1994 A. Benefits 1994 B. Remaining Questions 1995 CONCLUSION 2000 INTRODUCTION

Despite federal and state regulators' warnings and mounting civil and criminal enforcement actions, investors continue to flock to cryptocurrency markets, buying coins and tokens in initial coin offerings (ICOs). (1) At its high-water mark in 2021, exponential growth characterized the near one-trillion-dollar cryptocurrency market. (2) As governments, private stakeholders, and academics cast a spotlight on ICOs, a shadow fell, obscuring nefarious activity on secondary trading market platforms.

Media reports chronicle the endemic challenges in cryptocurrency secondary markets. Bitfinex, one of the world's largest cryptocurrency exchanges, is a prominent example. Founded in 2012, Bitfinex has survived Ocean's Eleven-style heists that emptied hundreds of millions of dollars of customer assets from its coffers. (3) Periodic cyberattacks have temporarily paralyzed Bitfinex's platform, suspending trading and halting customer withdrawals. (4) Yet, these incidents are only the tip of the iceberg.

Bad actors swarm secondary market trading in cryptocurrency markets. Traditional banks are reticent to permit cryptocurrency exchanges to open accounts; thus, these platforms often rely on "shadow banks." (5) For example, Bitfnex initially routed customer transactions through a Taiwanese bank to Wells Fargo. (6) Then, on April 18, 2017, Wells Fargo began blocking Bitfinex wire transfers. (7) Bitfinex pivoted to a Puerto Rican bank--Noble Bank. (8) On October 1, 2018, Noble Bank lunged toward bankruptcy. (9) Bitfinex transferred $850 million to a Panamanian nonbank payment processing platform--Crypto Capital. (10) Another fleeting solution. Within a year, the Polish government arrested Crypto Capital's President Ivan Manuel Molina Lee for his role laundering money on behalf of an international drug cartel. (11) Bitfinex shocked the cryptoworld, announcing that the $850 million in customer funds held by Crypto Capital had vanished. (12)

Beyond Bitfinex's firm-specific risk-management concerns--the conflicts of interest, woefully deficient compliance controls, anemic consumer protection policies, and remarkably inadequate cyber-security measures--the entire industry grapples with operational and systemic risks: fake bank accounts, mismanagement of customer funds, blatant theft, garden-variety fraud, and exploitative and abusive trading strategies. (13)

Stunningly, none of the three hundred trading platforms facilitating cryptocurrency secondary market transactions has obtained the requisite approval from federal or state authorities to operate as an exchange. (14) Regulators have formally prosecuted only a handful of trading platforms. (15) Most troubling, however, are the breadth and depth of these challenges among the small group of actors that has captured the greatest market share in global cryptocurrency secondary trading markets. Why have Congress and regulators failed to impose order in the Wild West of cryptocurrency secondary market trading?

Financial services regulation is complex and growing more complex each day. (16) Among other challenges, regulators do not always understand what exactly (transactions, other activities, or attributes) gives rise to regulatory intervention. (17) Complicated financial products precipitated the financial crisis that began in 2007, (18) and, in the wake of the crisis, many were disillusioned.

Legacy financial institutions and other market participants' avaricious, self-serving, and predatory behavior initiated a polarized debate regarding the federal government's $700 billion bailout of Wall Street intermediaries. (19) Developers began to imagine a financial services industry without traditional intermediaries--depository banks, investment banks, stock exchanges, brokers, and dealers.

Innovative financial technology (fintech) products and firms aimed to disrupt conventional financial markets and displace legacy financial institutions. (20) Programmers introduced alternative financial products and platforms, namely peer-to-peer distributed digital ledger platforms that originate and distribute cryptocurrencies. (21)

Since the publication of the Bitcoin blockchain White Paper in 2010, markets have witnessed the origination of more than five thousand cryptocurrencies. (22) In the ensuing decade, regulators have scrambled to keep pace. Distributed digital ledger technology and the popular subset of blockchain-based technologies are among the most innovative technologies in the financial markets ecosystem. (23) Central banks, national governments, and significant financial institutions increasingly signal an interest in the origination, distribution, and exchange of proprietary cryptocurrencies. (24) Indisputably, these coins and tokens have moved from the shadows to center stage.

In the summer of 2019, for example, Facebook released a White Paper announcing plans to issue a stablecoin--Diem, a global cryptocurrency designed to displace existing government-issued fiat and introduce a frictionless international financial payment system. (25) Facebook's description depicts Diem as sharing attributes with a variety of traditional assets and financial services; according to Facebook, Diem is a currency or cash-equivalent cryptowallet and private payment platform. (26)

Simply stated, Diem defies the rigid, siloed designations characteristic of the laws governing financial markets. Distributed digital ledger protocols enable developers to create multifaceted entities and products that play many roles. Diem operates as the issuer, the investment bank or underwriter for the initial offering of Diem, the broker-dealer who executes Diem trades for Diem holders, and the exchange platform that facilitates Diem secondary market transactions. (27)

Achieving regulatory aims may be difficult, if not impossible, if lawmakers and regulators do not understand exactly which entity attributes or characteristics give rise to regulation. For nearly a century, financial regulators have ordered markets based on the role that intermediaries play in the development and execution of primary and secondary market transactions. (28) Determining the proper timing, scope, and emphasis of regulatory intervention are questions that scholars, practitioners, and regulators have wrestled with for decades.

As the pace of innovation accelerates, the divergence between the limits of existing regulation and the creativity spurring alternative fintech-inspired financial products and intermediaries becomes increasingly salient. (29) Despite growing complexity, conventional wisdom continues to suggest that the existing regulatory framework sufficiently addresses normative goals such as customer protection and market integrity. (30)

Yet, the existing framework does not envision fluid intermediaries that have the ability to transform. (31) Developers' continuous improvement of application programming interface (API) may enable some cryptocurrency exchanges to create a dynamic operational or governance infrastructure; in other words, a platform that relies on intermediary-like functions may evolve or undertake a metamorphosis that reduces or eliminates reliance on intermediation, shedding the features of centralization and permitting peer-to-peer, decentralized transactions. Consequently, questions emerge regarding the efficacy of applying our existing regulatory framework to cryptocurrency secondary market transactions. The dynamic nature or potential for centralized trading infrastructure to morph into decentralized infrastructure remains undertheorized. (32) This Article helps to fill this gap.

This Article makes three critical contributions. First, this Article challenges regulatory approaches that prioritize the supervision and enforcement of primary market transactions. While regulators generally agree on the normative goals of regulation, opinions diverge regarding the optimal approach for achieving these aims. The consensus that drives the dominant narrative portraying primary market regulation--chiefly mandatory disclosure--as the "anointed" regulatory approach stems from a belief that imposing and enforcing material disclosure reduces asymmetries of information, fraud, manipulation, and exploitation of unwitting individual investors. In the context of cryptocurrency markets, emphasis on primary market transactions means regulating ICOs. Yet, evidence from Bitfinex and other platforms demonstrates the perilous consequences of neglecting secondary market infrastructure and the regulation of trading intermediaries.

Second, this Article identifies a transformative attribute of cryptocurrency trading platforms that confounds efforts to apply existing regulation. Cryptocurrency secondary market platforms have the capacity to change; they are dynamic intermediaries, meaning the operational attributes of broker-dealers, exchanges, and clearinghouses developed on distributed digital ledger protocols may gradually evolve.

Inspired by the goals that prompted the creation of cryptocurrency, programmers continuously adapt distributed digital ledger platforms in an effort to minimize the attributes that impede the execution of transactions "on-chain." In other words, distributed digital ledger platforms aim to...

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