In an unprecedented move that signals escalating oversight of the cryptocurrency industry, South Korean financial authorities are gearing up to initiate stringent eligibility reviews for major shareholders of cryptocurrency exchanges, mirroring the rigorous standards upheld within the traditional banking sector, multiple local media outlets reported late last week.
The planned reviews come amid increasing legal turmoil and allegations of fraud involving major shareholders of prominent domestic cryptocurrency exchanges such as Bithumb and Upbit. With billions in Korean won trading hands daily on these platforms, regulators fear that exchange operations could be systematically manipulated by ineligible major shareholders motivated by greed or engaged in illicit activities.
By screening major shareholders, the government aims to mitigate the risk of potential damage to exchange users while curbing fraudulent and manipulative acts by individuals who wield outsized influence over exchange businesses. But how far will regulators go to peel back the opacity surrounding exchange ownership and operations? And could a regulatory reckoning be coming for an industry that has historically operated in a legal gray zone?
Regulators Assemble Task Force, Revise Reporting Requirements
The Financial Intelligence Unit (FIU), an investigative bureau under the Financial Services Commission, has assembled a task force to reform cryptocurrency exchange reporting requirements, according to media reports. The revised requirements will be integrated into a mandatory renewal reporting process that existing exchanges must complete starting in October 2024.
Under South Korea's Specific Financial Information Act, all virtual asset companies, including exchanges, must file a renewal report every three years after submitting an initial report. Upbit, the country's largest exchange, finalized its initial report in October 2021, meaning it will be first to undergo the revised renewal reporting process.
The main focus of regulators will be scrutinizing major shareholder eligibility - a key procedural safeguard that enables periodic re-evaluation of whether a majority shareholder retains the qualifications necessary to operate a financial services company. Regulators hope periodic reviews will reduce illegal activities by influential major shareholders and lessen the potential for damage to users.
Lawmakers Push For Heightened Major Shareholder Scrutiny
The move to examine major shareholders comes as high-profile legal cases highlighting alleged shareholder fraud and market manipulation have brought intensifying public scrutiny on exchange ownership structures.
Most notably, Bithumb majority shareholder Jong-hyun Kang is currently embroiled in a criminal trial over accusations of fraudulent trading using a Bithumb corporate account. Meanwhile, Upbit's majority shareholder Song Chi-hyung, the Chairman of parent company Dunamu, is facing a Supreme Court trial related to allegations of market manipulation.
Citing concerns stemming from these cases, People Power Party representative Yoon Chang-hyeon has proposed legislative amendments to mandate reporting of major shareholder information and enable reviews of their eligibility.
Under the proposed amendment to the Act on Reporting and Use of Specific Financial Transaction Information, exchanges would have to report details on controlling shareholders so that the FIU can examine their financial and economic crime history.
Expanded Oversight Raises Questions About Industry Opacity
The planned eligibility reviews highlight two key points. First, they demonstrate that regulators are taking an increasingly strict approach toward mitigating potential abuse of power or criminal activity by influential major shareholders who operate behind the scenes.
Second, the move hints at the opacity and potential conflicts of interest that may be ingrained into aspects of the cryptocurrency exchange business model. Despite handling billions in customer funds, prominent exchanges are often controlled by individuals or entities whose backgrounds and qualifications have evaded public scrutiny.
But fundamentally, the planned reviews beg the question: could the murky ownership structures of major Korean exchanges represent an underlying vulnerability of the cryptocurrency sector's historically limited oversight?
A Reckoning For Regulatory Arbitrage?
Broadly, the South Korean cryptocurrency exchange market emerged rapidly thanks to "regulatory arbitrage" - the practice of structuring businesses to maximize profit in low regulation environments. With cryptocurrency oversight still evolving, some exchanges may have expanded while opportunistically operating around gaps in reporting rules and avoiding rigorous vetting of controlling parties.
However, as rules catch up to market growth, regulatory arbitrage could become increasingly difficult. Compliance may require greater transparency around ownership and prove costly for exchanges accustomed to minimal reporting requirements. Ultimately, the planned eligibility reviews could precipitate a reckoning, with non-compliant exchanges unable to adapt risking closure.
Decentralization: A Solution For Reducing Concentrated Power?
As oversight expands, it's worth considering whether inherent centralization makes cryptocurrency exchanges and their major shareholders easy targets for manipulation and misconduct. Could decentralized finance protocols and services reduce such risks by design?
Bitcoin's decentralized structure distributes power among an open-access network of participants, reducing centralized control. Similarly, decentralized exchanges allow asset trading without ceding custody to a single intermediary. Avoiding central points of control theoretically limits the potential for abuse.
Granted, decentralized services introduce their own challenges around governance, security, and regulation. But long term, decentralized alternatives may displace centralized intermediaries if transparency and fairness become users' highest priorities.
Ultimately, intensifying oversight in South Korea foreshadows the growing pains that may await cryptocurrency markets as regulations evolve to match the sector's maturity and risks. Users may increasingly gravitate toward solutions that prioritize transparency, integrity and decentralization. Meanwhile, non-compliant actors clinging to "old ways" of minimal disclosure and avoidance of accountability could face extinction.
Will stricter eligibility rules shut down non-compliant exchanges?
Realistically, heightened reporting requirements may initially force consolidation, with some exchanges shuttering or merging as the cost of compliance weighs on smaller platforms. But established leading players like Upbit and Bithumb are unlikely to disappear, even if they must shed questionable shareholders. With proper corporate restructuring, major exchanges could satisfy regulators and live on. However, they may lose pricing power if regulatory scrutiny intensifies competition.
What protections can users take to mitigate exchange risks?
Users should minimize holding funds on exchanges when possible to reduce exposure to exchange failure. Using decentralized exchanges for some trades can further diversify risks. Being selective in choosing established exchanges with transparent corporate structures is also wise. Paying higher fees on reputable platforms for key services like fiat on-ramps may be worthwhile for risk mitigation. As oversight evolves, users increasingly hold power via their purchasing decisions.