The U.S. Government’s BitMEX Crackdown Shows Bitcoin’s Resilience

By: Justice Clark Litle

Oct 06, 2020 | Educational

Last week saw so many head-spinning developments, it felt like the space-time continuum might implode as the speed and density of the political news cycle collapsed into a black hole.

So it’s understandable a major crypto-world development got lost in the shuffle.

The U.S. government came down like a ton of bricks on BitMEX, the world’s second-largest cryptocurrency derivatives exchange.

The charges, both civil and criminal, were as serious as it gets. The three BitMEX founders, along with the exchange’s first employee and head of business development, could be facing lengthy prison sentences.

While we don’t want to sound callous, it looks like BitMEX had it coming.

The complaints registered by the Department of Justice (DOJ) and Commodity Futures Trading Commission (CFTC) date back five years, to 2015. Prosecutors cited brazen behavior and explosive comments on the part of the most visible BitMEX founder, Arthur Hayes. With respect to angering U.S. regulators, the anti-regulatory attitudes and actions of BitMEX had the feel of waving a red flag in front of a bull.

Worse still, BitMEX had to know it was playing a dangerous game in offering unregistered trading access to thousands of American customers with a total absence of regulatory licenses and anti-money laundering procedures (AML). Other exchanges — like the world’s No. 1 crypto derivatives exchange, Binance — had taken clear steps to either restrict access for U.S. customers or provide a regulatory-compliant U.S. trading arm, precisely to avoid what is happening to BitMEX now.

From our perspective, the most notable thing about the BitMEX story is the way Bitcoin responded to the news. That is to say, Bitcoin did not react much at all in terms of price change, showing the degree to which Bitcoin is becoming a mature asset that trades independently of explosive developments in the crypto space.

BitMEX, as mentioned, is the second-largest crypto derivatives exchange in existence, and now it may be toast. If the BitMEX story had broken two years ago, Bitcoin likely would have fallen by a double-digit percentage, perhaps losing 20% or more of its value in a single trading session.

And yet, on Oct. 1, Bitcoin lost less than 3% on the BitMEX news, comparable to a run-of-the-mill volatile trading day for the S&P 500. Bitcoin, in fact, responded more to the explosive political news of the past week (which impacted the entire stock market) than to BitMEX specifically.

That was notable, too, because, when the BitMEX charges were announced, roughly 23,200 BTC — worth about $242 million at the time — were withdrawn from the exchange in the space of an hour. For Bitcoin to take that kind of disruption in stride is a positive sign.

So, what exactly happened with BitMEX?

BitMEX was one of the earliest crypto derivatives exchanges, founded in 2014. The firm pioneered breakthrough products like a perpetual Bitcoin futures contract — essentially a synthetic futures contract that never expires — and offered its customers as much as 100X leverage with an automatic risk cut-off.

BitMEX was also brazen in flouting government rules. Hayes bragged in 2015 that Seychelles regulatory officials could be bribed with “coconuts,” which did not reflect well on BitMEX being incorporated in the Seychelles.

BitMEX was also partial to high-profile publicity stunts, like renting three Lamborghini supercars and parking them outside a high-profile crypto conference in 2018.

Worse still, BitMEX seemed content to have thousands of U.S.-based customers without applying for U.S. regulatory licenses or submitting to Know Your Customer rules. The U.S. government sees BitMEX as a money-laundering hub, in part, because the exchange allegedly never filed a single report of suspicious activity in relation to its U.S. customers, and for years made no attempt to vet customers at all.

In its civil portion of the complaint, the CFTC alleged that Bitmex had taken more than $11 billion in deposits and earned more than $1 billion worth of fees, even as they “failed to implement the most basic compliance procedures.”

The DOJ criminal charges relate to alleged violations of the Bank Secrecy Act, and alleged conspiring toward future violations of the Act. Each count, if proven in a court of law, could be worth five years in prison.

One of the BitMEX founders was arrested in Massachusetts. The other founders are still at large. If the DOJ can track them down, it will probably seek to extradite them back to the United States. This is serious stuff.

The BitMEX crackdown is not an existential threat to the crypto space. As with the Securities and Exchange Commission (SEC) crackdown on Initial Coin Offerings (ICOs) in 2018, the government’s actions are a high-profile display of force, and a very public way of saying: “If you ignore the rules, you will regret it.”

It is hard to know what the BitMEX founders were thinking. Other top exchanges, like Binance, bent over backwards to either avoid U.S. customers or offer compliant access. BitMEX, meanwhile, seemed fine with playing regulatory Russian roulette.

We believe Bitcoin will be strengthened by this episode, on the grounds of “that which doesn’t kill you makes you stronger.” The resilience of Bitcoin even as a major crypto exchange is up-ended speaks to the robust nature of rising BTC demand.

The BitMEX enforcement action could, however, have a chilling effect on the red hot “DeFi” crypto craze. DeFi stands for Decentralized Finance, and represents the porting of high-yield lending products from Wall Street into the crypto space.

We have cast a wary eye on DeFi in general, for two reasons: First, because the technology is far from proven — as one person put it, the technological state of DeFi right now is like “trying to fly to the moon in a cardboard box” — and second, because overly aggressive DeFi products are just waiting to get smashed by a regulatory crackdown, just as fast-and-loose ICOs were hit in 2018 (and BitMEX is being hit now).

The U.S. government cannot stop the rise of crypto. On the positive side, it doesn’t seem to want to.

The government does, however, want to aggressively enforce the rules  around regulatory compliance and the hawking of complex financial products. That is not bad news for Bitcoin, and in the long run, it isn’t bad news for Decentralized Finance (DeFi), either.

But it does mean that, as crypto transactions scale and the world of crypto becomes more visible, Wild West attitudes — like the attitude embraced by the BitMEX founders — will have to go away.

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