It's all about cryptocurrency regulation.
Regulation is a hot topic right now as countries around the world grapple with ways to control the slippery beast that is cryptocurrency. The United States already has a number of rules in place, and is likely to introduce more.
It is these existing regulations, both at a state and national level, that prevent many crypto exchanges from operating in the U.S. Exchanges have to register as money service businesses (MSBs) and get money transfer licenses.
Some international exchanges have made the decision that the cost and paperwork aren't worth the effort. Others provide services that aren't compatible with U.S. laws.
Here are some of the big stumbling blocks for cryptocurrency exchanges in the U.S.
1. Know your customer (KYC) requirements
One reason authorities are concerned about cryptocurrency is that it is anonymous. The worry is that it can be used to finance crime or launder money from illicit activities. As a result, U.S. cryptocurrency investors need to fill in their personal information and often upload a photo ID to set up an account.
The challenge is that privacy and anonymity are part of the original ethos of cryptocurrencies. And both customers and exchanges get frustrated with the steps involved in stringent know your customer (KYC) processes. For example, exchanges may not want to manually check photo identification and proof of address.
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As a result, some exchanges opt out of asking customers for personal data. Those exchanges are not authorized to operate in the U.S.
2. Derivatives trading
Derivatives are complex financial instruments that let traders bet on the future price of a commodity. Traders can go short (bet on the price going down) or long (bet on the price going up). Crypto derivatives are becoming increasingly popular worldwide, but it's not something retail investors in the U.S. are allowed to access.
Several cryptocurrency exchanges offer derivatives trading, including leverage and margin. Investors can use leverage to increase their buying power. For example, if you put down $100 at 5x leverage, you'd be able to take a $500 position. However, you'd also take on a much higher risk, which is why there are restrictions on this type of trading.
The U.S. won't license cryptocurrency exchanges that offer derivatives trading to retail investors. Kraken used to offer limited margin trading to U.S. clients, but from June 23 onward, only qualified investors can access this service. (Qualified investors need to have more than $10 million in total assets.) CoinBase Pro has also disabled its margin trading.
Binance, which has an international site and a U.S.-specific site, is under investigation by the IRS and the Justice Department, who believe that U.S. customers are using the international site for these types of trades.
3. Taxation and other reporting
Money service businesses need to keep detailed records and report any cash transactions over $10,000 to the IRS. U.S.-based exchanges with foreign customers still need to track all customer activity.
U.S. authorities have crypto tax evasion firmly in their sights, believing that millions of dollars worth of transactions are going unreported. Earlier this year, the IRS got a court order to obtain records from Kraken; it has already taken similar actions against Coinbase. The exchanges need to hand over information on U.S. taxpayers with crypto transactions that total more than $20,000.
In the future, the government wants crypto transfers to be treated like cash. If new proposals are approved, any crypto transaction of over $10,000 would need to be reported.
4. State-specific regulations
Different states have taken wildly different approaches to cryptocurrency regulation. That's why you'll find certain cryptocurrency exchanges do not operate in every U.S. state.
Some, like Wyoming, Colorado, and Ohio, have introduced crypto-friendly laws, as they want to attract the burgeoning cryptocurrency industry. Others, like New York and Washington, have strict crypto requirements.
New York has led the way in crypto regulation. Its BitLicense controls how exchanges store currency and which coins exchanges can trade. Many believe New York's framework will be used as a basis for stricter federal regulation.
Can non-licensed exchanges still operate in the U.S.?
One of the many challenges in cryptocurrency regulation is that it is a global industry, and technology makes it easy to access services from all over the world. As such, some U.S. consumers use services that aren't licensed as MSBs.
The U.S. is cracking down on this type of activity and will likely ramp up its efforts in the future. At the end of last year, the Commodity Futures Trading Commission (CFTC) took action against crypto exchange BitMEX -- which is not licensed in the U.S. -- for allowing U.S. customers to use its service.
It may be tempting to circumvent the rules and use non-U.S. licensed services, but it's also risky. Exchanges may freeze access to customer accounts, authorities are actively pursuing crypto tax evasion cases, and consumers won't have the same protections.
As cryptocurrency investors, we have to accept that regulation is inevitable. As the industry continues to grow, regulators won't simply turn a blind eye, even if their actions go against the spirit in which Bitcoin was founded. And careful regulation is not necessarily a bad thing. It can protect against bad players and stop us from inadvertently supporting criminal activities.
