VASP’s & Cryptocurrency Exchanges

A cryptocurrency exchange, is an online platform that allows customers to trade cryptocurrencies (digital currencies) for other assets, this can be fiat money or other crypto, based on the market value of the given asset.

The cryptocurrency exchange acts as an intermediary between a buyer and a seller. They can be a market maker that typically takes the bid–ask spreads as a transaction commission for the service or, a matching platform that simply charges fees. Dedicated cryptocurrency exchanges allow cryptocurrency withdrawals to cryptocurrency wallets.

What are wallets?

Cryptocurrency wallets can be devices, a service, program or a physical medium. They store public and/or private keys used to digitally sign cryptocurrency transactions for distributed ledgers. They also often offer the functionality of encrypting and/or signing information. Signing can result in a cryptocurrency transaction, executing a smart contract or legally signing a document.

Wallets not only keep track of encryption keys used to digitally sign transactions. They also store the address on a blockchain where a particular asset resides. Crypto wallets come in two main types: software (hot storage) and hardware (cold storage). Hot storage wallets are accessible via the internet. Cold wallets are downloaded and reside offline on a piece of hardware. Because of this cold wallets are considered more secure, as they’re not connected to the internet. Most crypto attacks have occurred when hackers hit an online wallet service and transfer the keys to their own wallet.

cryptocurrency exchange acts as an intermediary between a buyer and a seller

Wallets can vary in terms of their complexity. A simple wallet will contain pairs of public and private cryptographic keys. The keys can track ownership, receive or spend cryptocurrencies. Public keys allow others to make payments to the address derived from it. A private key enables crypto to be spent from that address. Just one party is required to sign a transactions, whilst in contrast a multi-signature wallet requires multiple parties to sign a transaction.

Centralised (CEX) or Decentralised (DEX) exchanges

The majority of digital asset trading occurs on centralised exchanges (CEX). These require custody of your digital assets in order to make trades. They offer consumers a more familiar, user friendly way of trading and investing. As they are operated and controlled by a company centralised exchanges arguably offer more reliability.

However as the companies operating the centralised exchanges are responsible for holding their customers crypto, they make themselves a target for theft and hackers. Unlike peer-to-peer transactions, CEX’s often change high transaction fees for their services and customer friendly convenience.

Decentralised exchanges (DEX) allow user to execute peer-to-peer transactions without the need for a third party or intermediary. Users do not need to transfer their assets to a third party. Therefore mitigating the hack and theft risk of a CEX. As the exchanges taking place are peer-to-peer, the risk of market manipulation is removed. In addition CEX’s do not require customers to complete Know-Your-Customer (KYC), thereby offering privacy and anonymity.

The majority of digital asset trading occurs on centralised exchanges

Decentralised exchanges don’t facilitate the trading of fiat currencies for cryptocurrency, making them less convenient for consumers who do not already hold cryptocurrencies.

Additional complexity also exists for users of decentralized exchanges. They must remember the keys and passwords to their crypto wallets, or their assets are lost forever and cannot be recovered. They also require the customers to learn the platform and process, so are not necessarily as convenient and user-friendly as CEX’s.

The vast majority of cryptocurrency transactions occur on centralised exchanges, which have the majority of trading volume. Consequently, decentralised exchanges often lack liquidity. It can be hard to find sellers and buyers when trading volumes are low

UK Regulatory Landscape

Since 10th January 2020 to operate in the UK crypto exchanges need to register with the Financial Conduct Authority (FCA). They must also comply with Money Laundering, Terrorist Financing and Transfer of Funds Regulations. The FCA is the AML and CTF supervisor for businesses carrying out crypto activities in the UK.

All UK based Virtual Asset Service Providers (VASPs) must comply with a number of regulations covering KYC, AML and CFT. Regulations on VASPs have been created so as to not stifle innovation whilst maintaining the integrity of the wider financial system.

Whilst UK cryptocurrencies regulations allow users to buy and sell cryptocurrencies, the FCA announced that from January 6th 2021 trading of cryptocurrency derivatives was to be banned.

Leading UK based Exchanges and VASP’s include:

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Written By:
Penny Sommerfeld