Independent Reserve, a Sydney-based digital currency exchange, has come under the authority of the Australian regulator responsible for know-your-customer, anti-money laundering and counter-terrorism financing compliance.
This represents the first time an Australian exchange focused on crypto currencies has become part of the financial regulatory world, making it among the first in the world.
In the U.K., Digital Services Exchange partners with a regulated electronic payments company to access Swift and other traditional channels for fiat money, while in the U.S., two commodities exchanges now offer bitcoin futures, and the securities regulator has called for exchanges to obtain a license.
South Korea and other jurisdictions are also considering providing some sort of regulatory blanket for digital exchanges.
Going after traditional $$
Adrian Przelozny, CEO at Independent Reserve, says he has lobbied regulator Austrac for two years so that the exchange can chase more business from the self-managed superannuation funds market (SMSFs) and other traditional sources of capital.
He is also lobbying Asic, the Australian Securities and Investments Commission, to be allowed to apply for a license to deal and advise in financial instruments. He’s been lobbying them since 2014, he says. “They’re slowing coming around,” he told DigFin. “We’re pro-regulation, and want the authorities to set a framework.”
We want the authorities to set a framework
By winning a license from Austrac (the Australian Transactions Reports and Analysis Centre), he expects demand for crypto trading from large over-the-counter desks in Asia and the U.S. representing wealthy customers and family offices will spike. “This is the avenue that larger institutions seek,” he said.
Independent Reserve is the first digital exchange in Australia to have opened an OTC desk, and along with BTC Markets in Melbourne is one of the two most liquid in the country. At the start of the year, when bitcoin valuations were touching $20,000, Independent Reserve turned over around A$30 million a day; today, that figure ranges from A$5 million to A$10 million.
But he expects volumes to grow at a fast clip now, particularly from SMSFs. He says Independent Reserve already manages accounts for 6,500 such accounts, or about 1% of the industry.
SMSFs are retirement accounts in which individuals or groups act as their own trustees. According to the Australian Superannuation Funds Association, in 2017 there were nearly 600,000 SMSFs with A$656 billion of assets, or about a third of the country’s superannuation pool. “We’re marketing hard on them,” Przelozny said.
Getting KYC and related aspects regulated has required the firm to appoint a big-four consultancy to put in governance processes, and Przelozny hopes it will provide institutional investors with more confidence. In particular, he hopes to use this to convince insurance companies to give the company liability coverage.
“It’s hard for them to insure a digital exchange because they fear what happens if we get hacked,” he said. “We’re working with insurance brokers to find a way...it’s not a nut we’ve been able to crack just yet.”
Independent Reserve, as a centralized exchange, provides custody of its funds, of which 95% are kept in cold storage (not connected to the internet) and the remainder in a ‘hot wallet’ for daily liquidity. Right now it uses three different cold-storage vaults, any of which can only be accessed with two out of three private keys held by the exchange’s directors.
It's hard to insure a digital exchange
The exchange uses a third-party trustee to act as custodian for its fiat money. Independent Reserve trades three fiat currencies (US, Aussie and kiwi dollars) and four digital ones (bitcoin, bitcoin cash, ether and litecoin).
Przelozny, citing a model established by Coinbase in the U.S., says he is in talks with trustees about serving a similar function for crypto assets, perhaps in the form a joint venture.
Over time, as the industry matures and attracts more institutional money, he says underlying business models will come to resemble those in traditional finance. That will lead to consolidation among exchanges, who will need liquidity to survive. By becoming regulated, he hopes to be among the handful of exchanges left in Asia Pacific.