The BitMex Scandal Proves Even Bitcoin-Only Exchanges Are Vulnerable

After the charges were filed, the exchange continued to operate as usual, which indicated to some in the crypto community that it was immune from regulatory pressure due to its Bitcoin-only status. But the truth was starkly different – the exchange was only able to stay in the game because the charges were yet to be proven in court.

Does this mean crypto services that only deal with Bitcoin are untouchable by regulators and governments? The answer, quite simply, is no.

This piece debunks the notion that Bitcoin-only crypto services are resistant to censorship and compliance rules. BitMex, a high-profile, Bitcoin-only exchange caught in troubled legal waters, will be our case study.

What’s a Bitcoin-only Exchange?

This is an exchange that only handles Bitcoin. Everything – from fees to buying, selling, losing, and gaining is all done in Bitcoin. BitMex is one such platform.

The Seychelles-incorporated exchange, which doubles up as a derivatives trading platform, was founded in 2014 by Arthur Hayes. The exchange lists altcoins, too, with their value expressed in Bitcoin. BitMex’s product basket includes but is not limited to futures and contracts.

BitMex’s Scandal

October 2020, the US Department of Justice and the Commodity Futures Trading Commission (CFTC) filed charges against BitMex and its top executives for alleged violations of a raft of CFTC rules and a lax attitude on anti-money laundering regulations.

Those indicted in the filing include founder and CEO Arthur Hayes, as well as co-founders Ben Delo and Samuel Reed. Other indictees are entities affiliated with the exchange, including HDR Global Trading, 100x, and Shine Effort Inc.

The CFTC accused the platform of having received billions of dollars in BTC deposits and over $1 billion in fees while engaging with US customers despite not complying with the most basic regulatory requirements to do so in the US. Other grievances by the CFTC included:

• Failure by BitMex to enforce KYC regulations
• Failure to implement a customer information program
• Providing a haven for money laundering and sanctions violations
• Operating an unregistered platform

These woes were compounded on the same day when the Department of Justice slapped Hayes, Delo, Reed, and Head of Business Development Gregory Dwyer each with a criminal charge of “violating the Bank Secrecy Act and conspiring to violate the Bank Secrecy Act”. The Bank Secrecy Act is a US law requiring financial institutions to assist the government in cracking down on money laundering.

The potential punishment for the charges is up to a maximum of 5 years in federal prison. The DOJ claimed that Hayes even bragged about BitMex being incorporated in Seychelles – where, according to him, it takes just a “coconut” to bribe regulators. However, this time, said the DoJ, the exchange wouldn’t pay for their alleged crimes with “tropical fruit”, but they could be facing “fines, restitution, and federal prison time.”

Suppose the charges by the CFTC are proven true, the agency wants BitMex to:

• Surrender all “ill-gotten” gains
• Provide restitution to customers
• Pay civil financial penalties
• Retract from all user engagements if those engagements violate the law
• Permanent registration and trading bans for the exchange

The Fallout and BitMex’s Next Move

Despite BitMex moving quickly to assure customers of business “as usual” operations, the fallout from the indictments was swift. Bitcoin’s price tumbled by 4.11% from $10,883 to $10,437 immediately after the news.

Users moved their BTC out in droves in fear of the platform going into insolvency. A week later, BitMex announced that Hayes, Reed, Delo, and Dwyer would be stepping down from their executive roles. The exchange also scrambled to appease regulators, hiring a Chief Compliance Officer to help enhance its “compliance function.” In January, the company announced a deeper collaboration with Chainalysis – one aimed at intensifying its efforts to “identify, investigate, and stop illicit transactions.”

Why A Bitcoin-Only Exchange Would Seem Invulnerable

While BitMex is only one in a long line of exchanges targeted by regulators, some sections of the cryptosphere expected it to shake off any attempts at a clampdown. But the reality was always that the authorities can still force the exchange’s hand or come down hard on it if necessary.

If a Bitcoin-only exchange could resist government censorship, that would be a dream come true for cypherpunks and Bitcoin believers. After all, Bitcoin’s biggest selling point is its decentralization which is powered by all Bitcoin users around the world. The result is that it would be infeasible for any government, or even coordinating governments, to shut down Bitcoin.

It’s just darn near impossible to track down every single user across the globe. Even if governments wanted to target miners to keep track of transactions, that move still would be dead on arrival since miners are not dealing with any specific customers but rather just running the Bitcoin protocol.

However, for an exchange using Bitcoin only, it’s not that simple. The thing is, it doesn’t matter what currency an exchange deals with. The bottom line is that its platform is not distributed like that of the Bitcoin network.

All authorities need to do is “seize domain names and hosting servers, shutting down front ends and arresting developers”, as noted by data analyst Adam Cochran on Twitter. Cochran adds that if an exchange were to be the target of such actions, most users would just voluntarily jump ship, – “essentially killing the protocol”.

Other maneuvers by authorities would probably include:

• Blocking access to the exchange
• Coercing app distributors like Apple and Google Play to drop mobile apps
• Targeting clearing services, and so on

Such actions would effectively render the exchange toothless.

Final Thoughts

The decentralization genius of Bitcoin has made it an unstoppable train. For services offering Bitcoin, it’s not quite as easy as merely replicating that formula.

In the cryptocurrency regulatory environment, it turns out crypto services have to play by the book, or risk getting caught up in legal crosshairs and possibly getting erased from the map.