The cryptocurrency exchange Bittrex is protesting New York's decision this week to deny it a virtual license exchange, claiming that its rationale contains factual errors and its personnel were not well versed in blockchain.
While the New York State Department of Financial Services is notoriously tough on newcomers who want banking-related licenses, Bittrex, a well-established company with 1.67 million global users, operates in 40 U.S. states. It applied for a license four years ago and has been operating in New York under a safe harbor since that time. Moreover, its chief compliance and ethics officer, John Roth, is a former regulator who spent 25 years at the Justice Department, eight of them as special counsel for international money laundering policy.
Bittrex's executives argue the decision is flawed and dispute how the state regulator is characterizing it.
“This was a bolt from the blue,” Roth said in an interview. He said the firm found out about the decision, which included a cease-and-desist to do business in New York, only 15 minutes before it was publicly announced. He said the regulator never contacted the firm to sort out concerns it had.
“If you do a review and you find something, you allow the entity you reviewed to take a look at it and comment on it,” Roth said. “You do that as a matter of fundamental fairness and due process, but as importantly, you want to make sure you get your facts right.”
The New York agency declined to comment for this article, but the case is one of the first for the new acting superintendent, Linda Lacewell.
The case against Bittrex
Among other things, the New York regulator claimed that Bittrex lacked a "strong framework of controls" for monitoring and reporting suspicious activities and complying with Office of Foreign Assets Control requirements. It also claimed that examiners had found a large number of transactions for customers in sanctioned countries, including Iran and North Korea, that had passed through screening and been processed.
Additionally, the DFS said some Bittrex users were using obviously fake names like "Donald Duck" and "abcd."
But Roth and Bill Shihara, Bittrex's founder, deny such claims. For one, they argue that the fake accounts cited by the regulator were not active ones. Instead, those were created by people curious about the platform who started an application and never completed it. Those accounts were never verified, a process that includes complying with know-your-customer regulations such as providing a government-issued ID, and had no ability to engage in any transaction on the platform.
“We explained that to them, but that’s not in the letter,” Roth said.
As for its monitoring system, Roth said the company has a suspicious transaction monitoring process that’s partially automated and partially manual. It had been taking steps to fully automate it.
“We’re going to a fully automated system that DFS knew about this quarter,” he said.
According to Roth, Bittrex also has never conducted transactions for users in North Korea. “I don’t know where they got that from, but it’s absolutely not true,” Roth said.
The company did find out in October 2017 that some Iranians had been able to establish accounts and trade on Bittrex.
“When we discovered it, we immediately turned off those customers, disabled them from trading, and reported that to OFAC,” Roth said. “OFAC knows about it and is considering the matter.”
Hands-off approach
In its denial of Bittrex’s application, the regulator also describes a process of working with Bittrex to address continued deficiencies and assisting Bittrex to develop appropriate controls and compliance programs.
But Bittrex’s leaders say this never happened.
“We’ve been in New York a really long time and we were one of the first applicants for the BitLicense,” Shihara said. “Our application sat on their desk for years.”
Roth said the regulators didn’t work with or help Bittrex, but only sent requests for documents.
“There was a lot of back and forth where they thought they were missing documents that we had actually already sent them,” he said. “There were fingerprint cards that we had delivered to them that they had lost and we had to re-fingerprint.”
Though Bittrex kept the New York regulators up to date on what they were doing, it received no feedback or guidance, Roth said.
In January, the DFS sent Bittrex a supervisory agreement, which among other things would limit the number of cryptocurrencies the company could offer to ten and require Bittrex to ask permission before it could create additional corporate entities.
Bittrex’s principals saw the agreement as a contradiction of their business model and said it would have restricted their ability to grow. The company tried to negotiate the agreement, Roth said, but it was given a 10-day deadline to accept or decline it.
Bittrex declined the agreement and heard nothing until a few weeks later, when the DFS contacted the company on a Wednesday and said it was going to send a team of examiners to the company’s offices in Seattle and Washington, D.C., the following Monday.
“Typically the way an exam would work is you’d have months to prepare, gather documents and do the kinds of things you need to do to respond appropriately to a legitimate inquiry by a financial regulator,” Roth said. “We had two and a half working days to get everything ready. Then the folks they sent had no blockchain experience whatsoever, I think they were used to large banks and different kinds of systems and controls that would be put into place.”
For instance, Bittrex uses a popular transaction monitoring software program from Chainalysis that’s commonly used by cryptocurrency exchanges and by
The DFS examiners didn’t know what Chainalysis was, Roth claimed.
“We tried to brief them on it, we have people who are insanely skilled at this stuff, they’re ninjas at being able to look through these transactions,” he said. “We offered to demonstrate it and show how it works. They weren’t interested. That’s in stark contrast to other regulators.”
The DFS also accused Bittrex of failing to prove that it meets its own guidelines for launching tokens. Roth said the agency cited the company for not having applications from every one of the tokens it lists on its exchange. This is because some of those tokens are decentralized, he said.
“No one owns Dogecoin, nobody owns bitcoin, there’s nobody to speak for them to file an application,” he said. “There was no guidance from anyone in the government in 2014 when a lot of these coins got listed. This is part of a fundamental misunderstanding of how blockchain works.”
The regulators also said Bittrex didn’t meet their capital requirements.
Roth said that unlike other states, New York has a capital ratio formula that is based on the percentage of tokens in hot wallets and cold wallets that doesn’t take into account the risks of moving virtual currencies from one form of storage to the other. He said the founders of Bittrex developed secure payment platforms used by Amazon, BlackBerry and Microsoft.
“If they had spent more time with us to understand our processes, they would see that we were more than willing to help mitigate these risks,” Shihara said. “But there was no intellectual curiosity to understand what we’re doing or understand blockchain at all.”
Bittrex will suspend trading in New York on Thursday.
“We don’t have a choice in the matter,” Roth said. “We’ll comply with what New York wants.”
