Certain conversations will always drive trends in the crypt scene. One of such is regulation and its impact on the budding crypto exchange market. Although most governments are currently focusing on more pressing issues relating to economic sustenance, the fact remains that the growing appeal of crypto in the global investment landscape will always spur unprecedented scrutiny of the legal stance of crypto entities.
In response to this reality, pro-active crypto exchanges have begun to introduce and implement systems designed to boost compliance and protect users. At the forefront of this narrative is AAX, a next-generation platform focusing on providing crypto exchange services to retail and institutional clients. I recently had an interesting interview session with Michael Wong, COO of AAX, where we discussed the exchange’s innovative take on regulatory compliance and its move to establish a transparent trading platform, among other things. Below is an excerpt from the interview.
From the little I have researched about your stellar background in the financial sector, I discovered that you have played key roles in various fintech projects. However, I will love for you to introduce yourself to our esteemed readers and share with us the reasons why you have invested your time and expertise in the crypto space.
To introduce myself, I’m the COO at AAX; and I joined the company nearly two years ago as one of the VPs of Technology, specializing in the core trading systems behind AAX’s exchange technology. Prior to joining AAX, I led IBM’s Blockchain Business Development based in Hong Kong and before that, worked around the City of London and global financial markets specializing in building stock exchange systems, trading systems and data analytics platforms for the financial markets.
I decided to join AAX because I saw the opportunity to create a new generation of crypto exchange, one that would enable the intersection and mingling of two worlds; the nascent, native crypto industry and the well established existing pools of capital, liquidity and assets in what some describe as the traditional financial markets. AAX represented an opportunity to rethink markets and take the best of the regulated financial markets and apply them into a new emerging digital economy of crypto markets.
AAX is a new breed of crypto exchange equipped with impressive functionalities. Tell us more about the platform and its growing prominence in the crypto exchange market.
We set out to build a world class exchange, for the long run, and we knew this would take a long time to build and perfect. Our approach is to strike a balance between adopting proven technologies, such as our matching engine, and proprietary products, like our unique wallet system that enables users to trade across OTC, spot and derivatives from a single balance. In the past few months, we’ve seen our exchange rise in the rankings, and trade volumes pick up, but we are nowhere near we aim to be, and so we try not to get sidetracked by victories along the way. Our goal is to be the bridge between crypto and global finance, and the type of growth we’re looking at, for ourselves and the industry, has not been seen before.
There are reasons to believe that regulators will continue to introduce new crypto regulations and interpret the existing ones. What are your thoughts on the increased scrutiny of the operations of crypto exchanges?
There are so many unanswered questions still to be addressed in the crypto market. I personally welcome the increased focus and attention from an ecosystem of key players to enable the growth and innovation of crypto markets. From a trading standpoint that includes crypto and traditional asset managers but by virtue of the background of traditional markets participants, inevitably also the need for scrutiny, oversight and infrastructure that protects the assets of the investors that those funds represent. In any emerging market and economy there are those actors who may exploit the fact that the market exists on or beyond the margins of the regulatory frameworks, but the growth of emerging markets such as crypto depends on islands of integrity that can attract investors who have appetite yet also concerns about the validity and fairness of those markets. Therein is where we believe the opportunity lies for the future of crypto assets - access to innovation and markets where the investor is treated in a manner that is fair and trustworthy.
It is our hope that those islands become havens for investors and eventually hubs and key focal points in the global landscape of crypto and digital asset markets.
The over-saturation of the crypto exchange market is one of the reasons why it is difficult to establish standards. Is there a way of ensuring transparency and improving market integrity in this fast-paced sector?
To date, any global, inter jurisdiction standard has yet to be developed. However there seems to be a sort of emerging archetype that spans a number of domains that could be considered as fundamental building blocks. Such approaches could include the adoption of AML and KYC processes from traditional markets that are adapted to crypto assets. Several key vendors including the likes of Elliptic, Chanalysis and others have created tools in this space. Traditional KYC vendors also have tools which can be leveraged in this area; here at AAX for example we use Refinitiv for screening the backgrounds of users.
Other tools which we believe are key are those which scan and screen for market abuse, including Solidus, who have leveraged lessons from global financial markets to innovate for crypto markets.
There’s much yet to be developed in this area, but it represents an opportunity to create a new framework that leverages new technological approaches, legacy free, but still integrating with existing standards. If, as an industry, we get this right, it could set up the next generation of trading infrastructure for economies worldwide - one that satisfies needs for oversight and fairness as well as frameworks that permit a new generation of innovation. As much as the horse and cart gave way to the steam engine and the open outcry gave way to electronic trading venues, perhaps we are seeing a new iteration of technologies and standards that could support the future of global and crypto markets.
Do you believe that trade volume manipulation on the part of crypto exchanges pose a threat to the crypto market at large? If so, how much impact does this practice have on the anticipated influx of institutional investors?
For speculators who may simply want to ride the waves of price discovery, market manipulation or inflated volumes may not be an issue, but if we want our industry to be taken serious and to actually serve the purpose of channeling capital to the best tokens and blockchain projects, and if we do indeed want to see hedge funds and other serious market participants enter the market en masse then we need to get real and work together as an industry to completely rid our markets of unsavory trade practices. It’s a challenge, from a technical point, but also in terms of the culture in the crypto space. There is a reason why financial markets are among the most heavily regulated areas of activity in the world, apart from medical practices perhaps, but the key is to start understanding the crypto space as a component of a larger economy and society, and that the capital flowing in and out of these markets belongs to real people with real aspirations and lives. Integrity is about fairness and professionalism, but also empathy, and it will depend on our ability to understand the wider implications of inflated volumes and other questionable practices, to prioritize our commitment to upholding high standards, rather than chase quick profits and gestural success.
Implementing London Stock Exchange Group Technology’s Millennium Exchange has helped AAX to provide its users with a sophisticated matching engine and optimized price-discovery functionality. What other implementations set AAX apart, especially when it comes to security?
Along with integrity and performance, security is one of our core values, and it has been as such since day one. We’ve actually worked very closely with Kroll, a leading cybersecurity firm that has worked with financial institutions and even intelligence agencies. Security is an ongoing challenge, but we believe we are in a good position to meet that challenge. We have a multi-tiered security system in place, in line with the Cryptocurrency Security Standard (CCSS), with no single point of failure, and upon request (especially for institutional investors who are used to this kind of setup) we’re also able to offer third-party custody with a number of highly respected entities.
Speaking of partnerships, AAX just sealed a deal with Solidus Labs. Can you please elaborate on the purpose of this partnership and what the AAX community stands to gain?
Solidus Lab’s team has extensive experience from the traditional markets. We’ve partnered with them to implement the freemium version of their market surveillance system. This represents one of a program of activities that AAX is undertaking this year to focus on market integrity. Focusing initially on eradicating wash and cross trading, Solidus will help us with strengthening our home grown systems with leading edge technologies. To this end once we complete this program of work, AAX users can expect to see the quality of liquidity improve, as we work with our users to prevent wash trading and cross trading.
This will benefit AAX users because wash trading and cross trading essentially represents what we term as unaddressable liquidity. This is where the volume is presented on the book, but cannot be interacted with - as the instigators of wash trading essentially employ techniques to make it difficult, if not impossible, for other users to match against their orders. This practice is widespread in the crypto market - and one which we are constantly working to address and improve on here at AAX. Our partnership with Solidus represents an essential step on this journey. I believe that there is value in all crypto exchanges including AAX to take this seriously - even if it means reporting smaller volumes. The benefit is such that the remaining liquidity is addressable, more trustworthy and eventually also higher quality than before; a tangible benefit to users of exchanges that prioritize and invest in improving market integrity.
Information about AAX’s new market surveillance system details how it will factor in behavioral and historical patterns to identify illegal activities. Do you care to expand on this? (The answer is from Chen Arad, COO, Solidus Labs)
Traditionally surveillance systems were rule-based. Solidus Labs' solution utilizes a rule-based foundation, augmented by a layer of statistical analysis (or as it is often called - machine learning), that constantly looks for trading anomalies based on numerous factors like unusual trading activity or account behavior. For example, this allows us to identify not only if a trade by a specific account is unusual, but also how it compares to the same account's historical behavior, and how it compares to peer accounts, in order to assess associated risk holistically. This provides exchanges the most comprehensive ability to evaluate risk and when needed take action based on smart risk scores. In the big picture, statistical analysis allows not only detecting common forms of manipulation in near real-time, but also flagging new ways in which these behaviors manifest in the structurally different crypto markets, as well as identify new forms of crypto-specific manipulation.
According to a report, only five exchanges have deployed external surveillance systems. With this partnership, AAX has embarked on the same path. What are the advantages of incorporating an externally sourced surveillance infrastructure?
Now that we’re seeing some consolidation take place in the space and noticing the contours of a more sophisticated market infrastructure emerge, I think a big theme that will keep coming up over the coming months is the concept of ‘independence’. Outsourcing surveillance and other methods of oversight and risk assessment is vital to impartiality, transparency and quality.
We need to protect diversity in the crypto space - diversity of exchange, assets, service providers, market data aggregators, etc. - and while collaboration across these various participants is vital, so is their independence.
This will allow them to work with multiple partners and come to a set of best practices, rather than relying on a single experience and viewpoint alone, and simply from an integrity point of view, it’s better to spread power and responsibility.
Is there a potential backdrop of the implemented market surveillance system as regards users’ privacy? How will AAX ensure that its compliance tool does not infringe on users’ right to privacy?
The data that is subject to analysis by Solidus is anonymized - we’re interested in the entire environment and the overall dynamic rather than a single user. However, if indeed there is a case of clear misconduct, as an exchange, we are fully mandated to alert, reprimand or even ban such a trader - depending on the severity of the issue at play. In some cases, it may be a matter of educating the markets and together coming to an understanding of why everyone stands to benefit from market integrity. As we’ve indicated in some of our other communications, we take client data just as serious as their assets. In fact, if someone is robbed of their Bitcoin, they can potentially be reimbursed, or the funds can be retrieved. But once your personal data is out in the open, there is no way to recover that loss.
From what we have learned so far, AAX is serious about enabling a compliant and transparent trading platform. What other innovative solution should we be expecting before the end of this year?
We believe that there’s major potential growth in new markets created by crypto and digital asset derivatives. However, we also recognize that some fundamental components to the market, including tools to help manage market manipulation are missing from many derivatives exchanges. Here at AAX we’re working to improve this situation and ready the AAX markets to be fairer than where the market is today. On top of this foundation we hope to innovate and bring in new types of crypto derivatives, allowing the market to better manage risk and understand the correlations of core blockchain dynamics to the price and volatility of the assets they represent. We’re already seeing some of these products emerge into the market including FTX hashrate contracts and we have our own roadmap that include new products and innovations in this space.