Digitex exchange flouts regulations in hopes it won’t be noticed

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The Digitex exchange and its founder have taken a public stand against know-your-customer (KYC) regulations for digital asset trading platforms. Digitex’s show of defiance against international financial laws may be bold, but the conditions that allowed many platforms to fly under the radar in years past may not last for long.

CEO Adam Todd, who noted he’s a U.S. citizen, announced the decision to remove KYC requirements for Digitex customers in a blog post and livestreamed AMA this week. Calling the regulations “a major friction point” and “a crock of shit”, he said they only served to turn away potential sign-ups and exposed legitimate traders to unnecessary risk from data leaks.

The decision, he said, came after a third-party KYC services provider Digitex used had suffered a data breach, leaking customers’ private identification information.

“It’s a horrible, horrible experience. KYC is going to destroy our business if we go with that,” Todd said in his AMA.

He listed a number of steps Digitex has taken to (hopefully) avoid regulatory attention. His platform prohibits U.S. citizens from signing up—both by blocking U.S. IP addresses and requiring sign-ups to check a box stating they are not U.S. citizens. Additionally, Digitex does not handle fiat currencies or trade them on the exchange.

Some customers watching the live AMA on YouTube expressed support and appeared more interested in when they could buy digitex (DGTX) tokens. Others expressed concern about the legality of the move, but their comments were swiftly removed by chat moderators.

It appears Digitex’s strategy is to avoid trouble by hoping U.S. regulators are more interested in pursuing companies that affect U.S. customers. Of course, the U.S. remains the largest market for digital asset businesses, and use of VPN services to appear to be in another country is fairly mainstream in 2020. Checking a declaration box shifts some of the responsibility to the customer, but regulators also see that as a token, “nudge-wink” tactic. Large numbers of U.S. and Chinese investors have been able to participate in ICOs despite being explicitly prohibited from doing so—and both token sellers and exchange platforms know this.

Todd seemed more concerned about regulators moving to shut down his service than of prosecution, at least in public. “Are they going to aggressively come after our server providers?” he asked, adding, “I’m hoping the U.S. won’t try to physically interfere” if Digitex isn’t marketing to US customers. Given past incidents where U.S. regulators have shut down foreign servers, seized funds and arrested suspected operators, those concerns should be a red flag.

“I’m not trying to be reckless […] Let’s just deal with what consequences come,” he said.

International KYC regulations getting stricter as digital currency knowledge increases

Avoiding scrutiny by not handling fiat and (theoretically) blocking U.S. customers may succeed to some extent, at least temporarily. Law enforcement resources are not infinite and they’re more likely to zero in on instances of actual crime or harm. The main problems here are that (a) digital asset exchanges have been prone to security breaches in the past, and (b) without KYC, it’s impossible to know who’s using the platform or for what purpose. Crossing your fingers and hoping nothing bad happens is a risky strategy.

U.S. regulators definitely have the greatest extra-jurisdictional reach of any. However, as finance becomes ever more digital and location-agnostic, they and others regard anywhere in the world as their jurisdiction. Their knowledge of cryptocurrencies and their role (potential or actual) in financial crimes is also increasing, putting extra scrutiny on digital asset exchanges and their operators.

As a result, regulators in the U.K., E.U. and Australia have been toughening KYC/AML requirements for all financial institutions in recent times, from banks down.

The international Financial Action Task Force (FATF) on money laundering has also stated that exchanges trading only digital assets (and not fiat) are also subject to KYC requirements.

What is Digitex?

Digitex is a zero fee or commission futures exchange using the ERC-20 “utility token” DGTX as its base currency. Traders must acquire DGTX to use the exchange and all accounts are settled in DGTX. The company’s ICO in January 2018 raised over U.S.$5 million. Two more sales will follow: the Digitex Treasury Token sale from April 2020 to end of 2021, and the Digitex Token Issuance starting 2022.

Digitex trades (among other assets) BTC and precious metals futures, and is designed to be cheap and fast for its users. The Treasury buys DGTX on the open market via smart contracts to maintain its available supply.

Traders can buy DGTX tokens directly from the “Digitex Treasury” or acquire them on the open market at a number of exchanges, and hold them in any ERC-20 compatible wallet. Those exchanges may or may not have KYC requirements of their own—Changelly implements KYC/AML only if it flags suspicious activity.

KYC requirements have issues, but they’re reality

Todd himself is a former trader from the U.K. with a tough and straight-talking trading pit image. He has a clear dislike for the burden and risk of KYC regulations. Disliking rules that stand in the way of smooth business and profits may be admirable to many capitalists, but disregarding them rarely works as a legal defense.

While the decision to remove KYC altogether is risky, Todd does have a point—third-party data storage providers have been notoriously insecure with valuable customer data in years past, causing customers to suffer. It’s not just small companies either. 2017 saw the theft of up to 143 million customer ID files from major credit monitoring firm Equifax, exposing up to half of America’s population to the threat of identity theft.

The problem is, no matter how many data thefts occur from “reputable” or other providers, it’s unlikely to cause regulators to sympathize with businesses who respond by doing away with KYC altogether. An independently-run digital asset business presents a much easier target for prosecution than a large corporation that “made some mistakes”. Customers trading unregistered on cryptocurrency platforms also face a very real risk of having their assets seized, as happened to traders on the popular BTC-e exchange in 2017.

KYC, anti-money laundering (AML) and counter financing of terrorism (CFT/CTF) regulations exist for a good reason, and regulations have only become stricter in the past decade. Cryptocurrencies, whether they’re the most popular option for criminals or not, do present an attractive opportunity to move large amounts of money around the world near-instantly. Exchanges trading multiple assets also provide an extra chance to obscure financial tracks as users shuffle value between multiple wallets and cryptocurrencies before taking them elsewhere to convert to cash.

It may be true that organized crime still prefers cash in suitcases and other tried-and-tested methods for its finances. However, that argument rings hollow when it’s made by cryptocurrency supporters who talk of a future where the world uses Bitcoin or some other token as its main currency of choice. If and when that future emerges, cryptocurrency would also replace USD or EUR as the criminal’s financial vehicle of choice.