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FRM Part II · FRM Exam Part II · Regulating the Crypto Ecosystem: The Case of Unbacked Crypto Assets

A crypto exchange acts simultaneously as broker, market maker, custodian and lender, and trades against its own clients using the same order book information. Which market failure does this structure most directly create?

The main problem is conflicts of interest. When one platform is broker, market maker, custodian and lender, it can favour its own positions or misuse client assets, which traditional finance addresses by separating these functions.

  1. AConflicts of interest from combining functions that are kept separate in traditional financeCorrect
  2. BReduced settlement risk due to vertical integration
  3. CLower operational risk because a single entity controls all processes
  4. DElimination of asymmetric information between exchange and clients

Explanation

Bundling intermediary roles lets the platform front-run, misuse client assets or prioritise its own interests. Traditional markets separate these roles to limit such conflicts. Integration does not remove information asymmetry; it often worsens it.

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