FRM Part II · FRM Exam Part II · Regulating the Crypto Ecosystem: The Case of Unbacked Crypto Assets
A risk officer at an asset manager observes that a crypto exchange acts as broker, market maker, custodian and trading venue for its clients, and also lists its own token. Which market failure is MOST directly raised by this combination of functions?
The main concern is conflicts of interest. When one platform acts as broker, market maker, custodian and venue and lists its own token, it combines functions that traditional finance separates, creating scope for front-running, misuse of client assets and opaque pricing to the detriment of clients.
- AConflicts of interest arising from the concentration of functions that are normally separated in traditional financeCorrect
- BReduction of counterparty risk through netting of client positions
- CElimination of information asymmetry between the exchange and clients
- DLower operational risk because a single entity controls the whole chain
Explanation
Combining intermediary functions that traditional regulation separates, such as trading, custody and market making, creates conflicts of interest, for example front-running or misusing client assets. It does not remove information asymmetry, and it concentrates rather than reduces operational and counterparty risk.
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