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Centralized Exchange

CEX is usually a dealer broker with custodial services that takes fiat currency for swapping into non fiat currencies and smart contracts. It maybe regulated in the jurisdictions it operates and will follow best practices re KYC and AML.

One of the main risks of a CEX is conflict of interest. Unlike most TradFi exchanges, a CEX may participate on the buy and sell sides, as well as controlling the assets through its own wallets.

Market risk (2)
Does the CEX have a CoinMarketCap rating > 7
2.45 Third party verification of CEX helps validate internal due diligence.
"Top Cryptocurrency Spot Exchanges" CoinMarketCap, Dec 2021. https://coinmarketcap.com/rankings/exchanges
Does the CEX have a disclosed market integrity policy?
2.68 Best execution prices and policies to monitor and control potential market abuse ensures a level playing field for all participants
Market Practice policies and procedures
Governance risk (3)
Is the CEX regulated?
3.47 A regulated (by a government agency or independent community actor nn) are deemed lower risk.
"Prudential treatment of cryptoasset exposures" BIS, Sep 2021. https://www.bis.org/bcbs/publ/d519.pdf
Is the CEX actively improving its disclosure policies?
3.87 Many CEXs are becoming more institutional. Consequently they should have disclosure policies and transparent communications.
Does the actor disclose all of the following...
Does the CEX have ISO 27001 certification?
3.113 Certain ISO standards provide comfort that the CEX has adequate systems and controls regarding information security
"27001 Information Security" iso.org, Ongoing. https://www.iso.org/isoiec-27001-information-security.html
Has the CEX disclosed any SOC audits or other controls and procedures audits by independent auditors?
3.126 Audits of policies, controls and procedures by independent audit actors can provide comfort of good governance
Does the CEX have ISO 27701 accreditation (privacy policy)?
3.129 As more countries and jurisdictions implement privacy laws and regulations, reliance on ISO 27701 can provide comfort that your data is safe and secure
Does the CEX publish a regular Proof of Reserves?
3.141 Co mingling of customer assets is prohibited unless there is consent. Independently verified statements of customer assets and firm assets are required to demonstrate capital and liquidity robustness
Does the CEX have a visible and accountable board of directors?
3.142 Governance and Accountability are key controls of operating a business
Public Conduct risk (4)
How transparent are the communications?
4.92 Although transparency does not imply less risk, it can help determine risk factors.
Community resources include ...
Operations risk (5)
Does the CEX state who its fiat bankers are?
5.46 Confirmation of regulated bankers provides assurance of validity of the enterprise
Does the CEX have a published OpSec policy?
5.140 Operational Security policy reduces the risk of operational failure and loss
Liquidity risk (7)
Does the CEX state what its leverage is?
7.48 Knowing the leverage. risk of the exchange can help determine exposure tolerance
Reputation risk (16)
Does the CEX provide a privacy policy applicable in your jurisdiction?
16.95 Privacy laws can be different in different jurisdictions and transfer across borders must be assessed. Many policies are generic and cover all scenarios but this is not good practice as often covers the CEX for data breaches at the expense of the customer actor.
Accounting risk (17)
Are fees fully disclosed and understandable?
17.91 Fee cards can be extremely complicated and change frequently.
Experience risk (18)
Does the senior management team have the experience, or have other advisors with experience, to operate the CEX?
18.143 Financial services must have people involved who have experience in this sector
Legal risk (19)
Are the "legals" on the CEX website timestamped with a start date and end date?
19.90 T&Cs can be altered on the website easily and it is important the T&Cs contracted are accessible by all actors. It is likely there will be amendments and these should be accessible via archive. Ideally there should be an api.
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No financial advice

These global standards, best practice guidance and risk due diligence questions are an attempt to make DeFi a level playing field. They are not intended to provide any investment advice. Claims made in this website do not constitute investment advice and should not be taken as such. In the meantime, it would be very useful if the jurisdictional regulators would start working together and treating these new financial related projects as a different form of instrument. The Howey Test (1946) was designed in an era of deeds of title and paper bearer certificates. DeFi can be humanless and profit is not always the motive for using protocols. TradFi Derivatives for example are based on underlyings of real assets like the fair value of incorporated companies whose value is derived from fiat currencies which are themselves derivatives on an underlying like gold or a printing machine. Fiat is seen to be a real asset which it clearly is not. The new DeFi world matches actors with agendas. Most of the time the agenda is to do things better and faster. Defi enables everyone including the bankless and unserved members of the community to transact without having to understand how to use Excel or have an MBA from an elite university or be able to able to decipher the millions of pages of legal text opinions as to whether a bitcoin is a currency, a security, a commodity, a derivative, an underlying, a valueless number, type of gambling or something that will just go away. While we wait for a consensus by the old guard, the new guard will create their own computer based standards. Our aim is to turn these standards into bots or smart contracts that do all of this behind the scenes. Image a world where the community agree on how to transact and just do it without a parental overseer who is always a bit behind the curve...

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