South Korea has increased regulation on its crypto exchanges by requiring them to verify their internal record keeping every five minutes against their asset possession, after a surprise inspection found a lack of controls at the exchanges.
The initiative is among the boldest regulatory measures implemented in the nation in recent times, indicating the seriousness with which the regulatory body views risk management within a market environment that processes vast amounts of money daily.
The instruction came to light after a meeting between the FSC and top officials from leading cryptocurrency exchanges within the country, along with representatives from the Digital Asset Exchange Alliance (DAXA). The organization represents the leading digital asset exchange platforms within the industry.
The discussion was centered on the findings from a fast inspection carried out in response to a highly publicized payout issue earlier this year, raising questions on whether the exchanges had systems in place to detect such issues.
Rule mandates frequent matching of user balances with reserves
The new requirement centers around a crucial concept called reconciliation. It refers to the matching of the balances maintained in the exchange’s database – such as customer balance and ledger entries – against the balances of its actual crypto reserves stored in custodial wallets.
Reconciliation serves the function of making sure that the exchange will always be able to cover customer accounts with sufficient funds. Reconciliation procedures are usually viewed in traditional banking systems as a standard practice aimed at discovering potential problems before they escalate.
The findings of the inspection proved that many exchanges did not reconcile regularly enough to adhere to the current risk management standards. Three out of five top exchanges in the country conducted reconciliation once a day, which was deemed unsatisfactory by regulators.
While it could have been an adequate practice in the past, the current market situation demands more frequent monitoring of crypto balances.
Considering the fact that most of the exchanges operate at lightning speed, spending the whole day on analyzing the error and making sure that everything is alright can result in even more mistakes being made and money being misplaced.
The other reason why regulators wanted to investigate the situation was that there had been concerns that emergency systems responsible for halting the process of trading in case of major irregularities are not reliable.
These systems are supposed to automatically freeze all activities on the exchange platform if something happens until the problem is solved.
However, it turned out that not all of these platforms have the ability to do this reliably. This fact led to many speculations concerning how exchanges would behave in case of a technical malfunction or surge in trading activity.
The decision to investigate the problem resulted from an incident that took place in February in one of the biggest Korean exchanges – Bithumb. As part of a promotion, technical malfunctions caused distribution of too much Bitcoin among customers.
While this program was designed to reward participants with relatively small amounts of money, it went awry.
Bithumb responded promptly once the error was discovered, taking necessary measures to limit the extent of the impact. According to the company, it was able to retrieve 99.7 percent of the funds on that very same day due to the fact that most of the recipients had not withdrawn or sold their coins.
A small amount of funds, representing 0.3 percent—or 1,788 Bitcoin—had already been transferred before the correction began. To stabilize the situation and avert market disruption, Bithumb absorbed the outstanding losses with its own capital.
Although the event didn’t cause significant harm to users, it highlighted the potential risks of insufficient internal controls, providing a valuable lesson for regulatory authorities.
The five-minute rule: why bother?
Even a delay of just a few hours in discovering any error would mean higher risks and loss of confidence in the system.
In forcing the exchanges to reconcile accounts every five minutes, South Korea’s government agencies are practically forcing the platforms to monitor customer account balances and the amount of reserves on a near real-time basis.
The goal is to reduce the time between when a problem starts and when it’s found. This would give the platform more time to respond, which could potentially prevent more serious problems from happening.
This would not only ensure greater transparency but would also make the system more disciplined and help restore user confidence.
This move also fits into the government’s wider plan: to find a middle ground between fostering innovation and safeguarding consumers within the digital assets arena.
The Republic of South Korea has been ranked as having one of the most robust cryptocurrency markets in the world, where millions of retail investors trade cryptocurrencies on a daily basis.
This new five-minute reconciliation rule could potentially influence how regulators in similar areas approach their own challenges.
With the growing interconnectedness of the crypto market with the wider world of finance, regulators have been increasing their focus on operational resilience and risk management. The action taken by South Korea makes it abundantly clear that having internal controls in place is now an absolute must.