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The threat of nested exchanges: what you need to know

The threat of nested exchanges: what you need to know

Last updated 12th Apr 2022
Disclosure

Nested exchanges are a new and regrettable trend in the cryptocurrency space, the latest tool of money launderers worldwide. They provide crypto trading services through a wallet or account on an existing exchange, but typically operate in secret. They are rarely linked to the host exchange, Bitcoin.com wrote.

Minimal KYC and AML

The reason nested exchanges are preferred is because their know-your-customer (KYC) and anti-money laundering (AML) requirements are minimal. Here’s how they work.

Someone goes to a nested exchange and decides to trade ETH for BTC. They made a deposit in ether on the nested exchange. It sends the ether to their account or wallet on the host exchange to complete the exchange. Then, it returns the newly-converted funds to the individual. That’s it.

The minimal requirements render this process quite appealing for people looking to cover the traces of their illegal funds and evade requirements on Coinbase, Binance and other centralized exchanges.

Avoiding nested exchanges

Use a regulated CEX to avoid nested exchanges and the many risks associated with them. Few to no verification checks or trading limits on an exchange are a red flag. Use a blockchain explorer to see if your funds came from a wallet on another exchange if you’re starting to feel your provider is a nested exchange.

Look at the security

People are taking a huge risk by putting the complete trust of their funds in a platform with minimal security. Malicious entities use these services on purpose to avoid the hosts’ AML/KYC procedures. You could be funding terrorist or other criminal activity without knowing it when you use a nested exchange for your daily crypto trading. Law enforcement might take the nested exchange down, blocking or confiscated your funds for an indefinite period of time.  

Binance and nested exchanges

Binance states:

As an industry leader, we have a responsibility to combat bad actors and safeguard the crypto ecosystem. While we do our best to spot and flag nested exchanges on our platform, these accounts don’t always declare their status as a nested exchange. We recommend that our users follow best security practices, trade on KYC and AML-compliant exchanges, and look for nested exchange-red flags.

Binance conducts regular audits of business and personal accounts that look like they are running a business. This includes fund flow analysis and risk scoring. They implemented a security tool called TRM Labs Chain Analyzer, which can identify nested exchanges within macro ones.

Daniela Kirova

Daniela Kirova

Daniela is a writer at Bankless Times, covering the latest news on the cryptocurrency market and blockchain industry. She has over 15 years of experience as a writer, having ghostwritten for several online publications in the financial sector.