Photo by janilson furtado on UnsplashA closer look at rehypothecation, proprietary trading, and the growing risks emerging across crypto and digital asset markets.
There is a certain irony embedded in the history of cryptocurrency.
Bitcoin emerged in the aftermath of the 2008 financial crisis – a moment when the world had just watched excessive leverage, hidden risks, and overreliance on financial institutions nearly bring down the global economy.
The pitch was simple and compelling:
what if we built a financial system that didn’t depend on trusting intermediaries at all? One where code, not institutions, kept things honest?
That vision still animates a lot of what happens in crypto but something else is happening too.
The further the digital asset industry has traveled from its origins, the more it has begun to resemble the system it set out to replace.
The Infrastructure Looks Familiar
In the early days, crypto was genuinely outside the financial mainstream. Today, it has its own exchanges, custodians, lending platforms, stablecoin issuers, and a whole ecosystem of intermediaries collectively known as Virtual Asset Service Providers, or VASPs.
These entities do things that would feel recognizable to anyone who works in traditional finance. They hold assets on behalf of customers. They provide liquidity. They manage reserves. They extend credit-like services.
That evolution has brought real benefits – broader access, institutional participation, deeper markets but it has also brought something else: the same categories of risk that regulators have spent decades trying to manage in conventional financial markets.
Two of those risks are now getting serious attention: rehypothecation and proprietary trading
What Is Rehypothecation, and Why Does It Matter?
Rehypothecation sounds technical, but the basic idea is straightforward. When you pledge an asset as collateral – say, to take out a loan – the institution holding that collateral may turn around and use it for their own purposes.
They might lend it out, pledge it somewhere else, or use it to support their own borrowing.
In traditional finance, this practice has existed for a long time. In controlled circumstances, it can make markets more efficient. The problem appears when the same collateral gets reused across multiple interconnected institutions. The chain becomes fragile. When something breaks at one link, the damage doesn’t stay contained.
That is essentially what happened in 2008. Collateral chains stretched across the financial system in ways that very few people fully understood, and when stress arrived, the interconnectedness amplified the damage rather than absorbing it.
In crypto markets, the same dynamic is emerging in a new form.
When you deposit digital assets on an exchange or lending platform, a reasonable set of questions follows.
Are those assets sitting in custody, untouched? Are they being lent to third parties? Are they being staked? Are they being pledged somewhere else entirely?
In many cases, users simply don’t know and in several high-profile collapses in the digital asset sector over recent years, that uncertainty turned out to matter enormously – particularly when insolvency proceedings began and customers discovered their assets weren’t quite where they thought they were.
Let me be clear, rehypothecation isn’t automatically illegal or even improper. The regulatory concern isn’t the practice itself. It’s whether customers are told what’s happening, whether they’ve genuinely consented, and whether they understand the risks they’re actually taking on.
The Proprietary Trading Problem
The second issue is proprietary trading – when a platform trades digital assets for its own account rather than on behalf of its customers.
This isn’t unique to crypto. Banks and brokers have done it for years, which is partly why regulators in traditional finance developed specific rules around it (the Volcker Rule in the United States being the most prominent example).
The concern in crypto follows the same logic.
A platform that both operates a marketplace and participates in that marketplace as a trader sits in a structurally unusual position. It may have access to information that ordinary market participants don’t – customer order flow, pending transactions, liquidity conditions across the platform.
Even if nothing improper is occurring, that informational advantage creates a perception problem. Markets function on confidence. If participants believe the house has an edge that they can’t see or counter, trust erodes.
There’s also a more direct financial risk. If proprietary trading positions grow large enough and go wrong, the losses don’t stay neatly separated from the firm’s obligations to its customers. The line between “our money” and “customer money” can become dangerously thin.
The Transparency Problem Behind Modern Crypto Markets
Rehypothecation and proprietary trading look like separate problems but they’re really expressions of the same underlying issue.
In both cases, customers have less information than the institutions holding their assets. Whether through collateral reuse, lending arrangements, staking programs, treasury management, or trading activity, users are frequently operating with an incomplete picture of how their assets are being put to work.
That information gap is precisely what regulators are increasingly focused on closing.
How Regulators Are Responding
The regulatory response is still developing, but the direction is increasingly clear.
In the European Union, the Markets in Crypto-Assets Regulation – MiCA – imposes obligations on crypto-asset service providers specifically designed to address conflicts of interest and improve market integrity. Platforms operating trading venues face restrictions intended to reduce the risks that come with proprietary dealing.
In The Bahamas, the Digital Assets and Registered Exchanges Act emphasizes client-asset segregation, governance standards, and disclosure obligations. Similar frameworks are taking shape across other jurisdictions.
The collapses of several prominent crypto firms have accelerated all of this. Those events reinforced a view that’s now fairly widespread among regulators: the risks in crypto often don’t come from the blockchain itself. They come from the institutions built around it – and from what those institutions do when no one is watching closely enough.
What This Means If You’re Building in Web3
The space of regulatory ambiguity that many crypto firms operated in for years is shrinking. That’s not necessarily a bad thing, but it does require a genuine shift in how businesses think about their obligations.
Regulators increasingly expect clear answers to basic questions.
How are customer assets held? Are they being used for anything beyond custody? What conflicts of interest exist, and how are they managed? What does the customer actually know?
Transparency, in this environment, isn’t just a compliance checkbox. It’s becoming a genuine competitive advantage. Firms that communicate clearly about how customer assets are handled are building something that will matter more as the industry matures: trust.
The Irony at the Core of All This
Perhaps the most striking thing about this moment in crypto’s development is the shape of the problem itself.
A technology designed to eliminate the need for trusted intermediaries is now producing its own class of intermediaries – and confronting the same governance failures that motivated its creation in the first place.
That doesn’t mean the experiment has failed.
It means it has arrived at the hard part: the part where the human institutions built around the technology have to be held to the same standards as any other institution handling other people’s money.
Regulators are essentially asking the same questions they once asked of banks and brokers.
Who controls the customer’s assets? How are those assets being used? And does the customer actually know?
Those questions were inconvenient in traditional finance. They’re proving just as inconvenient here.
This piece is intended for informational purposes only and does not constitute legal, financial, or regulatory advice. Regulatory frameworks vary across jurisdictions and continue to evolve.
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Is Crypto Repeating the Mistakes of Traditional Finance? was originally published in Coinmonks on Medium, where people are continuing the conversation by highlighting and responding to this story.