The Risks (and Benefits) of Using an Offshore Crypto Exchange

Many crypto investors use unregulated exchanges to avoid onerous U.S. regulations. But are they safe? Here are risks and benefits to consider.

By
&
Tom Blackstone
Gabe TurnerChief Editor
Last Updated on Apr 14, 2022
By Tom Blackstone & Gabe Turner on Apr 14, 2022
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Many American investors have started using offshore, unregulated exchanges to buy crypto. These exchanges can offer greater privacy, less hassle, and greater coin selection than their U.S.-based competitors.

But are they safe? And what risks are you taking if you use an unlicensed exchange? Most importantly, do the benefits outweigh the risks?

In this article, I’ll attempt to answer these questions and more. I’ll go over the benefits and risks of using an offshore, unlicensed exchange as a U.S. resident.

Let’s begin with a basic definition.

What Is an Offshore Crypto Exchange?

As the name implies, an offshore crypto exchange is one not located in the U.S. If an exchange is located in the U.S., it has to be licensed as a money services business, similar to Western Union or MoneyGram. But an exchange that is headquartered in another country doesn’t need to have this license.

Depending on the country it is located in, an offshore exchange may also not need to comply with know your customer and anti-money laundering (KYC/AML) provisions, which means that it can potentially sell crypto to people without verifying their identities.

Another way of referring to an offshore exchange is to say that it’s “unlicensed” or “unregulated” in the U.S.

Pro Tip: Want to know more about licensing? Check out our guide to crypto regulations in the U.S., and be sure to look up the crypto laws in your state.

Now let’s talk about the benefits to using an offshore exchange.

Benefits of an Offshore Exchange

Avoiding U.S. regulations brings plenty of benefits to investors. Here are a few of them:

  • Greater coin selection: Most unregulated exchanges have greater coin selection than regulated ones. For example, Binance.US has fewer than 90 different coins available, but its offshore counterpart, Binance.com, has over 500 different coins available.
  • Less hassle: Unless you’re doing $100,000 or more per day in crypto withdrawals, many offshore exchanges won’t require you to upload a photo ID to prove your identity. This means that you won’t need to deal with the hassle of uploading your photo and (possibly) getting told multiple times that it is too blurry. Also, this means more anonymity.
  • Greater privacy: No KYC means that you won’t need to worry about your identifying info getting stolen in a hack and ending up on the dark web.
  • Access to futures and options: Some offshore exchanges offer products that are very limited or simply not available in the U.S., like crypto futures and options. If you’re interested in these high-risk/high-reward products, using an offshore exchange may be your only option.

These are the benefits of using an unregulated, offshore exchange, but there are also some serious risks to using these exchanges.

Risks of Using an Offshore Exchange

After reading the list of benefits in the previous section, you might be tempted to sign up for an unregulated exchange right away. But before you do that, here are some risks to consider.

Location blocking

If an offshore exchange knowingly sells crypto to a U.S. resident, it may be fined by the Financial Crimes Enforcement Network (FinCEN). To avoid this threat, it may take steps to block U.S. residents from using its app.

Did You Know: Congress never passed a law specifically requiring crypto exchanges to verify identification. But FinCEN claims that crypto exchanges must do this to comply with the Bank Secrecy Act.1

The easiest way for it to block U.S. users is to ban U.S. IP addresses. So there is always a risk that the exchange will stop working if you try to access it from within the U.S.

Some people choose to use a VPN to get around these location restrictions.

Paused withdrawals

Even if you use a VPN to hide your location, your withdrawals might still end up getting blocked temporarily if your transaction gets flagged as “suspicious.”

If an exchange is unlicensed, this doesn’t mean that it can completely do away with KYC. It still has to take steps to make sure that it is not being used for money laundering.

Most unlicensed exchanges use algorithms to try to detect money laundering transactions. But unfortunately, these algorithms sometimes ensnare innocent users along with the guilty ones. So even if you didn’t sell nuclear weapons to a rogue country, hack an exchange, or take part in some other nefarious activity, your transaction may get flagged anyway.

If you’re unlucky enough for this to happen to you, your withdrawals may be blocked until you can prove your identity and show that your crypto deposit is from a legitimate source.

This problem can usually be fixed in a few days by contacting customer service and sending them your driver’s license. But in the meantime, you may be under a lot of stress while your crypto is stuck in the exchange.

To get your deposit, you’ll also need to come clean and admit that you live in the U.S. and are violating the exchange’s terms of service. This can be an uncomfortable conversation to have, and once your deposit is returned, your account is likely to be deleted.

But in this case, at least you’ll get your deposit back.

FYI: Want to take a deeper dive into how to protect your crypto? Read our complete guide to investing in crypto safely.

Lost deposit

In rare cases, you may not get your deposit back at all. This can happen if you can’t prove your identity or verify the source of your funds. Or it can happen because the exchange is a scam.

On a licensed exchange, you generally have to prove your identity before making a deposit. This helps to protect you in case you are accused of money laundering. It shows that you’re not hiding your identity. But with an anonymous account at an offshore, unregulated exchange, you don’t automatically get this protection.

Using a licensed exchange also helps to protect against crypto scams. When an exchange applies for a license, it is required to verify the identities of its executives. This makes it easier for authorities to hunt down team members if the exchange goes offline and runs off with your money.

But if you use an unregulated exchange, this information may not be publicly available, and you may have no options if the exchange disappears.

Even extremely reputable offshore exchanges like Binance.com have been accused of freezing accounts for no good reason,2 and users have had difficulty to bring legal action against them because of their unregulated nature.

FYI: To be clear, it’s rare to run into these withdrawal problems. The vast majority of offshore exchange users have no problem withdrawing their funds. But the risk of losing your funds is inherently greater when using an exchange with no clear legal boundaries. So it’s a risk you should be aware of.

Should I Use an Offshore Crypto Exchange?

At this point, you may be wondering whether the benefits are worth the risks. Should you use offshore exchanges?

Ultimately, it’s up to you. But unless there is no other way to buy the coins you want, you may want to consider avoiding them.

Most major cryptocurrencies can be purchased on a licensed, U.S.-based exchange. If you buy many different cryptos, you may have to open accounts at several different U.S. exchanges. This means that you’ll need to pass identity verification at each of them. But once you are verified at each of them, you generally don’t need to deal with this nuisance ever again.

In addition, most reputable U.S. exchanges do a good job of protecting users’ identifying info. In fact, we are not aware of any major crypto exchange that has leaked photo ID images or names and addresses of users.

If you want to trade crypto futures, then you’ll have no choice but to use an offshore exchange. But if you want to trade Bitcoin options in particular, you can do that through Quedex, LedgerX, TD Ameritrade, or CME Group — all of which are licensed options exchanges in the U.S.

Overall, most investors should be able to accomplish their objectives without using an offshore exchange. But if you do decide to use an offshore exchange, this explanation of the risks will hopefully help you to minimize them as much as possible.

Pro Tip: You can learn about how to find a legitimate crypto exchange in this crypto exchange guide.

Wrapping Up

The U.S. has some pretty strict crypto regulations when compared to other countries. So it’s no wonder that many investors are attempting to circumvent these rules by using offshore exchanges.

These regulations could be loosened in the future. Congress could pass laws restricting the power of regulators, or the courts could overturn the regulations. If this happens, offshore exchanges would no longer offer advantages over U.S.-based ones.

In the meantime, these are the benefits and risks of using an offshore exchange.

Citations
  1. FinCEN. (2013). Application of FinCEN's Regulations to Persons Administering, Exchanging, or Using Virtual Currencies. fincen.gov/resources/statutes-regulations/guidance/application-fincens-regulations-persons-administering

  2. NBC. (2021). Crypto traders want payback after losing millions to Binance glitches. nbcnews.com/business/personal-finance/crypto-traders-want-payback-after-losing-millions-binance-glitches-n1277111