Structural Reforms Needed to Prevent Opaque Enforcement and Protect Retail Traders in Crypto Markets

The collapse of centralized crypto exchanges like FTX in 2022 exposed systemic vulnerabilities in the industry, leaving retail investors exposed to opaque practices, mismanagement, and regulatory ambiguity. Centralized exchanges (CEXs) have long operated in a gray zone, where lack of transparency and inconsistent enforcement have enabled risks ranging from liquidity crises to outright fraud. As the crypto market matures, structural reforms are critical to addressing these gaps and safeguarding retail participants. The CLARITY Act of 2025, alongside evolving state-level regulations, represents a pivotal step toward creating a framework that balances innovation with investor protection.

The Opaque Risks of Centralized Exchanges

Centralized exchanges have historically operated with minimal oversight, often leveraging their dominance to obscure operational details from users. For instance, the FTX collapse revealed how a single entity could misappropriate customer funds, exploit governance loopholes, and engage in high-risk trading without adequate safeguards, as described in an a16z article. Retail investors, lacking access to real-time data on fund custody or exchange solvency, are particularly vulnerable. According to an Arnold Porter report, the absence of a unified regulatory framework prior to the CLARITY Act allowed "regulation by enforcement," where agencies like the SEC and CFTC competed for jurisdiction, creating legal uncertainty and inconsistent protections.

The CLARITY Act: A Structural Overhaul

The CLARITY Act (Digital Asset Market Clarity Act of 2025) seeks to resolve these issues by categorizing digital assets into three classes: digital commodities, investment contract assets, and permitted payment stablecoins, as outlined in the Arnold Porter advisory. This classification clarifies jurisdictional boundaries, assigning the SEC oversight of investment contracts (e.g., tokens sold via ICOs) and the CFTC authority over digital commodities (e.g., Bitcoin, Ethereum). By doing so, the Act reduces regulatory arbitrage and creates a predictable enforcement environment.

A key innovation is the "control-based maturity framework," which allows investment contract assets to transition to commodity status once a blockchain system becomes decentralized. This incentivizes projects to build transparent, community-governed networks while reducing regulatory burdens post-issuance, as the Arnold Porter advisory explains. For example, a token initially treated as a security under SEC jurisdiction could shift to CFTC oversight after meeting objective criteria like decentralized governance and operational independence from founders, as noted in the a16z article.

Retail investor protections are embedded in the Act's design. Mandatory disclosures for digital commodity issuers, restrictions on insider trading, and custodial standards for regulated entities aim to prevent the kind of opacity that fueled the FTX crisis, as described in the a16z article. Additionally, the Act requires exchanges and broker-dealers to register with the CFTC, subjecting them to compliance standards akin to traditional financial institutions, per the Arnold Porter advisory.

State-Level Variations and the Path Forward

While the CLARITY Act provides federal clarity, state-level regulations remain fragmented. California's Digital Financial Assets Law (DFAL) and New York's BitLicense impose stringent licensing and compliance requirements, creating barriers for smaller exchanges, as detailed in a Sumsub guide. Conversely, states like Wyoming and Texas have adopted crypto-friendly policies, offering tax incentives and streamlined licensing to attract innovation. This patchwork approach risks creating jurisdictional loopholes, where exchanges may relocate to avoid stricter oversight.

The Act's success also hinges on its Senate passage. Though the House approved it in July 2025, competing proposals from the Senate Banking Committee have delayed finalization. Critics argue that the Act's focus on federal preemption could undermine state-level consumer protections, while proponents stress its role in preventing regulatory fragmentation.

Conclusion: A Framework for Trust and Innovation

The CLARITY Act marks a turning point in crypto regulation, addressing opaque enforcement and investor vulnerability through structural clarity. By delineating regulatory roles, enforcing transparency, and incentivizing decentralization, it aims to rebuild trust in digital markets. However, its effectiveness will depend on harmonizing federal and state policies and ensuring robust enforcement of custodial and disclosure requirements. For retail investors, these reforms represent a critical defense against the risks of centralized control-a defense that must evolve as the market does.