TL;DR (SUMMARY)
A nested cryptocurrency exchange provides its clients with cryptocurrency trading services through an account on another exchange. It does not facilitate trading directly on the exchange itself. Instead, it acts as a bridge between users and other service providers. Nesting is commonly used in traditional banking to provide services that a specific bank cannot, such as in the case of international transfers.
In the cryptocurrency environment, nested exchanges often have inefficient KYC and AML processes or none at all. This lack of compliance is often exploited by cybercriminals. Nested exchanges help support money laundering, ransomware payments, and scammers.
When you trade on a nested exchange, you trust it with custody of your assets. These types of exchanges provide less security and guarantees than a centralized or decentralized exchange that complies with regulations. You could also face legal problems for trading on sanctioned nested exchanges.
If you use an exchange, make sure it has proper KYC and AML verifications. These usually take days to process. If the exchange allows you to trade almost instantly and without limitation, you should investigate it further. A legitimate exchange won't hide how transactions are made, and you can easily see the origin of your funds in a blockchain explorer.
Introduction
When buying and selling cryptocurrencies, it is essential to trade on a trusted website. However, you must be patient while completing KYC and AML verifications in order to stay safe. For this reason, some users choose to use exchanges that offer little or no registration verifications and allow instant trading.
While some may be legitimate decentralized exchanges, others could be nested exchanges that handle stolen or laundered funds. Your funds are never guaranteed to be safe on a nested exchange. To make sure you keep your cryptocurrencies safe, it's important to understand what nested exchanges are, what they do, and how you can recognize them.
What is nesting?
Nesting occurs when a financial services provider creates an account at another financial institution to use their services. The account holder acts as a bridge, offering services to their clients through the nested account. This happens for many reasons. For example, a bank in one country can provide its banking services and ecosystem to a bank operating in a different country, known as a correspondent bank.
Imagine a customer wants to transfer money to a bank account in Australia. Your bank may not be able to do this, but you could use a correspondent bank to transfer the funds for you. The customer's bank would process the transfer request through their nested account at the correspondent bank. The correspondent bank must exercise caution and carry out due diligence on the bank it works with. The correspondent bank basically serves customers it doesn't know, so you have to trust the nested account holder.
What is a nested cryptocurrency exchange?
A nested cryptocurrency exchange works quite simply. An entity or person creates an account on a regulated exchange. You then use this account to offer trading services to third parties through your nested account. These nested exchanges are sometimes known as instant exchanges and often have multiple accounts on different exchanges.
Some may ask for identification documents, but others may require little or no identification. This makes them a popular choice among scammers, criminals, and ransomware practitioners. Some nested exchanges even allow the buying and selling of cryptocurrencies in person and with cash.
What is the danger of nesting?
When it comes to traditional finance, one of the biggest problems is the risk of money laundering. As the correspondent bank only deals directly with the underlying issuing bank, there is no way to know exactly who it is dealing with. This is why nesting requires enhanced due diligence controls from the underlying bank. Citizens and entire countries could be blacklisted and subject to sanctions. If an underlying issuing bank does not comply with these requirements, the correspondent bank could end up supporting illegal activities, such as sanctions avoidance or money laundering.
Since the cryptocurrency industry is still in the process of developing strong regulations, it is easier for nested exchanges to operate under the radar. A nested exchange could open an account on a large cryptocurrency exchange without the latter easily noticing.
What are the dangers of a nested cryptocurrency exchange?
When using a nested cryptocurrency exchange, it doesn't just affect centralized exchanges. You and your funds are also in danger for several reasons:
1. Your deposits have fewer security guarantees than on a regulated exchange.
2. You could be supporting illegal activities that finance crime and terrorism.
3. Regulatory authorities may close the exchange, resulting in the loss of your cryptocurrencies and other funds.
4. You could face legal repercussions from authorities if you knowingly trade on an exchange involved in illicit activities.
The best way to avoid them is to not use nested cryptocurrency exchanges. Detecting them can be complicated, since it is not always obvious. Follow our tips below to give yourself the best chance of protecting yourself.
What is the difference between a nested exchange and a decentralized exchange?
At first, a nested exchange and a decentralized exchange have similar aspects. Decentralized exchanges do not require KYC, and nested exchanges may have inefficient KYC processes or none at all. However, the way they handle transactions is different. A decentralized exchange connects buyers directly with sellers or even uses liquidity pools. The exchange will never take custody of the exchanged cryptocurrency. Instead, smart contracts handle the process. For its part, a nested exchange takes direct custody of your cryptocurrencies and will use the services of another exchange.
The Suex Nested Exchange Incident
Let's look at a real case. On September 21, 2021, the Office of Foreign Assets Control (OFAC) sanctioned the Suex cryptocurrency exchange incorporated in the Czech Republic and operating from Russia. Suex OTC provided a nested cryptocurrency exchange service using Binance and other major exchanges to serve its customers. Suex required virtually no KYC, and even provided in-person cash-for-cryptocurrency exchanges.
According to Chainalysis research, Suex helped launder a large amount of funds from ransomware attacks and hacks. Binance proactively disabled several accounts associated with Suex, and OFAC blacklisted nearly 30 different Bitcoin, Tether, and Ethereum wallets. Binance also delisted Chatex, a crypto bank reported to have ties to Suex. Chatex has since faced sanctions from OFAC. Anyone who used Suex's services is now at legal risk and, following the OFAC decision, several websites have been taken down.
How to detect a nested exchange?
Nested exchanges generally do not make it obvious that they are a nested exchange. The following points are a good start to detect a nested exchange and protect yourself and your funds:
1. They do not require KYC or AML checks, or ask for minimum requirements. Signing up for an exchange almost instantly and without any limitations is a good warning sign.
2. The user interface does not clearly show where trading takes place.
3. There is no explicit statement that the exchange facilitates trading activity. A legitimate exchange will state that trading is done directly through their platform and not nested accounts.
4. The exchange adds different rates that you can choose from. This means that the exchange is using nested accounts on multiple exchanges.
5. If you suspect you have used a nested exchange, try tracking your crypto on the blockchain through a blockchain explorer. You may find that the funds are coming from a wallet associated with another exchange.
Conclusions
You're always safer buying your Bitcoin, BNB, and other digital currencies on a regulated cryptocurrency exchange, like Binance. While it may take a while to register for the first time, proper KYC and AML procedures will help keep you safe. You should treat exchanges as you would any other financial institution and do your due diligence before deciding to use one.
