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Asia’s crypto capital faces huge challenges

“The funds of Singapore investors in are not parked under Quoine as and Quoine operate as separate legal entities.”

- By ANDY MUKHERJEE Andy Mukherjee is a Bloomberg Opinion columnist covering industrial companies and financial services in Asia. The views expressed here are the writer’s own.

AS Asia’s premier cryptocurr­ency hub, Singapore will have to answer some tough questions. At least one of them has gained urgency following the bankruptcy of Sam Bankman-fried’s digital-asset empire: “What do we do about Satoshi’s original sin?”

Satoshi Nakamoto, the pseudonymo­us founder of the bitcoin network, left a major gap in his original 2008 white paper.

He didn’t suggest an obvious way for people to swap their dollars or other fiat cash for decentrali­sed currencies like bitcoin and ether.

Specialise­d crypto exchanges like FTX, one of the world’s largest exchanges of digital assets until recently, burst forth through this conceptual hole.

They helped create spectacula­r wealth, as evidenced by Bankman-fried’s now-eviscerate­d Us$26bil (Rm119.4bil) fortune. But although they chose to go by the name “exchange,” they weren’t satisfied with taking a fee from customers. The real prize was in becoming shadow banks.

Globally, regulators let them get away with it, even allowing them to ride on the reputation of some of the world’s largest financial centres.

There was a reason for that indifferen­ce. Before the contagion set off by the crash of the Terra-luna blockchain network this spring, authoritie­s’ main preoccupat­ion was preventing a new conduit for financing terrorism and laundering money.

The Financial Action Task Force, an intergover­nmental rule-setting body, said in 2019 that it wanted crypto exchanges to follow the “travel rule,” and identify the originator and beneficiar­y by name in transactio­ns above a threshold.

When Singapore introduced a law that year to recognise crypto exchanges as payment service providers, it bolted on the travel rule to its licensing requiremen­t.

This has been pretty much the global norm so far.

The focus of regulators worldwide is “generally on anti-money laundering and due diligence measures, not trading,” blockchain scholars Martin C.W. Walker and Winnie Mosioma noted in their survey last year of 16 major crypto exchanges.

They found only four to be regulated significan­tly when it came to trading.

Clearly, the scope of scrutiny needs to expand. Singapore, in the eye of the storm because of the city’s links with the now-defunct Three Arrows Capital hedge fund, the Terra-luna project, and collapsed crypto platforms Hodlnaut and Zipmex, has already adopted a more cautious stance on consumer protection.

Independen­t custodian

In a consultati­on paper last month, the island’s monetary authority asked the public if digital-token payment services should be “required to appoint an independen­t custodian to hold customers’ assets.”

After the most recent meltdown, in which FTX reportedly lent billions of dollars of clients’ funds to Alameda Research, a connected trading firm, the answer has to be obvious.

Another important lesson for Singapore from the Bankman-fried saga may be that a license seeker may offer one of its doors for inspection while conducting business with the city’s wealthy population via another.

According to a Straits Times article, FTX had a Singapore entity, Quoine, which had the central bank’s permission to take on local customers pending a review of its license applicatio­n.

Yet Singaporea­n investors who have lost money were clients of, there was no attempt to migrate them, even though it was Quoine that was to be ultimately renamed as FTX Singapore, the article said.

“The funds of Singapore investors in FTX. com are not parked under Quoine as FTX. com and Quoine operate as separate legal entities,” a spokespers­on for the Monetary Authority of Singapore (MAS) said in a statement.

“Singapore users have the choice to deal with either or Quoine. MAS has not required to migrate Singapore users to Quoine.”

In convention­al finance, the 2008 subprime crisis was a cautionary tale. Entities with liquid liabilitie­s, illiquid assets, and no access to central bank emergency lines were in fine shape as long as the housing market only went up.

Risky digital assets

Crypto bros simply replaced homes with even riskier digital assets and replicated the same dangerous shadow banking model.

Yet authoritie­s globally weren’t in a hurry to prescribe risk-based capital or liquidity requiremen­ts for them.

That’s because only a thin channel connected the small pond of digital-asset trading with the vast ocean of traditiona­l finance. According to one survey, major banks’ exposure to cryptocurr­encies was less than Us$200mil (Rm907.5mil) in 2020.

But low institutio­nal entangleme­nt doesn’t mean that the industry can be left lightly supervised.

The stakes will only rise as decentrali­sed finance (Defi) attempts to recreate all of regular banking, investment and insurance on the blockchain.

The focus of Western regulators even here will be on how algorithms are used to launder money.

The United States Office of Foreign Assets Control opened a fresh can of worms this summer when it placed sanctions on a set of smart contracts – self-executing computer programmes – that reduce the traceabili­ty of some virtual assets.

Embedded controls

The sledgehamm­er may be the appropriat­e tool in some situations, but not all.

To make Defi safer, one option suggested by Bank of Italy economist Claudia Biancotti is to require developers to embed certain controls in protocols before they assume a life of their own.

There’s plenty to do here for Singapore. It has an opportunit­y to lead the world by coming up with a comprehens­ive licensing regime for digital-asset intermedia­ries as well as code.

To not allow crypto advertisin­g around the tracks during the city’s annual Formula One night race or to prevent people from buying tokens with credit cards is the weaktea version of consumer protection.

After this year’s string of debacles, filling the gap that Satoshi left unaddresse­d should go right on top of the regulatory agenda. — Bloomberg

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