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Fintech is falling short in its bid to be third economic pillar

In this screengrab from an interview with ABC News is Sam Bankman-Fried, former CEO of the failed cryptocurrency exchange FTX. The interview, which appeared on the programme Good Morning America, took place in the Bahamas island of Nassau, where FTX was headquartered. (Photograph from Good Morning America/ABC News via AP)

Today’s Royal Gazette has an in-depth look at Bermuda’s efforts to add a new pillar to its economy through financial technology, cryptocurrencies and blockchain, the underlying technology for digital coins. Five years after Bermuda’s fintech revolution was launched with great fanfare by David Burt, the Premier, it is timely to measure progress.

It is also timely due to the collapse of FTX, a cryptocurrency exchange that domiciled itself in the Bahamas this year. At the time, it might have appeared that the Bahamas had surged past Bermuda in the race for offshore fintech leadership. Months later, whatever envy there may have been was replaced with relief after FTX’s spectacular failure.

The reputational harm done to crypto and the Bahamas by FTX is impossible to measure. For crypto and fintech, it will have scared off mainstream investors, who will long believe that the whole sector is permeated with fraudsters and scam artists. For the Bahamas, and offshore domiciles including Bermuda, there will be a belief that the regulators of small jurisdictions simply do not have the weight or ability to monitor the behaviours of these exotic financial instruments.

That is bad news for Bermuda. As today’s articles show, the Bermuda Monetary Authority’s reputation for sound regulation is a — perhaps the — key argument for locating fintech companies in Bermuda.

But The Economist magazine offers a more measured view of fintech. After FTX’s collapse, it said: “Amid the wreckage of the past week, it is worth remembering the technology’s underlying potential.

“Conventional banking requires a vast infrastructure to maintain trust between strangers. This is expensive and is often captured by insiders who take a cut.

“Public blockchains, by contrast, are built on a network of computers, making their transactions transparent and, in theory, trustworthy. Interoperable, open-source functions can be built on top of them, including self-executing smart contracts that are guaranteed to function as written.

“A system of tokens, and rules governing them, can collectively offer a clever way to incentivise open-source contributors. And arrangements that would be expensive or impractical to enforce in the real world become possible — allowing artists to retain a stake in the profits from the resale of their digital works, for instance.”

So there is an argument that fintech may have a purpose in the real world and is more than a economic bubble akin to 17th-century tulips.

But The Economist adds: “The more scandals ensue, the more the whole enterprise and its aspirations become tainted. The lure of innovation means nothing if investors and users fear their money will disappear into thin air. For crypto to rise again, it must find a valid use that leaves the dodginess behind.”

The search for a valid use is the fundamental problem with crypto and fintech. While the technology is clever and the basic idea may be worthwhile, no one seems to be able to explain what its purpose is, giving the sense it is a solution in search of a problem .

Bitcoin and Ethereum are not currencies in the traditional sense because they have not been adopted as a practical means of exchange. You cannot buy a loaf of bread with Bitcoin, or a house, in part because of the wild swings in value that occur. The fact that there are innumerable coins, and varieties of coins, makes this even more difficult.

Proponents argue that if the coins are not viable as means of exchange, then they can still be investments or holders of value. The series of downturns that have hit the sector in the past year, culminating in FTX’s collapse, seems to put the lie to this, but there were legitimate doubts already; namely, that the coins had no assets behind them, unlike buying shares in a company, real estate or a commodity like wheat or oil.

Even if cryptocurrencies are flawed as a means of exchange and are at best a highly speculative investment, then enthusiasts argue the technology may still be useful. Just as the space race led to the invention of various useful applications on earth, so technological advances like blockchain may turn out to be useful.

Blockchain may indeed be making business transactions more efficient and trustworthy, and may also be of value to creative people who wish to protect their work in the copyright wild west that is the internet.

But to date, progress in this area has been slow.

Bermuda is a case in point. At one point, the Bermuda Land Registry was going to use blockchain technology to register and monitor property ownership, replacing the cumbersome current process of conveyancing. But this seems to have been abandoned. Others have found the technology falling well short of its promise, and say it is clunky and slow.

That may yet change. But for now it remains at best a work in progress. Certainly the early hopes that it would become a third pillar of the Bermuda economy to rival reinsurance and tourism remain unfulfilled. It is fair to argue that neither of those industries matured overnight, or even in five years. But the current size of the fintech sector, at 16 licensed companies and somewhere between 50 and 80 employees, is a low return by any measure for all of the effort and money that has been invested.

In fact, the costs to Bermuda have been higher than dollars and cents. It has attracted a remarkable number of dubious characters both as founders of their businesses and as customers. That includes the infamous case of Arbitrade, whose founders are now embroiled in litigation with each other and innumerable others.

Other companies have fallen afoul of onshore regulators , mainly for failing to follow money-laundering rules. In part this is because onshore regulators have been extremely cautious in dealing with this technology and the concepts behind it. Part of its initial attraction was that it was difficult for governments to regulate, after all.

Now most industry leaders say they want to be regulated, recognising that they will struggle to get investors or customers without it, but the industry as a whole remains tarnished by the multitude of scandals that have occurred.

Proponents argue that other new industries had had similar birthing pains, but some of this is whataboutism. There will always be bad actors, but Bermuda has from early on worked hard to keep them away, notably rejecting Russian oligarchs from coming to the island in the 1990s.

Fintech seems to contain all of the problems of past industries in one place. The enthusiastic backing of the Government means that any failures are then attached to Bermuda as a whole.

Unlike tourism or insurance, which are at their cores relatively easy to understand, few people understand what fintech is.

Further, beyond regulation and perhaps geography, there is no obvious reason for fintech to be in Bermuda. Thus it runs the risk of being a haven for people who don’t want to be noticed — for the wrong reasons.

Finally, it is still not clear what its valid use is.

This is not to say that fintech has no function in Bermuda or elsewhere. It may turn out to be a success. But increasingly, it looks far from the economic panacea that Mr Burt made it out to be in 2017.

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Published December 19, 2022 at 8:00 am (Updated December 19, 2022 at 8:05 am)

Fintech is falling short in its bid to be third economic pillar

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