Crypto: learning lessons from FTX
In December 2020, the Bahamas passed the Digital Assets and Registered Exchanges Act (Dare). According to the securities regulator, Dare was supposed to “put in place the legal framework for a vital, well-regulated and compliant industry in the Bahamas for those interested in entering the digital asset space”.
Only nine months later, FTX, the world’s third-largest cryptocurrency exchange, moved its headquarters from Hong Kong to Nassau, spent tens of millions of dollars acquiring Bahamian properties, employed 40 local staff and acquired the land to build a $60 million head office.
Just over a year later, FTX collapsed, losing billions of dollars amid accusations of fraud. Local staff are all losing their jobs, the new headquarters will never be built and now the Bahamas is a centre of international attention for all the wrong reasons.
Like the Bahamas, Bermuda is an offshore financial centre that has been trying to find new areas of growth such as crypto. Bermuda initially moved faster than the Bahamas, its equivalent to Dare, the Digital Asset Business Act, passed into law in 2018.
It was presented as a way to support the growth of the fintech industry in general but the first major firm it attracted was Binance, the world’s largest cryptocurrency exchange, which signed a memorandum of understanding with the Bermudian Government to invest in Bermuda. Perhaps it was for the better that little tangible came from the agreement. To quote the Financial Times of London: “One of the world’s leading financial regulators has said it is ‘not capable’ of properly supervising Binance despite the ‘significant risk’ posed by the cryptocurrency exchange’s products, which allow consumers to take supercharged bets.”
Despite the collapse of FTX, the Bermudian Government continues in its effort to support the growth of the crypto industry. So, it is worth considering whether there is something unique about the FTX collapse or whether it is symptomatic of the industry.
Going back to their earliest days of cryptocurrency exchanges, they have suffered from sudden collapses, massive thefts of client funds and major technical failings; as well as often being the instruments of wide-scale market manipulation. Even the so-called “DeFi” areas of cryptocurrency investment, where investments are controlled by publicly available computer code rather than corruptible people, have experienced $10 billion of fraud in the last year alone.
Many of the issues with the industry grew out of the fundamental nature of crypto. Crypto was designed to avoid regulation, to be “censorship resistant” in the words of the proponents and to be “decentralised”, ie, unaccountable. Cryptocurrencies and related assets are bearer assets, like the bearer bonds loved by early generations of money launderers, a feature that also makes them uniquely easy to steal. They also, with the exception of so-called stablecoins (backed to varying degrees by other assets), lack fundamental value, making values exceptionally volatile. To quote the UK Financial Conduct Authority: “If consumers invest in these types of product, they should be prepared to lose all their money.”
An important question is why is the crypto industry so keen to move to offshore centres and even help to draft crypto-friendly legislation. Regulators in major economies have been slow in effectively dealing with the crypto industry for a variety of reasons. This included its size relative to conventional finance, confusion about how to enforce existing laws and the challenge of dealing with so many new products.
However, the tide is turning, led by the US federal and state regulators. Regulatory enforcement and various scandals discourage what the industry needs most, a constant inflow of new funds from new investors. If “new money” dries up, prices collapse. When the crypto lobby asks for “regulatory clarity”, they really mean “legitimisation”, to encourage the money to keep flowing in.
Legitimisation is clearly easier to obtain in smaller, more flexible jurisdictions. Looking at legislation such as Dare, it provides a veneer of respectability but does not put crypto businesses such as the exchanges on the same footing as conventional finance. A large part of the reason crypto exchanges such as FTX collapse is because they do things that would never be allowed in conventional finance, combined with the innate characteristics of assets traded themselves. What seem like large funds can be injected into an economy but the “bearer” nature of crypto assets means they can very quickly disappear. As the Bahamas is learning, fees can be earned from licensing crypto businesses but dealing with the mess of collapsed crypto business can be very demanding and expensive.
The risks are clear, the benefits of encouraging crypto less so, but the one thing that should not confuse this analysis is the attempt of the crypto lobby to muddy the waters. Whether crypto is encouraged or not is irrelevant to whether Bermuda becomes a centre for the broader fintech industry or e-commerce.
Martin Walker is the banking and finance director at the Center for Evidence-Based Management in the Netherlands.