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FTX debacle poses challenges for Asia’s crypto capital

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 decentralized currencies like Bitcoin or Ether.

Specialized crypto bourses 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 $26 billion fortune. But although they chose to go by the name “exchange,” they weren’t satisfied 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 centers.

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 with preventing a new conduit for financing terror and laundering money. The Financial Action Task Force, an inter-governmental rule-setting body, said in 2019 that it wanted crypto bourses to follow the “travel rule,” and identify the originator and the beneficiary by name in transactions above a threshold. When Singapore introduced a law that year to recognize 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 the 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. 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 it conducts 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 FTX.com; 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 said in a statement. “Singapore users have the choice to deal with either FTX.com or Quoine. MAS has not required FTX.com 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. 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 $200 million in 2020.

But low institutional entanglement doesn’t mean that the industry can be left lightly supervised. The stakes will only rise as decentralized finance, or 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 US 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 programs — that reduce the traceability of some virtual assets.

The sledgehammer may be the right tool in some instances, 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 weak-tea 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 OPINION

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