Singapore Should Stop Beating Itself Up on Crypto Regulations

“Code is law.” Whereas the catchphrase has caught on with the crypto crowd, it has little cache with the crew that truly formulate regulation — legislators and people who execute the regulation — regulators. And therein lies one of many greatest challenges of regulating the cryptocurrency area — lawmakers are actually writing regulation on paper, whereas the blockchain is constructed on code. And whereas regulators can produce reams of laws, few (if any) can write a single line of code. Even because the regulation struggles (at greatest) to maintain tempo with technological advances, speeding to manage in a piecemeal method can and sometimes does lead to unintended penalties.

Proper Code Not Regulation

Take as an example Singapore’s Fee Companies Act (“PSA”).

When the concept of the PSA was first mooted, it was heralded (particularly by these within the cryptocurrency business) as a forward-looking piece of laws that might assist cement Singapore’s place as a world hub for digital property.

While the PSA could have been hyped as the primary try by a significant monetary centre to manage the rough-and-tumble cryptocurrency sector, a little bit of legislative historical past would reveal that its thrust and parry was way more restricted each in scope, scale and ambition.

Within the aftermath of the preliminary coin providing (ICO) bubble and bust, as an alternative of utilizing present laws (as has been the strategy within the US) and enforcement motion to convey the cryptocurrency business to heel, lawmakers in Singapore selected a special strategy — to begin (kind of) from scratch.

The Financial Authority of Singapore (MAS), which serves as each the central financial institution and regulator for monetary providers in Singapore, mooted a invoice that might cowl not simply digital tokens, however funds as nicely.

Earlier than the PSA got here into impact in January 2020, fee service suppliers had been regulated by the Fee Methods (Oversight) Act (“PSOA), while money changers and remittance companies by the Money-Changing and Remittance Businesses Act (“MCRBA”).

There have been overlaps between the PSOA and the MCRBA and on the time it was believed that since cryptocurrencies had been rising in utilization, there was a necessity to manage them in a simpler method, particularly for the reason that nascent asset class didn’t match neatly inside the present authorized framework.

As a substitute of making an attempt to transform present laws, Singapore’s strategy was to begin over and convey all the things beneath one piece of laws.

Enter the Fee Companies Act

At its core, the PSA was supposed to do two issues — streamline the prevailing two items of laws, the PSOA and the MCRBA, and create an “activity-based” piece of regulation that might higher deal with all the things from digital funds (comparable to digital wallets in apps) to digital tokens (comparable to cryptocurrencies).

At first blush, Singapore’s strategy to regulating cryptocurrencies regarded promising.

On the one hand, MAS would have expanded powers beneath the designation regime of the PSA to make sure improvements in fee techniques wouldn’t undermine monetary stability, whereas however, a licensing regime can be put in place overlaying not simply present fee providers suppliers, however aspiring cryptocurrency firms as nicely.

Underneath the PSA, there are seven key fee providers that appeal to licensing necessities:

account issuance providers;

home cash switch providers;

cross-border cash switch providers;

service provider acquisition providers;

e-money issuance providers;

digital fee token providers; and

money-changing providers.

Related to the cryptocurrency business had been licensing necessities beneath 5 and 6, e-money issuance providers and digital fee token providers and the licensing regime consisted of two broad classes:

Cash-changing License

Customary or Main Fee Establishment License (with the excellence between the 2 being one of many quantities processed and base capital necessities)

With Singapore’s licensing regime now in place, crypto firms (each overseas and home), desperate to burnish their credentials and look of compliance in an business rife with fraud, raced to use.

Whose license is it anyway?

Sadly for the legion of “Crypto Bros” intending to use for a license beneath the auspices of the PSA, the listing of admission necessities was lengthy and daunting, and for many of them, given their lack of expertise in monetary providers, unfamiliar.

An e-money issuance service for the needs of the PSA permits customers to make use of e-money to pay retailers or switch e-money to a different particular person and a plain interpretation of the act would cowl all the things from stablecoins to pay as you go digital wallets.

Digital fee token providers beneath the PSA however dealt solely with shopping for or promoting digital fee tokens (“DPTs”), in any other case often called cryptocurrencies, or offering a platform to permit individuals to change DPTs.

The principle concern in fact is that the PSA can’t (nor was it designed to), seize all the actions ancillary to e-money and DPTs, beneath the umbrella of a fee providers license.

As an illustration, a cryptocurrency change working in Singapore can be required to use for a license beneath the PSA, however outdoors of the next ongoing necessities for sustaining such a license, nearly no steering is offered for the way it ought to function the change:

AML/CFT necessities

Periodic Returns — e.g. quantity of transfers

Cyber Hygiene — primarily cybersecurity

Enterprise conduct — together with safeguarding of shoppers’ monies, file of transactions, issuance of receipts, and so on.

Disclosures and Communications — correct representations on the scope of its license and actions to clients

Annual audit necessities

Nowhere within the PSA or its attendant laws and laws does it point out {that a} crypto change working in Singapore wants to carry shopper’s crypto separate from its personal, or that its house owners ought not even have their very own proprietary buying and selling agency that may commerce in opposition to clients on its change.

The PSA actually doesn’t stipulate any restrictions on frequent shareholding between the house owners of a crypto change and a market maker that plies the identical change, regardless of the evident battle of curiosity.

Such necessities are discovered as an alternative in a wholly totally different piece of regulation — the Securities and Futures Act (“SFA”), a well-established piece of laws that governs actions within the capital markets and ensures such fundamentals as the necessity for exchanges to take care of impartial custodians and different frequent sense measures to keep away from conflicts of curiosity.

At its core in fact is the battle with what precisely a cryptocurrency is.

Whereas US Securities and Alternate Fee Chairman Gary Gensler considers that the majority cryptocurrencies fall beneath the definition of securities, the Chimera-like high quality of a lot of them resists simple classification.

And on the time that the PSA was mooted, cryptocurrencies had been handled as distinct and aside from conventional securities.

Due to the classification bifurcation, regulators working beneath the PSA can be exhausting pressed to correctly police the area, not to mention oversee it.

To Securitise or Not Securitise, That’s the Query

As an illustration, what if a Singapore firm was to supply crypto lending and borrowing actions in Singapore, how precisely would that be ruled?

In keeping with the PSA, the definition of a “digital payment token service” means:

(a) any service of dealing in digital fee tokens (aside from any such service that the Authority could prescribe);

(b) any service of facilitating the change of digital fee tokens (aside from any such service that the Authority could prescribe);

Presumably, borrowing and lending crypto would fall beneath “dealing” for the needs of the PSA.

But neither the PSA nor its ancillary laws present for a way such “dealing” must be performed.

How a lot are you able to borrow and the way a lot are you able to lend?

Who must you lend to and who are you able to borrow from?

How a lot of buyer property are you able to lend out to and to whom?

There aren’t any necessities that Singapore-based crypto firms segregate customers’ crypto from their very own, or keep capital reserves in case a few of that lending goes awry, solely an obligation to “safeguard” buyer monies, no matter which means.

Additionally absent from the PSA are necessities that licensees keep ample reserves to satisfy withdrawals or different well-established threat administration measures required by the SFA and the Banking Act.

But it surely ought to come as no shock that the PSA couldn’t cowl all these situations — it was by no means designed to neither is it clear that it was ever supposed to within the first place.

Gimme a License, Make it Two

As a result of the PSA gives a licensing regime, crypto firms with a license, obtain an nearly immediate halo-like stamp of approval from a regulator in a significant international monetary centre.

And that halo doesn’t even have to be crystalised to bear fruit, as was the case for Hodlnaut, a Singapore firm that supplied eye-popping yields on crypto deposits and was granted an in-principle license beneath the PSA.

On 8 August 2022, in the future earlier than Singapore’s Nationwide Day (Independence Day), Hodlnaut shocked clients by saying that it was freezing all buyer withdrawals citing “recent market conditions.”

In actuality, Hodlnaut, which in March 2022, had been granted an “in-principle” PSA license was off to the races by April of that very same 12 months, taking publicity to the finally doomed algorithmic stablecoin UST.

Upon receiving its “in-principle” qualification to obtain a PSA license from MAS, yield-hungry depositors flocked to Hodlnaut.

Solely a month after being sprinkled with MAS pixie mud, Hodlnaut was providing 14 per cent annualized returns on 180-day mounted deposits, that it deployed to the finally doomed Anchor Protocol utilizing UST, an algorithmic stablecoin the place it earned yields of just about 20 per cent, clearing a cool 6 per cent within the course of.

When UST ultimately misplaced its peg and its sister token LUNA grew to become nearly nugatory, 1000’s of Hodlnaut’s clients, lured by the promise of 14 per cent annualised returns, would quickly discover that they had been not in a position to withdraw cash from the platform.

A part of the issue in fact was that firms like Hodlnaut don’t even have “assets” within the conventional sense — they’ve liabilities.

Whenever you deposit cash with a financial institution, that’s not the financial institution’s asset, it represents an unsecured mortgage to the financial institution (aside from authorities deposit insurance coverage to a set quantity) and a legal responsibility on the financial institution’s books.

In return for having the privilege of borrowing cash from you, banks want to take care of what’s often called capital adequacy ratios — the ratio of a financial institution’s capital in relation to its risk-weighted property and present liabilities.

If the financial institution carries loads of dangerous property on its books, it wouldn’t be capable of obtain very a lot as deposits, which is why banks carry loads of Tier 1 capital (CET1), the very best high quality of regulatory capital, which has the flexibility to soak up losses instantly ought to they happen.

Hodlnaut’s clients loved no such privilege.

Whereas firms like Hodlnaut boasted of their property beneath administration, these “assets” had been actually unsecured loans that the corporate owed to its clients.

However as a result of these “assets” had been cryptocurrencies and Singapore has particular laws governing DPTs — they didn’t come beneath the auspices of the SFA or the Banking Act, however the PSA as an alternative, laws that’s significantly ill-suited to cowl such situations as within the case of Hodlnaut.

If it Acts Like a Financial institution, Regulate it Like One

It’s been mentioned that if it seems like a duck, walks like a duck and quacks like a duck, odds are it’s a duck.

Though firms comparable to Hodlnaut aren’t banks, they behave as if they’re and must be regulated as in the event that they had been — utilizing a mix of the SFA, Banking Act and the PSA.

As a substitute, the PSA offered firms like Hodlnaut with a veneer of legitimacy and regulatory stamp of approval as in the event that they had been working to the identical requirements as firms ruled by the Banking Act and the SFA, with out holding them accountable to such.

So was Singapore fallacious to have cobbled collectively the PSA in such a rush?

“Yes” and “no.”

The PSA represents a progressive piece of laws emanating from one of many world’s main monetary facilities, and stitched collectively by lawmakers intent on constructing the longer term.

Typically talked about in the identical breath as New York, London, Zurich and Hong Kong, however missing the identical hinterlands and geographical benefits of these cities, Singapore is merely doing what it could actually to take care of its edge as a monetary centre.

Which explains why in 2018, Singapore launched into a course of to take a stab at governing what many different regulators had decided was “ungovernable” — cryptocurrencies.

As a result of Singapore doesn’t profit from the huge hinterland like New York, or the strategic location of Hong Kong and London, it has to leverage the benefits that it does have — velocity and agility.

Sadly, legislating for any new know-how, particularly cryptocurrencies, requires a “Goldilocks Approach” — not too quick, however not too sluggish both.

And maybe legislators can lean on the Hippocratic Oath for steering — primum non nocere — first, do no hurt.

Whereas a haste to manage doesn’t prima facie do hurt, arguably the creation of a licensing regime with out the required infrastructure to help such a framework does.

First Do No Hurt

Slightly than attempt to match the spherical peg of cryptocurrencies into the sq. gap of the PSA, another might have been to not concern licenses to start with.

Singapore might have used all the prevailing instruments on the disposal of regulators to police the cryptocurrency business which US Securities and Alternate Fee Chairman Gary Gensler famously labelled the “Wild West.”

And which means the PSA, SFA and Banking Act, while catering for such exceptions and carve outs the place present regulation proved cumbersome and inapplicable.

Exterior observers could also be fast to evaluate Singapore’s early experiment with regulating cryptocurrencies to have failed primarily based on the variety of high-profile insolvencies and collapses related to the city-state.

However that statement can be misguided.

Cryptocurrencies aren’t (but) a part of the larger monetary system and it’s unclear in the event that they ever shall be.

By carving out crypto and defending probably the most feckless of buyers from pointless publicity, it may very well be argued that on the very least, Singapore’s lawmakers are committing to “do no harm.”

And whereas a lot of latest high-profile crypto failures are proximate to Singapore, lawmakers within the monetary centre might hardly be mentioned to have been their proximate trigger.

Disgraced crypto hedge fund Three Arrows Capital (“3AC”) could have had its workplace in Singapore, however its fund and authorised funding supervisor had been within the British Virgin Islands.

By the point 3AC’s founders Kyle Davies and Zhu Su ghosted buyers, its funding administration license issued by MAS had lengthy lapsed.

Terra-Luna’s Terraform Labs could have had an workplace and been included in Singapore, but it surely wasn’t regulated by MAS and its founders and principal employees weren’t from the city-state.

And even when Singapore’s buyers bemoan how the town state’s sovereign wealth fund’s funding in FTX gave the cryptocurrency change the aura of “investability” and “reliability,” neither the change nor its officers are regulated by MAS neither is the corporate included in Singapore.

As a substitute, cryptocurrency buyers and merchants no matter jurisdiction want to acknowledge that retaining their property protected finally falls on private duty greater than anything.

Regulation, licensing and official endorsement will do nearly nothing to ensure funds are SAFU — to maneuver ahead, regulation and regulation alone is a paper tiger, laws must be mixed with know-how.

No Extra Paper Tigers

One potential method of giving tooth to laws is requiring sensible implementation of safeguards for purchasers.

As an illustration, a license beneath the PSA, whether or not in-principle or in any other case, might require a declaration of all public pockets addresses managed by the license-seeking entity to the regulator.

Even when the licensee loathes to make its public pockets addresses recognized to one and all (uncertain at greatest, else how would you are taking deposits?), absolutely the authority issuing the license must be entitled to oversight?

Third celebration firms or auditors might then be tasked for validating and verifying property inside these wallets are ample to satisfy buyer withdrawals, and as an alternative of periodically, this monitoring may very well be completed in real-time.

Regulators might leverage the very blockchain know-how that they search to control, utilising its inherent transparency as a instrument for oversight, slightly than counting on it posthumously after issues have gone fallacious.

Whereas monetary establishments function in a much more structured surroundings, lawmakers who wish to correctly police the cryptocurrency sector want to make use of the very infrastructure that the business is determined by for enough policing.

And that features real-time crypto asset monitoring, unscheduled inspections and pockets identification — the flexibility to take action already exists, however lively policing and whistleblowing has been left largely to the neighborhood.

This may’t be the way in which ahead.

Final November, the Financial Times recommended Hong Kong was well-positioned to wrestle the crypto capital crown from Singapore, given the latter’s latest setbacks and its knee-jerk response to carry again on all issues crypto-related — however such a view can be considerably untimely.

Singapore is usually lauded for instance of a startup nation that succeeded, however that course of was not with out trial and error and the PSA is prone to be no totally different.

While expedient, the PSA and its implementation must evolve, however maybe at a quicker tempo than already fast regulators and lawmakers in Singapore are already accustomed to.

The velocity at which Singapore rolled out the PSA isn’t any small feat, however removed from resting on its laurels, lawmakers within the nation might do extra to make it useable and to unfold its ambition past its present iteration.

If the raison d’etre of licensing is to offer a protected framework for stakeholders to function in, then arguably, the PSA has moved too shortly.

With out enough infrastructure to help a complete licensing regime, which incorporates utilizing technological instruments to supervise the licensed, the PSA dangers turning into nothing greater than a advertising instrument, offering licensees with a coat of credibility, at the same time as they “crypto” covertly.

By Patrick Tan, CEO & Normal Counsel of Novum Alpha

Novum Alpha is the quantitative digital asset buying and selling arm of the Novum Group, a vertically built-in group of blockchain improvement and digital asset firms. For extra details about Novum Alpha and its merchandise, please go to https://novumalpha.com/ or electronic mail: ask@novum.international 

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