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Finding the balance between regulation and innovation

Khairani Afifi Noordin
Khairani Afifi Noordin9/30/2021 09:28 PM GMT+08  • 17 min read
Finding the balance between regulation and innovation
Regulators worldwide have been sharpening their focus as the ecosystem gets bigger and more people trade cryptocurrency
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It has been an interesting year for cryptocurrencies. While China’s central bank may have banned all digital tokens (see sidebar), Bitcoin — the most famous of them all — has defied gravity and Tesla CEO Elon Musk tweets to reach record levels. Other cryptos have also been able to put behind occasional bouts of sell off to chalk up new highs as well.

Beyond geeks in their darkly-lit rooms, there has also been heightened interest among institutional and sophisticated investors, which has led to incumbent financial institutions to enter into the foray with their own offerings involving the blockchain technology.

Inevitably, as the whole ecosystem gets bigger and as more people trade cryptocurrency, regulators worldwide have been sharpening their focus on the digital assets, increasingly looking for a stable framework of regulations.

In Singapore, for example, the local cryptocurrency community was abuzz earlier this month when on Sept 2, the world’s largest cryptocurrency exchange Binance.com was placed by the Monetary Authority of Singapore (MAS) on its Investor Alert List.

On the very same day, senior Binance executives, including founder and CEO Zhao Changpeng, were scheduled to have a meeting with MAS officials.

In a statement, a MAS spokesman said the operator of Binance.com may be in breach of the Payment Services Act (PSA) after a review of the company’s operations. This stemmed from Binance.com continuing to provide payment services to Singapore residents, as well as soliciting such business without an appropriate licence.

In a response to queries from The Edge Singapore, Binance.com — founded by Chinese-Canadian Zhao Changpeng in 2017 — says it is aware of the notice from the MAS and confirms that it is actively working with the regulator to address concerns that they may have through constructive dialogue.

It asserts that Binance.com and Singapore-registered Binance.sg are separate exchanges. Operated by Binance Asia Services —which, in turn, is backed by Temasek Holdings’ venture capital arm Vertex Ventures — Binance.sg is solely focused on servicing users in Singapore. Binance Asia Services has submitted a licence application under the PSA.

“Binance.com takes a collaborative approach in working with regulators in navigating this emerging industry and we take our compliance obligations very seriously. We are actively keeping abreast of changing policies, rules and laws in this new space. We will work closely with MAS and other global regulators to comply with the relevant regulatory standards,” the company says in the statement.

In a notice posted Sept 27, Binance.com said its users in Singapore will not be able to access certain functions including fiat deposit services, spot trading of cryptocurrencies and the purchase of cryptocurrencies through fiat channels from Oct 26 onwards. Users in Singapore are advised to cease all related trades, withdraw their fiat assets and redeem tokens prior to the date to avoid potential trading disputes.

Sparking regulatory discussions

The saga sparked discussions regarding the local regulator’s stance on cryptocurrency-related platforms and exchanges operating in Singapore. Hagen Rooke, counsel at Reed Smith in alliance with Resource Law LLC, says MAS has sent a clear signal that the city state is policing and enforcing its regulatory perimeter, similar to regulators in key onshore jurisdictions such as the UK, US, Germany and Japan.

Regulations are designed to ensure stability and fair play in the financial system. Hence, when an industry moves by leaps and bounds in terms of technology in a matter of a couple of years, regulations tend to lag. Yet, for FinTech, regulatory priorities have evolved very quickly. Regulatory shifts have taken place in data privacy, ownership and storage, cloud, electronic know-your-customer (e-KYC) and licensing.

Rooke notes that Singapore is often viewed as a cryptocurrency-friendly location that offers a more conducive business environment to crypto-service providers than many other jurisdictions.

“To some degree, this is true. Singapore is committed to retaining an edge over its competitors when it comes to developing the tech economy, and it clearly recognises the potential of the digital-assets sector as a source of growth, jobs and innovation,” he says.

A critical mass of firms, from international banking groups to grassroots start-ups, have set up shop here. This, in turn, has created a virtuous circle and is attracting ever more players, adds Rooke.

However, a friendly and conducive ecosystem here should not be equated with a light-touch regulatory jurisdiction that turns a blind eye on questionable crypto-business models, warns Rooke.

The PSA, which is often lauded for its risk-based, proportionate approach to regulating activities, sets high standards for firms wishing to become approved to operate those activities.

The PSA will soon be extended to capture additional services such as transfer, arranging and custody services relating to digital payment tokens, to achieve full alignment with standards for virtual asset service providers published by the Financial Action Task Force.

“The regulator is taking a strict approach to assessing the eligibility of firms which apply for a licence under the act, interviewing their key personnel and conducting detailed assessments of each firm’s ability to counter money-laundering and technology risks. It is apparent that the regulator will only grant licences to the best-resourced applicants with a suitable calibre of management staff,” says Rooke.

Meanwhile, professor of economics at global business school Insead Antonio Fatas argues that Singapore and the MAS has provided a friendly environment towards FinTech and cryptocurrency compared to its neighbouring countries. This is in pursuit of being a hub for innovation in financial markets, similar to countries like Malta and Switzerland.

“The MAS has been experimenting with some of these technologies, partnering with the private sector. Was there a fear that some of these innovations could create instability or fraudulent activities? Yes, but because the activities were not large enough, the assumption was that the risk was limited,” says Fatas, referring to the “sandbox” approach touted when Singapore began to push for the FinTech ecosystem to grow.

However, with more established financial institutions embracing cryptocurrencies, the need for clearer regulations became more apparent. “The reality is that the unregulated world in which these companies operate will become a disaster waiting to happen if they continue reaching a larger share of the population. That’s why you see things like the Binance call by the MAS,” says Fatas.

Not applying the same regulatory requirements to cryptocurrency companies the same way as regular financial institutions would seem like a risky proposition, Fatas adds. This is especially as cryptocurrency companies are increasingly offering financial products that resemble those of the regular banks — such as deposits, credit cards and loans.

“The issue that makes regulation more complicated is that many of these companies operate from other countries and they simply reach Singapore customers in ways which are hard to regulate. International coordination can provide a much safer regulatory environment.”

Pursuing the licence

The MAS’s PSA, which came into force on Jan 28 last year, is to regulate traditional and digital token-based payments. Further amendments to the PSA were introduced a year later on Jan 4, allowing MAS to regulate Digital Payment Token (DPT) service providers. Following the amendment, cryptocurrency businesses in Singapore are required to register and apply for a licence to operate in the jurisdiction.

Responding to The Edge Singapore, a MAS spokesman said it had received 170 licence applications from DPT service providers. It has recently notified several applicants that it is prepared to grant them payment services licences under the PSA.

“Applicants who have received such notifications from MAS do not yet hold payment services licences. A licence will be subsequently granted to an applicant, provided it puts in place necessary measures to meet MAS’ requirements in order to operate as a licensee.”

The MAS is continuing to review the outstanding DPT applications, adopting a rigorous approach in reviewing licence applications. The spokesman adds that a number of DPT applicants have not met MAS’s standards in the area of money laundering and terrorism financing (ML/TF) as well as technology risk controls.

Out of the 170, 30 DPT applications have been withdrawn after engagement with MAS and two have been rejected. “MAS takes a serious view of weaknesses in controls to address ML/TF and technology risks, and will reject applicants who fail to meet the required standards.”

In early August, Australia’s largest cryptocurrency exchange, Independent Reserve was the first to receive an “in-principle approval” from the MAS to provide DPT services, two years after establishing its presence in Singapore. Shortly after, it was announced that DBS Vickers, the brokerage arm of DBS Group Holdings, has also received the same approval.

As a result, DBS Vickers is able to trade on the DBS Digital Exchange (DDEx) and directly support asset managers and companies to trade in digital payment tokens through the exchange. DBS Vickers is also licenced to trade on the Independent Reserve.

The others are still playing the waiting game. Aspiring licensees say they engage very closely with the MAS, despite not knowing when they would be notified of any updates.

One such applicant is Cake DeFi. The platform, which claims to have almost a million users, has engaged a legal counsel to assist the company with its active discussions with the regulator. While the application process did involve long periods of uncertainty, seeing the in-principle approval being awarded to other parties has provided the company with a positive outlook, says Cake DeFi CEO Julian Hosp.

“Regardless of how our application turns out, we want to continue to abide by the rules and be as transparent as we could to our users and stakeholders. We want them to trust us, to know that we are providing them with a safe platform,” says Hosp.

He does not think that the MAS’s regulatory requirements are stifling innovation — but rather, trying to balance between regulation and innovation. “For example, we wanted to introduce a very innovative product called decentralised stocks. We were encouraged by the MAS to seek legal advice from a reputable law firm to see whether that product would fall within the current framework. We think it is good that they encourage us to do our own due diligence and understand whether we are on the right track.”

Marcus Lim, CEO of another PSA applicant Zipmex, concurs. As a platform licenced in Thailand and operating under regulatory supervision in Indonesia and Australia, Lim says getting a licence in Singapore is a priority.

“I think the licences do work as some form of barrier to entry for us, but we are not opposed to regulations and compliance because we think it is important to help us build trust. We have a lot of great ideas in terms of what products we know the customers want, but they are in the heavily regulated areas such as collateralised lending via stable coins (digital coins backed by fiat). This might be something that would fall under the money lending licence,” says Lim.

He also adds that the company would wait for their licence application update before announcing any new products and offerings. As clarified by the MAS, the PSA licence applications are reviewed and approved based on the information submitted.

A licensee has to inform MAS if it offers new products and services, as well as any other material changes to its business model. This facilitates MAS’s supervision of a licensee’s operations, including its ability to operate in compliance with the PSA.

In June, Singapore-based cryptocurrency borrowing and lending platform Hodlnaut suspended its “token swap” feature to Singaporean users just two months after introducing it. The feature allows users to swap between asset pairs and execute trades instantly between any of the assets offered on its platform.

In a note, the company said it made the decision in light of the MAS’s requirement for it to obtain its approval for any new features that it supports. The feature was re-enabled in August, after the company had found a “stronger ground”, said Hodlnaut’s head of growth Sten Ivan.

“We made the decision after conducting several rounds of internal risk assessments. We wanted to take a more proactive regulatory approach while conducting our extensive legal and compliance investigations, so we suspended the feature as an act of caution. We were not asked by the regulators to suspend or re-enable the feature,” says Ivan.

More investors than punters

In terms of products and offerings available, Singapore’s cryptocurrency space has definitely gotten more sophisticated over the years, says the industry players. Companies are no longer offering just cryptocurrency exchanges that allow investors to buy and sell their digital assets.

Cake DeFi’s Hosp says one trend he has observed that might have shaped the offerings available is investors’ move towards less speculative, long-term focused investments. “Investors are no longer dipping their feet in cryptocurrencies just to cash out immediately after. They see the benefits of holding their investments,” says Hosp. In other words, there are more investors than punters.

Cake DeFi has three offerings: Liquidity mining, lending and staking. Liquidity mining refers to the act of providing liquidity via cryptocurrencies to decentralised exchanges. Cake DeFi allows its users to deposit their cryptocurrency assets into shared liquidity mining pools and mine coin pairs for rewards.

Staking refers to locking one’s cryptocurrencies in a proof-of-stake blockchain for a certain period of time. These locked assets are used to achieve consensus, which is required to secure the network and ensure the validity of every new transaction to be written to the blockchain. In exchange for locking their assets and providing services to the blockchain, the “validators” are rewarded with new coins from the network.

Both Zipmex and Hodlnaut also offer a way for investors to earn from their cryptocurrency assets. Zipmex, for example, offers ZipUp, a flexible earnings account with daily payouts of up to 8% annual percentage yield and ZipLock, a fixed-term earnings account with yields up to 14% per annum.

Hodlnaut, on the other hand, provides investors with interest on their cryptocurrencies by lending it to corporate borrowers. The platform offers up to 12.73% annual percentage yield.

Ivan says it took some time before investors were comfortable with the idea of earning interest from their cryptocurrency assets. “What we observed from the beginning of operating was that our product was only relevant to sophisticated investors, or those who have significant knowledge in the technology.

“However, as the players in the ecosystem go hand in hand to educate the general public, we started seeing laymen coming on board. They start to understand how holding cryptocurrencies can actually provide them with passive income, this is encouraging for us platform operators,” says Ivan.

The awareness of cryptocurrency continues to rise here. In The State of Crypto in Singapore survey jointly published by cryptocurrency platform Gemini, personal finance platform Seedly and cryptocurrency tracking website CoinMarketCap, 67% of its 4,000 respondents are currently cryptocurrency holders. Of this, two-thirds said that the pandemic has prompted them to increase their cryptocurrency investments.

In terms of their reasons for investing in cryptocurrency, 81% of the cryptocurrency holders said buying and holding cryptocurrency for the long-term investment potential is the top reason to invest in cryptocurrency. This is followed by 58% who trade to earn profits and 43% who have used cryptocurrency deposits to earn interest.

Are Singaporean investors truly ready for more sophisticated cryptocurrency products and riskier investments related to the asset class? Lim says generally, the city state’s retail investors are typically more sophisticated than the rest of Southeast Asia. Financial education has also been very progressive over the last two decades. However, any riskier investments should be fully regulated to ensure consumer protection.

“People here are brought up to invest their money wisely and look at alternative instruments such as options or futures — anything that could attract higher return. The demand is definitely there. But the regulation in this space is very important for consumer protection. So I think when the supply of the more sophisticated products would catch up once the landscape is fully ready for it,” says Lim.

Hosp agrees, adding that some cryptocurrency derivatives can be too risky for the average investor. “If a platform is offering 100 times leverage, I would be questioning if it is an investment or pure gambling. I understand that perhaps the demand might be there, similar to the demand for such products in traditional financial markets.”

He adds: “However, investors should consider less riskier offerings that have cash flow opportunities such as staking and liquidity mining.”

China bans cryptocurrency transactions

Major cryptocurrencies have experienced significant price fluctuations this year, largely affected by the clampdown in China. On Sept 24, Bloomberg reported that China banned all crypto transactions and vowed to root out mining of digital assets — delivering the toughest blow yet to the industry.

China is one of the world’s largest crypto-currency markets. However, the People’s Bank of China (PBoC) has blocked access to all domestic and foreign cryptocurrency exchanges, aiming to clamp down on all cryptocurrency trading with a ban on foreign exchanges, since 2019.

In May, the Chinese government began warning investors against speculative crypto trading. The following month, the PBoC ordered the Ant Group and four state-owned banks to cut off cryptocurrency transactions.

Chinese officials are now going further to stamp out crypto trading for its ties to fraud, money laundering and excessive energy usage, reported Bloomberg. Amid the heightened pressure, mining operations across the country — which had hosted the majority of Bitcoin’s mining power — were also gradually shut following a ban on digital currency mining.

On Sept 24, the PBoC announced that all transactions of cryptocurrencies are illegal, citing its danger towards the “safety of the people’s assets” with offenders facing possible jail time.

The crackdown has already hit the crypto mining industry, reported BBC. In September 2019, China accounted for 75% of the world’s Bitcoin energy use. By April, that had fallen to 46%. Crypto mining, the process by which computers create new virtual currency, requires vast amounts of energy and processing power.

The clampdown — as well as environmental concerns and rising speculations — have caused Bitcoin to tumble over 50% to US$29,971 ($40,813) on July 21, from its historical high of US$63,576 on April 14.

Ethererum, the second largest cryptocurrency, also experienced the same decline. The price of Ether fell to US$1,794 on July 21, from the historical high of US$4,182 recorded on May 12.

As of Sept 26, Bitcoin is trading at US$43,373 apiece, while Ethereum is trading at US$3,017 apiece.

China’s central bank has also been testing its own digital currency — known as the digital yuan — which it has developed since 2014, with plans for it to replace some of the cash in circulation.

The cross-border payments market

Cryptocurrency trading should not be confused with the technology that enables the manufacture of cryptocurrencies, distributed ledger technology (DLT). Eventually, cryptocurrencies may be just a sideshow, valued at a few billion.

Following the five phases of “Project Ubin”, launched by the Monetary Authority of Singapore (MAS) to experiment with central bank digital currencies (CBDC), DBS Group Holdings, JP Morgan and Temasek set up Partior in April this year.

With DLT and blockchain, the open source Partior platform has set its sights on developing wholesale payments based on digitised commercial bank money to enable “atomic” or instantaneous settlement of payments for various types of financial transactions.

If Partior — which means “to distribute and share” in Latin — is accepted by banks globally, it would disrupt one of the largest markets in the world. Accounting firm EY estimates that the cross-border payments market is worth some US$148 trillion ($201 trillion).

By next year, it will reach US$156 trillion, growing at a CAGR of 5% a year. The bulk of the market comprises business-to-business (B2B) transactions.

Traditionally, cross-border payments flow via the correspondent banking network (CBN) which most front-end providers use to settle their payments. Ideally, Partior will enable a point to point transfer immediately, without the need for a CBN.

“New back-end networks have emerged to optimise cross-border payments and enable interoperability between payment methods and provide senders with more possibilities to reach the receiver,” EY notes.

MAS Chief FinTech Officer Sopnendu has said that Partior is likely to be a “a global watershed moment for digital currencies, marking a move from pilots and experimentations towards commercialisation and live adoption”.

Partior, he adds, is a step towards a global infrastructure for transacting with digital currencies in a trusted environment.

From left: Insead professor Antonio Fatas, Cake DeFi CEO Julian Hosp and Zipmex CEO Marcus Lim

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