Digital assets are turning into a litmus test for global financial centres. Regulators are competing to set rules that are effective enough to establish their jurisdictions as responsible hubs for digital finance, but not so onerous that they strangle the market for innovations like cryptocurrencies, stablecoins and non-fungible tokens. Two early cases when it comes to effective regulation are the United Arab Emirates (UAE) and Singapore.
The dash for hub status
With no central repository of information, blockchain-based assets like cryptocurrencies are hard to regulate at a national level. That makes a global approach important. Singapore and the UAE are great examples of markets ahead in terms of the environment they have created for digital assets. However, they arrived at their destinations via different routes.
Let’s start with the UAE, which has long sought to diversify its economy away from its reliance on energy markets. To this end, it moved as a matter of national strategy into fields like financial services, manufacturing and sustainable enterprises, investing in new technologies and building a skilled workforce for the future. Digital assets, then, are a logical element of this diversification.
When it comes to regulation, the UAE differentiates between onshore and offshore, with the latter referring to companies that are based in the UAE but regulated on an international basis. In the emirate of Abu Dhabi, for example, the Abu Dhabi Global Market (ADGM) launched in 2018 as the region’s first comprehensive crypto-asset regulatory framework. This was later updated to cover the term virtual assets1 in line with the guidance issued by the intergovernmental Financial Action Task Force (FATF).
That alignment has allowed Abu Dhabi to attract digital businesses to the emirate, seeding the start of a mutually reinforcing nexus of firms, talent and job openings. In April 2022, for instance, the ADGM licensed Kraken, the first large US-based cryptocurrency platform, to operate in the UAE as a regulated crypto-assets exchange and custodian.2
The emirate of Dubai is also engaged: Dubai Financial Services Authority, regulator of the special economic zone, the Dubai International Financial Centre, has recently consulted on rules related to virtual asset businesses. In February 2022, Dubai established the Virtual Assets Regulatory Authority and legislated to create an onshore industry for virtual assets as well as an offshore one.3 Adding impetus to the UAE’s regulatory roll-out is that it faces mounting regional competition, with Bahrain and Saudi Arabia also seeking to encourage crypto-business.4, 5
The push factor in Singapore
Singapore saw a somewhat different push-pull equation. From 2013 onwards, the city-state began to naturally attract Bitcoin exchanges, brokers and ATMs, a flurry of innovation that left regulators in catch-up mode between 2017-2020. This process is now complete: the Financial Services and Markets Bill, passed in April 2022, bringing Singapore fully in line with FATF standards and establishes a rigorous set of controls.6
In its explanatory note on the legislation, the Monetary Authority of Singapore – the city’s financial regulator – said it considers that all transactions related to digital-token services carry higher inherent money-laundering and terrorist financing (AML/CFT) risks due to their anonymity and speed. These two factors, though, are part of the tokens’ appeal, and while many legitimate traders appreciate them, they inevitably also appeal to criminals seeking to trade illicit materials, launder money or breach international sanctions.
This aspect of cryptocurrencies, however, is no longer a barrier to effective oversight, with the growth of data analytics around cryptocurrency blockchains helping regulators bring the rule of law to the digital frontier. The emergence of firms like Chainalysis, Elliptic and TRM Labs affords greater visibility over which crypto-wallets are associated with bad actors when it comes to the most popular protocols like Bitcoin and Ethereum. The latest analytics tools can reveal the kinds of entities operating on crypto-exchanges, and even detect attempts to obfuscate the source and destination of funds.
These analytics technologies along with robust know-your-customer regulations provide a basis for effective due diligence, AML/CFT controls and sanctions enforcement. Indeed, far from being secretive, cryptocurrencies are now arguably more transparent than the fiat economy, given the transparency innate to distributed ledgers.
Yet herein lies a tension. Regulations must be designed in such a way that mitigate AML/CFT risks, but without eliminating the pseudonymity that is part of the appeal of crypto currencies. If analytics reach the point of depriving cryptocurrency users of basic privacy when it comes to payments, the market as a whole could flounder.
The future of the middle ground
Another tension lies between banks and financial centres that see digital assets as an opportunity, and those that see them as a threat. With the advent of Ethereum, which allows for the issuance of an unlimited number of tokens, there is a burgeoning market for securitised coins backed by everything from traditional equities to shares in artworks and physical assets. Some regulators even envision a future of digital securities that do not need intermediaries to trade, further enabled by the advent of official central bank digital currencies (CBDCs).
Although the market for digital securities is relatively small compared to cryptocurrencies – the market capitalisation of which reached nearly US$3 trillion in late 2021 before tumbling in the months afterwards7 – it is likely to grow rapidly.8 Consequently, banks need to adapt if they are to survive the potentially sizeable cost-savings and disintermediation that tokenisation is beginning to offer issuers.
The most adept banks will be able to leverage their understanding of the regulatory and risk environment surrounding digital assets to guide their clients through what is a fast-evolving and volatile market. This is particularly true of jurisdictions like the UAE and Singapore, which act as investment gateways to the wider Middle East and Asia respectively, including to emerging and frontier markets.
Banks that are well-versed in navigating those markets, and are experienced in dealing with complex company and regulatory structures, are ideally positioned to advise clients on maximising the opportunities presented by digital assets while minimising the risks associated with them. In future, these banks may even be able to shoulder the technological burden of managing blockchain infrastructure, alleviating not just the compliance burden but the technological burden on the issuer – though this would require most to staff-up in terms of technical and operational expertise in digital assets.
While Singapore and the UAE took different routes, what unites their emerging regulatory emphasis is a focus on client protection. Protecting issuers and investors in digital assets from market manipulation and abuse, as well as preventing their entanglement in AML/CFT and sanctions-related compliance problems, is fundamental to establishing a digital financial centre that enjoys the confidence of participants.
For their part, banks must align with this goal, because when it comes to digital assets, banks cannot simply be the infrastructure – they must provide protection for their users as well. Only by knitting together the robust institutional focus and appropriate regulatory framework will financial institutions, and financial centres, be able to establish themselves as safe, dynamic hubs for the future where digital-assets will play a central role.
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