Just a couple of years ago, governments and regulators were proposing regulations that encourage decentralised finance (DeFi) experimentation, such as sandboxes and special passes, rather than preventive regulations targeting specific functions or actors. However, in light of recent revelations to the fragility of the DeFi market, regulatory sentiment has shifted. In particular, the shifts in the tone and approach have affected the relative attractiveness of Singapore and Hong Kong as large cryptocurrency markets in the world.
Both Singapore and Hong Kong aim to create an environment that attracts capital and investment while also providing adequate protection for investors and customers. But international capital flows are fickle, particularly in the DeFi market, which has less regulation and oversight. Minor changes in regulatory attitudes may set off capital flights. Regulators in both cities face a difficult balancing act as they compete to attract capital flows.
Recent lessons
Much of cryptocurrency markets seem to be speed-running financial history and the various lessons that led to today’s deluge of financial regulations. It starts with basic things like the safekeeping of client assets—something that the now-defunct cryptocurrency firm FTX notoriously did not do, as its affiliated trading arm Alameda Research used client assets to make large directional bets in the cryptocurrency market. The recent arrest of co-founder and then CEO of FTX Sam Bankman-Fried is also a wake-up call of the real consequences of wrongdoing in that market.
Singapore learned a painful lesson as Temasek was forced to fully write down its US$275 million investment in the ex-second-largest cryptocurrency exchange in the world. The incident also implies the trickiness of balancing innovation and safeguarding.
And even before this, Singapore was the grounds for the collapse of Three Arrows Capital. This crypto hedge fund owes creditors over US$3 billion—an amount under management well over the regulatory license they held with the Monetary Authority of Singapore.
Hong Kong is not without its own issues. Cryptocurrency trading service Genesis, headquartered in the special administrative region, also ceased withdrawals following the FTX collapse. Just in November, Hong Kong’s Securities and Futures Commission considered a new regulatory regime that potentially allows the launch of exchange-traded funds with exposure to Bitcoin and Ether. This move, in competition with the Chicago Mercantile Exchange among others, intensifies the race to the bottom.
Strong competition
Cities vie to be financial centres to attract capital flow, and cryptocurrency is part of the equation. Hence, cities are not banning cryptocurrency, even if they discourage retail investment in cryptocurrency.
Singapore has banned cryptocurrency advertisements targeted at retail investors. But the country is also frank about the limits of its protection. Singapore’s Deputy Prime Minister and Finance Minister Lawrence Wong had said in Parliament that cryptocurrency platforms could collapse due to fraud, unsustainable business models or excessive risk-taking. “No amount of regulation can remove that risk” of cryptocurrency losses.
In the face of FTX’s collapse and misconduct from the unauthorised use of customer funds, the Monetary Authority of Singapore stated that while FTX does not operate in Singapore, it is impossible to prevent Singapore users from directly accessing overseas providers.
Regulatory measures such as the segregation of client and firm assets are in the works. This is something foundational to broker-dealer regulations around the world and could improve the situation. The ban on cryptocurrency advertisements for retail investors, though, may make them more in the dark or push them to other places.
Viewed through the lens of regional competition, the Monetary Authority of Singapore’s response makes sense. It fears clamping down on cryptocurrency too hard would simply push funds and talent abroad.
Hong Kong’s potential winner’s curse
Geopolitics in Hong Kong has put it in a weaker position compared to Singapore, as skilled talent has swarmed from the special administrative region to the city-state. Political stability in Singapore is better. However, due to China’s unfavourable attitude towards cryptocurrency, activity may flow over to Hong Kong as it acts as the conduit for Chinese participants.
The Hong Kong Securities and Futures Commission issued a statement that crypto savings and staking products are not protected like bank deposits. In fact, some products may be unlicensed investment funds for which the offerer could face a fine and prison time. Whether the Hong Kong market can ride out the aftermath of FTX’s collapse remains to be seen. At the time of writing, another cryptocurrency firm, Atom Asset Exchange, has suspended customer withdrawals.
Given the current economic outlook, Hong Kong’s regulators may be approaching an excessive risk-taking territory. This could be potentially dangerous for investors and customers. The biggest market for cryptocurrency attracts the most capital but it is also where the biggest risks lie.
In an interview with The Straits Times, Ethereum blockchain co-founder Vitalik Buterin has commented that “if you get a certain kind of reputation, it’s very easy to accidentally attract all of the Do Kwons”, referring to the controversial Terraform Labs founder Do Kwon, whose stablecoin TerraUSD had collapsed spectacularly.
Overall, cryptocurrency regulations in Singapore and Hong Kong have been changing in the past few years, moving from regulations that encourage experimentation like sandboxes to preventive regulations that ban specific wrongdoing. Regulators in both cities face a difficult balancing act, as they must compete to attract capital flows while also ensuring customer protection with more stringent rules. There are benefits from adopting and enforcing regulations that improve stability, although competitive pressures to attract more capital make it an unfortunate prisoner’s dilemma.
The article is an edited version of the first one published in ThinkChina.