How should The Bahamas respond to the FTX debacle?

The potential failure of FTX represents a bump in the path of The Bahamas in its effort to establish itself as a major digital asset center. However, nothing about this development is anywhere near fatal.

There should be no doubt that some reputational issues will emerge from this event. There will be jurisdictional pressures, from both sovereigns and supranational organizations.

There is certainly likely to be those who seek to leverage the development to further their ongoing agendas and perpetual attacks.

I maintain though that the vision for digital assets leadership remains viable and what is transpiring should be seen as a defining and refining of the options that are viable for pursuit. Alternatively, the ones that are not so highly viable for pursuing.

In May of this year, on the release of the digital assets white paper, I stated the following: “We [I] believe that the focus should be on the technology while seeking to benefit from what is currently evolving.

“The technology in the interim will be disruptive in different ways to financial services and must therefore be carefully managed.

“The financial values that are being observed today may very well fall away but we must be mindful that it could take a system with it.

“Regulations, risk management, compliance and strategic thinking become paramount as this evolves.”

I still maintain this position and underline the fact that what obtains in the crypto space today, largely outside the reach of stringent regulatory oversight, is not sustainable.

The recent announcements regarding FTX’s challenges, especially because it has its headquarters here in The Bahamas, draw the vagaries of the crypto currency sector into sharp focus.

Based on public reporting, being mindful that some may be speculative, FTX ran into a liquidity roadblock. That’s about the sum of the issue except that the foundations for such a roadblock has to be seen as being largely self-created with an operation seemingly lacking in sufficiently robust internal limits and triggers to protect liquidity.

We are also mindful of the speed with which these assets themselves can become illiquid – having no buyers.

Earlier this year, we saw the spectacular failure of Terra Luna, the reputed stable coin that turned out be an algorithmic-stable coin.

In other words, while it should have been backed with real assets, it was in fact being supported by complex mathematical calculation.

The lesson was clear. There must be closer regulatory oversight. The once prevailing argument that crypto should remain generally unregulated is untenable.

It is my view that regulators and industry will need to work together to create a mechanism which consistently balances movements in value with “reserve requirements”.

What those requirements look like is a matter to which we must apply an open mind but remain firmly guided by the overarching objective of protecting investors.

The risk management regimes must be reflective and responsive to the operational practices of the industry and should be informed by the plethora of recent failures and the speed to failure. The incidence of failure suggests that this is not currently the case.

The seemingly accepted industry practice of entities saving each other could become a potent regulatory tool where as a condition of licensing the need for contingency arrangements must be evident.

This could be a requirement for cross agreements with like size entities which has the ability to buy out the distressed entity in a crisis.

The big question on the lips of many is what does this mean for the country.

The reality is that what has transpired is a manifestation of the risk inherent in that sector without the necessary regulatory checks and balances.

I believe therefore that we should be focusing steadfastly on these incidents with a view of extracting lessons for making adjustments.

Terra Luna delivered lessons on stable coins and by implication, the potential value of CBDCs (such as the sand dollar).

FTX is delivering lessons on settlement risks and the faults of a purely virtual assets business model.

By implication, it should draw our attention the value of NFTs, the underlying utility of block chain technology, the value and utility of smart contracts and its potential to redefine operational practices in the traditional finance and banking sectors.

The recurring incidents are pointing to the inherent risk of the industry including reputational risk for jurisdictions. As the country moves forward with its digital asset strategy and ambition we must therefore consider what risk treatments are necessary from both industry players and regulators. This must be the focus.

As the prime minister is currently championing the cause for carbon credits, so too, if we are committed to the course, must we have an evangelist calling for greater scrutiny. Done strategically and well, the potential to gain clear regional and financial center leadership is immense.

This approach should be supported by “regulatory activism”, privately from regulators and publicly from concerned industry groupings.

Ultimately, if the country is to build a firm digital asset presence, it cannot rest on the foundation of operations that could be “here today, gone tomorrow”.

The challenges are by nature global and this will therefore require regional and international regulators and international organizations, such as IOSCO and Bank of International Settlements, taking steps to restrain the looseness of the sector.

As an example, it should not be allowable that players can legally send market signals by tweets and similar means.

The main point here is that the crypto sector has to moderate more to the well-developed requirements of the security sector, maybe in nuanced ways so as not to lose its essence. It is evident that such an approach is necessary to protect the investor.

The idea that the crypto sector can continue to resist regulation at the current level is yesterday’s discussion and can no longer be tolerated.

We should, however, be very careful not to seek to apply normal regulatory approaches that may destroy the business models.

The FTX story is an unfolding one. We should resist the temptation to draw hard conclusions in any direction at this point.

We should be convinced that government, regulators, industry and committed minds, properly engaged, have the ability to find the viable and profitable paths forward, consistent with the stated strategy.

As a country, certainly the task of regulators is to observe, question, learn and shift our focus to be able to embrace and exploit these disruptive developments, seeking to leverage them for national gain.

• Hubert Edwards is the principal of Next Level Solutions Limited (NLS), a management consultancy firm. He can be reached at
info@nlsolustionsbahamas.com. Hubert specializes in governance, risk and compliance (GRC), accounting and finance. NLS provides services in the areas of enterprise risk management, internal audit and policy and procedures development, regulatory consulting, anti-money laundering, accounting and strategic planning. He also chairs the Organization for Responsible Governance’s (ORG) Economic Development Committee. This and other articles are available at www.nlsolutionsbahamas.com.

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