FTX, the failed crypto exchange that filed for bankruptcy protection in November after a customer run on the exchange revealed an $8 billion hole on its balance sheet, has damaged not only the crypto asset industry, but also the reputation of the Bahamas, where the company was headquartered.
Industry observers are now fearing that the wider Caribbean and offshore jurisdictions in general could be hit by the reputational fallout.
Last week, Bloomberg published an article suggesting that the biggest red flag in the FTX fiasco may have been that the company relocated from Hong Kong to the Bahamas.
Pirate islands
The article by Stephen Mihm, history professor at the University of Georgia, said FTX founder Sam Bankman-Fried was just the latest in a string of notorious characters whose business interest have been tied to the islands, ranging from pirate Blackbeard to organised crime bosses and financial fraudsters.
“For centuries, the island nation has been defined by its close ties to dodgy, even criminal finance. Far from being an anomaly, FTX was simply the latest in a long line of sketchy enterprises,” he wrote.
At the Caribbean Conference on Corruption, Compliance and Cybercrime 2022 last week speakers expressed concern that the region as a whole could become the unwitting victim of the criticism levelled at a perceived lack of regulatory oversight of FTX in its host country.
Speaking on a panel discussing the crypto exchange’s collapse, Oliver Gale, co-founder of financial software company Bitt in Barbados, said, “The big concern is that this undoubtedly will have a reputational blowback on the region as a whole,” even if it should not, because each jurisdiction has its own distinct legal framework.
Danger of new blacklists
His fellow Bitt co-founder Gabriel Abed referenced the Bloomberg article stating the region’s reputation was “sullied”. “Again, we’re seen as the home for pirates, and that is quite sad to me,” he said.
He believes the deficiencies in the Bahamas could trigger another blacklist for inefficient or improper regulatory environments.
“That’s going to burn us [the Caribbean] harder than anything else.”
Abed, who is now ambassador of Barbados to the United Arab Emirates, said some years ago one of the largest crypto exchanges was looking at Barbados as a hub. Government representatives told the company that existing regulations could be applied to the exchange’s business model but that would require the separation of user funds via custody and a separation of brokerage and trading.
The exchange argued that, in the new crypto world, things should be done differently with exchanges acting both as custody agents and brokers, enabling users to trade directly with the exchange.
Barbados did not budge, maintaining that new technology should not trump due process and customer protection, and, as a result, missed out on potential business and investments, Abed said.
In hindsight, FTX had confirmed the exact concerns raised at the time. “Now that we can look back at it, maybe we dodged a massive bullet on this one,” he added.
Speaking on the same panel, Christopher Malcolm, a former attorney general of the British Virgin Islands, said, in an ideal world, the entirety of the Caribbean should not be affected.
“But in reality, we will all be affected by what has happened, because the OECD and all the others looking on will say there goes another instance again of the Caribbean demonstrating that it is biting off much more than it can chew.”
Corporate governance
However, speakers also noted some shortcomings when it comes to regulating crypto businesses in the region.
Malcolm pointed out that, as far as corporate governance was concerned, FTX had a management board, but he questioned what capability that board had to effectively influence how the entity operated.
He suggested a lot more attention should be paid to conduct of business regulation rather than purely prudential regulation.
Malcolm noted that Antigua, where FTX initially set up a business corporation, and the Bahamas have similar company laws that, in order to attract business, allow shareholders unanimously to constrain the capacity of the board to act and carry out what would ordinarily be fiduciary obligations.
“In the interest of laxity, in some instances, in the interest of what we consider to be a capacity to compete with others, we have set out some environments which allow for boards not to be able to do what they traditionally would be able to do,” he said.
Regulatory arbitrage
Gale, who is now involved with Panther, a privacy-focused cross-chain protocol, argued that some of the crypto instruments that are traded should be classed as securities or credit instruments and fall under existing legislation, which in many cases would mean they should not be available to retail investors.
He further noted there is a general assumption among crypto entrepreneurs that they cannot operate in the United States because regulations there are overly restrictive or unclear.
“So, when you’re looking for offshore businesses, you’re trying to find the perfect marriage between trustworthy and credible and permissive. And what ends up happening is bad actors look for the most lax regulatory framework they can find. So there’s this game of regulatory arbitrage, which is happening on a global scale.”
The threats and the downside to this arbitrage becomes visible with FTX, in terms of reputational damage, potential fraud and customers losing their funds, Gale said.
At the same time, he added, “regulatory arbitrage is also the opportunity that particularly this region needs to be mindful of and find a way to harness responsibly to drive our economic growth through this 21st century”.
Gale said he is concerned that the FTX debacle could trigger a regulatory overreaction, when, in fact, appropriate controls were needed.
He said, “One wonderful thing about blockchain technology is that it does improve accountability, transparency, verifiability and efficiency.”
Abed agreed saying, “We shouldn’t let a century-old business model that was using inefficient regulation and oversight to pass a broad stroke of negativity against the technology”.
Jurisdictions need to be selective
However, FTX showed that Caribbean jurisdictions needed to be selective and careful in how they take on the crypto industry. “I’m not saying that we can’t focus on a specific area and get it done right. I’m saying that it requires us to be very careful in how we approach this industry,” he said.
Abed added, “I don’t believe any small island developing state is equipped to take on this technology.”
Regulators, that are frequently under-resourced, understaffed and undereducated, simply cannot keep up with this rapidly evolving field, he argued.
Therefore, “many of these companies should not be operating from our shores, because we simply cannot effectively police and force the responsible regulation required to allow these systems to operate, while avoiding systemic risk and user risks.”
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