What the US can learn from the Philippines to regulate crypto smarter
The failure of some of the giants of the crypto industry and the subsequent fallout last year serves as a much-needed wake-up call for the entire industry. Over the past year, hundreds of billions of dollars have been lost to the likes of Celsius Network, BlockFi, Voyager Digital, Genesis and FTX. Most recently, the contagion has spread to the crypto-related banks, with Silvergate, SVB and Signature banks all collapsing within a week.
After these events, I am more convinced than ever that the future of this space depends on sensible regulation, and this is the only way to maintain the confidence of consumers who use crypto exchanges to explore the world of digital assets.
One of the biggest collapses was from Sam Bankman-Fried’s FTX empire. FTX claimed to welcome regulation, but it’s pretty obvious that this was just a front. Despite its pro-regulation talk, FTX was fundamentally an offshore exchange serving international clients. Yet there are other businesses that support regulation not just with words, but with actions – by obtaining licenses and submitting to central bank audits in the countries where we and our customers are physically located.
Ultimately, however, the crypto industry’s openness to regulation is only half the puzzle. Regulators must be willing to take responsibility to step up and protect consumers in their jurisdictions through proactive regulation – and not just by coming in to mop things up after millions of people are harmed by fraud and business failure.
Why regulators missed major system failures in 2022
It was only after the collapse of the industry giants that regulatory agencies began to file legal charges against the founders. Prior to these collapses, regulators seemed to have missed the massive problems occurring at some of the crypto industry’s biggest and best-known companies. How was this possible?
FTX serves as the best case study, and a good place to start is the fact that it was an offshore exchange, setting up shop in the small jurisdiction of the Bahamas while serving a global clientele.
But as details of FTX mismanagement emerge in the press, account holders and other crypto users may also wonder why America’s powerful financial regulators only learned about and responded to these problems after they had already blown up in the faces of customers, many of whom were American .
The truth is that this is largely how crypto regulation is done in the US – regulation by enforcement. Instead of laying down sensible rules and monitoring firms’ compliance, regulators in the US, and in several other countries globally, prefer to stand on the sidelines until something breaks, then step in with civil and criminal charges.
Over-regulation through enforcement tends to push platforms completely out of a jurisdiction and drive them offshore, which is where these wild west environments thrive. The consequences of that are now clear.
Go back to basics
Another problem is that regulators in some countries are too focused on surface-level issues rather than execution-level details. In some places, regulation has become a major debate over definitions, such as the question of which tokens should be considered securities. This may be of interest to legal researchers, but the answer ultimately has little to do with whether consumers’ funds are safe.
Although many regulators in developed markets are concerned with these largely academic questions, other financial watchdogs around the world have a much more pragmatic focus on the fundamentals of customer protection: things like know-your-customer (KYC) and custody of assets.
In places like our home market in the Philippines, regulators are diligent in monitoring matters at the execution level to protect consumers. Virtual asset service providers are regulated by the Bangko Sentral ng Pilipinas (BSP), the central bank of the Philippines, which has a good understanding of the industry and is very focused on practical issues.
Measures against money laundering (AML) are still a central part of regulation around the world. The G-7’s Financial Action Task Force’s travel rule is the kind of standard we’re likely to see more strictly applied to crypto market participants in the coming years. It requires VASPs to record the identity of both senders and receivers for all transactions over USD 1,000.
Custody is another core issue. Only a framework of active regulation and auditing can help ensure that financial platforms have solid balance sheets and act as responsible managers of customer deposits.
It is important to have these basic rules in place through a formal licensing regime as a first step. On this basis, the authorities can delve into other market practices and begin to regulate things like asset commingling, self-trading and trading against clients, just as they do for more traditional financial brokerages and exchanges.
What sound regulation looks like
Let me tell you a little about how the regulatory regime in the Philippines works.
The apex bank directly regulates all crypto exchanges in the country. To operate a crypto exchange one must obtain a VASP license and for additional services other licenses apply, including an Electronic Money Issuer (EMI) and a Remittance and Transfer Company (RTC).
The BSP, the central bank of the Philippines, is also expanding the scope of its crypto regulations to adapt to changing market needs. For example, it recently issued coins with the first Advanced Electronic Payments and Financial Services (EPFS) license, a credential previously reserved for traditional banks.
Like any other regulated sector, AML is one of the industry’s most important compliance issues. As an industry, we have taken significant steps in our KYC processes. For example, the Philippines does not have a uniform national ID card, so the company’s technical systems must be able to recognize valid ID documents from all over the Philippines, which has 82 different provinces.
And perhaps most importantly, the BSP expects the industry to cooperate in quarterly audits where we share information about our balance sheet and disclose the digital assets we hold in our hot wallets and cold wallets. The BSP closely monitors the crypto space and takes a proactive approach to regulation. When FTX went bankrupt, they quickly reached out to find out if there was any potential contagion among crypto platforms in the Philippines, which luckily there hasn’t been.
Regulators in the Philippines and some other jurisdictions have operated a sensible framework based on sound knowledge of the crypto space for years now. When regulators in countries with more developed financial systems say that digital assets are still a nascent asset class and that they are still learning about the space, that is a weak excuse. Clients worldwide should demand much more from the agencies that will look after them.
