In July 2017's edition of Offshore Investment Andrew Radnear wrote on "cyber insecurity". In it he gave a succinct description of cyber currencies, blockchain and distributed ledger technology (DLT). There is therefore no need to repeat such a description here. Andrew also wrote of some of the risks, not least in respect of money laundering. As a supplement to what he wrote, this article sets out the approach taken by one jurisdiction, Gibraltar, in respect of this growing area and seeks to explain why Gibraltar (like Switzerland and Singapore) is making significant inroads into becoming a hub for these activities.
At the end of July this year, GSX Group, which operates the Gibraltar Stock Exchange, announced a significant new shareholder, Cyberhub Fintech Holdings Limited, so giving Cyberhub a strategic ownership stake of the share capital of GSX. This deal took GSX a massive step forward in its aim become one of the world's first regulated exchanges to fully integrate blockchain into its operational processes.
The fact that a small and comparatively new EU stock exchange could embark upon such an ambitious venture and obtain financial support for its realization, is a testimony of how blockchain and DLT has become the most disruptive technological developments since the internet.
The aim of GSX is to develop and implement DLT to facilitate both transactions and settlement. The youthful age of the exchange, plus the fact it currently doesn't have a trading platform means that it can do so with no issues of migration and no resistance from existing players who, in a legacy exchange, would stand to lose some or all of their business (eg those currently undertaking settlements). The speed, low cost, resilience and resistance to error make this technology inevitable and there is considerable first mover advantage to those exchanges that embrace it sooner rather than later.
GSX is one of Gibraltar's leading, but not the only, proponent of this new technology. About two years ago the Gibraltar Government, on the initiative of Minister Albert Isola, decided to develop the jurisdiction as a hub for virtual currencies and, as a natural evolution of this, DLT. A consultative paper was produced in 2016 and this was followed earlier this year by formal proposals to bring part of this sector within the scope of financial service regulation. The critical issue was, what part and how?
Clearly some areas fell within existing regulations as they fell within the definitions of money transmission or E-money. Indeed Xapo, a leading fintech operation chose to be licensed as a full E-money institution.
Led by Government and with strong support from the Gibraltar Financial Services Commission (GFSC) and the private sector, it was agreed that the sector needed to be robust in ensuring adequate safeguards to prevent money laundering and deterring fraud. Therefore, amongst others, the providers of wallets and the operators of the businesses using blockchain technology to transmit or store value themselves needed to be subject to regulatory oversight. Similarly so did exchanges where fiat currency could be transferred into virtual currencies.
It was also agreed that decentralised virtual currencies themselves, provided they met certain criteria and did not fall within existing licensing criteria, would not be subject to regulation.
The new regulatory regime is on course to come into force at the beginning of 2018. However it is already clear that, in creating a regime fit for purpose, Gibraltar has already succeeded in attracting an influx of new entrants, including Xapo. It has also become a leading centre for Initial Coin Offerings (ICO's).
Under the Gibraltar approach the ICO offeror can obtain the ICO "holy trinity" of certainties, namely legal certainty, regulatory certainty and fiscal certainty. Furthermore this entire process can be achieved at the speed necessary to meet the needs of the offeror, partially because Gibraltar permits corporate structures to be used. Firms are also strongly encouraged to comply with the anti-money laundering requirements, even though they are not formally covered by them (but will be under the new regulatory regime).
Having a single regulator to deal with, when compared to up to 53 in the USA is also a major attraction. Many firms now coming to Gibraltar have found the regulator in their home jurisdiction unwilling or unable to provide the certainty necessary to deliver the confidence the offeror wants on the legal compliance of their launch.
Does this mean that all ICOs will succeed? Of course not. Participating in an ICO is a high risk activity and one that should not be undertaken by the retail consumer unless they are willing to potentially lose their entire investment. There is a bubble in the market at the moment that will explode and some crypto currencies will not survive. However the market as a whole will continue and other will deliver high returns. As such it is not a place for the faint hearted.
Bubbles and crashes are how the market operates; they are an inevitable result of human behavior as it interacts with the capitalist system. They cannot be "regulated out of the system". To attempt to do so, as some national and international regulatory bodies have occasionally tried to do, is both futile and foolhardy. It will simply result in stifled innovation and stunted growth. It is far better to design a sound regulatory system that reduces systemic risk and protects consumers whilst accepting that bubbles and bursts will always be with us.
For a number of years I used to lecture at Offshore Investment's Oxford Seminar. I generally covered regulation, anti-money laundering and fraud. However for a couple of years I also spoke on bubbles and their resultant crashes, including the warning signs. Without doubt the current ICO environment is a classic bubble. The market is too frenzied, some of the White Papers too vague and poorly thought out for it to be anything else. A number will fail to deliver a valuable end product and their tokens will be worthless. However this bubble not one like Tulipamania where the speculation was in what were, after all, just flower bulbs. In this bubble there are ICO's of real potential. As such it is closer to the Dot-com bubble which burst early in the new millennium. Within this were companies like Amazon and EBay, hardly poor long term investments. These "pearls amongst the swine" can be identified but not with certainty.
One positive identifier is their being located in an environment with a sound regulatory environment on which the resultant DLT will operate. Therefore the Gibraltar proposals have been welcomed by both the industry and investors. The new regulations will bring far higher structural security for consumers as the wallet they store their crypto currency, the exchange they switch their currencies on, and the block chains on which they are founded, will come under the regulator's supervision and regulations put in place to ensure consumer safeguards are in place. The proposed delegation of powers to the regulator to adapt new regulations and impose requirements on a case by case basis will also build ongoing fitness of purpose to this rapidly changing landscape.
As Nick Cowan, MD of GSX said when announcing the Cyberhub' s investment in GSX: "The transaction clearly demonstrates high confidence in the jurisdiction, despite the current Brexit negotiations, as well as recognition of the Government of Gibraltar's and the Gibraltar Financial Services Commission's initiatives to establish Gibraltar as a global fintech hub. Our operational influence and network now extends to Hong Kong and Singapore and we look forward to establish and grow an Asian – European capital markets pathway."
What Gibraltar has shown is that GSX is not going to be alone in that hub.
Marcus Killick OBE is Chairman of the Gibraltar Stock Exchange and CEO of the law firm ISOLAS LLP. He was formerly CEO of the Gibraltar Financial Services Commission.
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