With the consecutive lawsuits filed by the U.S. SEC against two cryptocurrency exchange giants, the cryptocurrency industry is gradually transitioning from its initial wild growth phase to becoming more compliant. Apart from Bitcoin and Ethereum, which have not been classified as securities by the SEC, over 50 cryptocurrencies have been categorized as securities by the SEC, including even BUSD, widely considered a stablecoin, while the remaining survivors might be only exempt due to their small scale.

The nature of cryptocurrency remains financial, and the financial industry is inherently highly regulated, using rules to counteract inherent human greed and bad behaviour. Without understanding regulations, navigating the cryptocurrency industry can be challenging.

In addition to the significant actions taken by the U.S. SEC, other countries and regions have their own initiatives. Of particular concern are the two major financial centres in Asia, Hong Kong and Singapore, with their cryptocurrency-related policies attracting significant attention.

Why has the US SEC taken action？

The SEC was of the view that various cryptocurrencies are unregistered securities. According to the SEC, under US law, these assets would be viewed as investments where purchasers of the assets are expecting to earn profit from others’ efforts. Some of the named cryptocurrencies were also accused of having inappropriate marketing, indicating the growth in token price with a view to encouraging investors to buy their tokens for outsized profits. Setting aside the regulatory angle, some implications of and hidden risks behind “unregistered securities” are:

- The issuance structure, process flow or risk management measures might be unsound.

- Investors might not receive comprehensive information disclosure.

- The executive team might lack professional finance know-how.

- Underlying assets might not be properly segregated.

For the above reasons and others, the SEC has publicly condemned these projects.  It should be noted that the above points are all circumstances which can adversely impact investors.  Furthermore, the cryptocurrency industry is known to have incidents of price manipulation (‘pumping and dumping’), which is prohibited in the financial sector.

In other words, if an asset has not properly registered as a security and fulfilled the compliance standards imposed by regulators, investors  in such cryptocurrency assets would have to purely rely on their trust of the relevant project teams. Investors expect those teams to deliver expected products in the future. But for teams without a proper track record, this kind of trust can only be justified as a result of FOMO (fear of missing out) in a certain market movement, which could well end up as a financial market meltdown in the near future.

As a regulatory compliant DEX based in Singapore, DigiFT follows a rigorous registration process for the assets issued on our platform to provide maximum protection for investors. Below, we proceed to share Singapore’s legal framework for security tokens as well as some of our practical experiences in facilitating security token issuance.

The role of regulation in finance

Singapore is one of the largest financial centres in Asia. The Monetary Authority of Singapore (MAS) has been proactive in creating a supportive environment for the development of innovative financial technologies. Singapore also has a well-established legal system, strong infrastructure, and a business-friendly environment. With Singapore’s competitive tax policies (e.g. low corporate tax, tax incentives for startups, and no capital gain tax), Singapore continues to attract investors to its shores.

The purpose of MAS’s regulation is to protect investors, which has benefits for the whole financial system. The messaging from MAS and the broader government have been quite clear. In Jan 2022, MAS released its Guidelines on Provision of Digital Payment Token Services to the Public, reiterating that MAS has consistently warned the public that digital payment tokens (DPTs), which cryptocurrencies are classified as under Singapore laws, is highly risky and not suitable for the general public. In August 2022, the Managing Director of MAS, Ravi Menon, stated at a Greenshoot event: “Yes to Digital Asset Innovation, No to Cryptocurrency Speculation”. The Deputy Prime Minister and Minister of Finance, Lawrence Wong, has also stated: “... Cryptocurrencies are a different matter [from security tokens]. [Cryptocurrencies] are purely speculative as an investment asset and have no intrinsic value. That is why MAS has consistently warned the retail public not to deal with them.”

Besides protecting investors, from a company’s perspective, being compliant can also have various benefits, such as:

- Minimizing legal and compliance risk.

- Building trust and credibility with stakeholders.

- Improving operational efficiencies and risk managements.

- Promoting responsible and sustainable business.

Of course, being compliant comes with costs, including regulatory costs, services restrictions, and privacy issues.

It is also important to note that decentralization does not necessarily mean deregulation. Regulations require a company to establish proper governance and internal controls, and developing a compliant company is a slow and steady process.

So how does the Singapore government regulate crypto? Let’s have a deep dive into Singapore’s crypto regulatory framework.

How does the Singapore Government regulate crypto?

Payment Service Act (“PSA”)

The main legislation for cryptocurrency in Singapore is Payment Service Act (“PSA”), and it’s regulated by the Monetary Authority of Singapore (“MAS”). Under the PSA, most cryptocurrencies are considered as Digital Payment Tokens (“DPT”). Currently, if you are buying or selling crypto as a service or operating an exchange, which involves exchange between a DPT and another DPT or between DPT and fiat currency, you will need a licence under PSA for providing the DPT services. Once the Payment Services (Amendment) Act (“PS(A)A”) comes into force, if you are handling crypto in any way, as a service, you will likely need a licence under PSA for providing the services involving DPT. The scope of DPT services basically will expand significantly under the PS(A)A.

Securities and Futures Acts (“SFA”)

Another main legislation is security token regulatory regime, the Securities and Futures Acts (“SFA”). Any cryptographic token that is deemed as a security (“security token”) needs to comply with the relevant provisions of the SFA. To be in the business of offering security tokens, it potentially require either one or both of the following two licenses: Recognised Market Operator (“RMO”) license, which is to operate a security token exchange, and Capital Market Services (“CMS”) license, which is to market capital market products (“CMPs”), for example, securities, funds, etc.

Under SFA’s definition, CMPs means any securities, units in a collective investment scheme, derivatives contracts, spot foreign exchange contracts for the purposes of leveraged foreign exchange trading, and such other products as the Authority may prescribe as capital markets products. Here, unlike U.S SEC using “Howey test”, “securities” means:

- Shares, units in a business trust or any instrument conferring or representing a legal or beneficial ownership interest in a corporation, partnership or limited liability partnership.

- Debentures, or

- Any other product or class of products as may be prescribed.

SFA regulates those CMPs, with all perspectives regarding what, who and how. For example, SFA controls which services are CMP-related and who can offer them (licensing), what one needs to do to sell CMPs (e.g., disclosure), how one can market or advertise CMPs (restrictions), and what penalties are imposed if one breach those provisions.

Our practice: DigiFT, a regulatory-compliant DEX in MAS Sandbox

Of course, being a DEX in MAS’s Fintech Sandbox, DigiFT’s business model is in line with all the regulations mentioned above. Since the blockchain is an unprecedentedly transparent, accurate, complete, and timely data ledger, it can enable real-time execution, clearing and settlement, without using intermediaries.  Building an exchange based on blockchain can dramatically increase efficiency and reduce costs, and that’s what DigiFT is currently building.

DigiFT is the first and only regulatory compliant DEX currently in MAS Sandbox. Some might say that as a decentralized exchange, 'regulatory compliance’ is a grey area. However, DEXes can also be regulated, albeit with a different paradigm and legal freamwork. The main purpose is to create a fair, orderly, and transparent marketplace. Besides the relevant legal and compliance frameworks and documentation, from a technological perspective, DigiFT has developed several features to achieve that goal:

- Frontrunning prevention. MEV (Maximal Extractable Value) affects billions of dollars of trading volumes every week. The root cause of MEV is the informational advantage held by certain traders, creating an unfair market situation that needs to be avoided. DigiFT addresses MEV by ensuring that all transactions submitted during a block are settled in the same price, which means MEV bots would be unable to benefit from slotting front-running transactions.

- Circuit break implementation. In extreme market conditions, circuit breaker mechanisms can protect the market by preventing excessive volatility and sharp fluctuations. They help mitigate systemic risks, provide the market with a cooling-off period, and prevent the spread of panic sentiment.  DigiFT has implemented circuit breakers for each security token in line with expected price fluctuations to ensure that excessive price volatility is minimised.

- Robust legal structure and asset segregation. DigiFT provides investors with robust legal frameworks for all the assets on the platform, with assets custodied on qualified custodians. Investors’ own assets are self custodied to have full self-control of their own wallets.

- Know your customer (“KYC”) + Know your wallet (“KYW”) + Know your transactions (“KYT”). While the blockchain is an anonymous environment, anti-money laundering (“AML”) and counter-terrorism financing (“CFT”) regulations require identity verification for real-world individuals. Through combining KYC with KYW measures performed on customers’ wallet addresses, and by tracing transactions associated with those wallets, we can achieve real-time monitoring for suspicious financial activities.

Challenges and future directions

New technologies, particularly in the financial sector, require collaboration between professionals and regulators. It is important to broaden the boundaries of technological use and enhance social efficiency while maintaining system order. Communication and understanding take time, and in the vibrant cryptocurrency field, new technologies and innovative applications continue to emerge. Compliance in the Web3 industry still has a long way to go, but for DigiFT, we intend to continue making slow but steadfast progress on this journey.

About DigiFT

DigiFT aims to provide regulated decentralized finance solutions on the Ethereum public blockchain. We are operating the first regulation-abiding decentralized digital asset exchange where asset owners can issue blockchain-based security tokens efficiently and cost-effectively. Investors can trade with continuous liquidity via an AMM mechanism and retain control over digital asset tokens in their own wallets. We are a global outfit backed by well-established venture partners. The founding team originates from international financial institutions and has deep blockchain technology knowledge.

For more information, please contact:

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Disclaimer:

This article and its contents are prepared solely for informational purposes only and do not replace independent professional judgement. Under no circumstances should the information contained herein be used or considered as an offer to sell, or solicitation of an offer to buy any security. The content of this presentation is proprietary and no part of it may be reproduced or redistributed without the prior written consent of DigiFT Tech (Singapore) Pte. Ltd. (“the Company”). This article contains public information as of the specified date, and may be stale thereafter. No representation or warranty, express or implied, is made as to the fairness, accuracy or completeness of the article and the information contained herein and no reliance should be placed on it. None of the Company, its advisers, connected persons or any other person accepts any liability whatsoever for any loss howsoever arising, directly or indirectly, from this article or its contents. All information, opinions and estimates contained herein are given as of the date hereof and are subject to change without notice. This material should not be viewed as advice or recommendations with respect to asset allocation or any particular investment.