In June 2022 an institution called Jewel Bank was awarded the first-ever banking licence in Bermuda for a digital bank. It bills itself as “The Digital Asset Banking Platform”, and its launch was hailed by the government of Bermuda as an important development of the jurisdiction’s world-leading regulatory framework for digital assets and FinTech.
Bermuda has form in developing intelligent and flexible regulation, having done so over the second half of the twentieth century to make it the most important offshore centre for reinsurance. The digital asset regulation is no different. In 2017 the Bermuda government announced that it would dedicate resources to developing the territory as a stable and regulated international financial centre for FinTech and digital assets. The primary legislation that came out of this initiative is the Digital Asset Business Act 2018 (DABA), which creates the regulatory framework for “digital asset business” under the supervision of the Bermuda Monetary Authority (BMA). “Digital Asset Business” has been defined broadly and covers numerous activities involving digital assets, if provided to the general public.[i] Following on from DABA is the Digital Asset Issuance Act 2020 (DAIA), covering initial offerings of digital assets.
Under DABA, a licence is required to carry on digital asset business, and three types of licence are available. Under DABA, the licences available are Class F, Class M, and Class T. Class F is a full licence, permitting large-scale digital asset business. Class M and Class T are innovative “sandbox” licences, that serve two main aims. The first is to allow rapidly developing digital asset technology and business models to experiment on a smaller scale, with a reduced risk to firms themselves and to consumers, and a correspondingly reduced regulatory burden. The second is to provide an opportunity for small players to enter the market at reduced cost. For a Class T licence, the minimum net asset requirement is only US$10,000, and the costs of application and the licence itself are only US$1,000 each.
In keeping with this goal of encouraging innovation, Bermuda has also launched its own fund for the purpose. This includes the i3 Incubator, set up to encourage innovation in FinTech, InsurTech, digital asset management, and digital law and compliance, as well as hospitality, tourism, and environmentalism – sectors which are also important to the island.
The wider aims of Bermuda’s bet on digital asset business and FinTech are to increase competition in the financial sector, thus producing cheaper and more efficient services; to increase access to financial services by those who find such access difficult in an age of thick global red tape that especially stifles offshore financial centres; to be an early adopter of future technology; and of course, to provide economic activity for the island. The issuance of licences to Jewel Bank is one such example. Jewel Bank is licensed under both DABA and the Banks and Deposit Companies Act 1999, the latter of which has provided the regulation for more traditional financial institutions as well.
Government sources say that it is not for them to prescribe what technology, or business model, is appropriate and what is not – to do so with a rapidly-emerging technology would be counterproductive. Instead, the regulation provides room for experimentation, but also with safeguards for clients. If clients can trust the innovators and the innovators are free to innovate, without risking clients’ financial wellbeing, this creates a positive feedback loop.
How then do DABA and DAIA create this environment of trust? Under DABA there are a number of safeguards. Accounts for and from digital asset business must be kept separate from any other funds held by a licensed entity. Licensed undertakings holding any client funds must also have a surety bond, indemnity insurance, or a trust account with a qualified custodian to protect these assets. Furthermore, there are requirements to hold enough digital assets (but not hard currency) to cover any obligations to clients, not including the undertaking’s own assets or those on which its creditors may have a claim. Licence-holders must also appoint an approved senior representative to report certain events to the BMA, such as potential insolvency. The BMA retains broad powers to restrict or revoke a licence in cases of malfeasance, or petition for the winding-up of a licensed business. It can also give binding directions to the undertaking to protect client interests. Failure to comply with these directions may result in fines up to US$2m. Accounts must be prepared and audited, shareholders over 10 per cent must be declared and must be fit and proper persons, and the BMA retains powers to object to shareholdings by unfit persons, and even restrict the sale of shares if an objection has been made. The BMA may also investigate licensed undertakings, and impose, or ask the courts to impose, various disciplinary measures in certain cases. There are, of course, proper procedures for, and rights of appeal against, BMA actions. Finally, no undertaking shall be licensed unless its controllers and officers are fit and proper persons, and its business is conducted prudently, with integrity and skill, and with proper corporate governance. Beyond DABA, some activities carried on in the digital asset space may also require further licences, and the general anti-money laundering, anti-terrorist financing, and transparency rules will apply. Digital asset business is not a “relevant activity” for the purposes of the Economic Substance Act 2018. This is a well-regulated framework in which investors can have confidence. In turn, entrepreneurs can benefit from increased investor confidence.
Recent difficulties in the cryptocurrency market may make some sceptical about the prospects for digital assets. However, while caution is advisable with something new and esoteric, the blueprint for Bermuda’s digital asset economy is not predicated on speculative crypto assets, nor have we gone the way of El Salvador and invested public money in such assets. Firstly, with BMA supervision, firms offering excessively speculative or even fraudulent assets are very unlikely to be licenced or permitted to carry on business from Bermuda.
Secondly, the ecosystem that is developing in Bermuda shows that the territory’s ambitions are to create an economy based on offering services to the digital asset world, and services to those firms, rather than trading per se. Furthermore, it should be understood that Bermuda’s environment is not based on cryptocurrency, but digital assets. Cryptocurrency has not yet lived up to its most noble aims as a widely-accepted, “trustless” means of exchange. However, the technology that underpins it, distributed ledgers, has applications to many more types of digital asset, many less speculative than cryptocurrency. What Bermuda has done is create a safe environment in which these applications can be explored, and new applications can be developed. The expectation is that such technology will become widespread, and Bermuda intends to be at the forefront, keeping the risk and reward largely in the private sector, while benefitting from improvements in technology and service.
One such application that already exists is stablecoins. Stablecoins are digital tokens, like cryptocurrency. However, unlike cryptocurrency the token is backed by a real-world asset, often an existing “fiat currency” issued by a central bank. This helps to avoid the wild volatility experienced by cryptocurrency. Stablecoins also offer a solution to a vexing legal issue with many digital assets – fundamentally, are they “property”? In most (if not all) common-law systems, property can be divided into “things in possession”, such as tangible assets, and “things in action”, meaning a thing against which a property right can be enforced, such as intellectual property. Digital assets are arguably neither, which may cause problems in disputes such as those related to interests in the digital asset, or for succession and inheritance, among other areas. There have been some important court cases and government papers around the world, which provide some support for the proposition that digital assets can be treated as property under the law. However, it is submitted that the issue is not yet settled. Stablecoins are arguably more like property in the traditional sense, since the real-world asset backs the token creating a thing in action.
The Bermuda government expects that stablecoins will represent a leap forward in financial technology, and as such plans to accept any stablecoin issued by a licensed entity for any transaction with the government, which may in turn encourage their use in the private sector. The hope is that local stablecoins will address a number of issues that exist in Bermuda’s retail banking and payments architecture. One is that a new banking licence has not been issued for over 20 years and there is little competition to drive lower fees and improved service. It is thought that new digital financial firms will not only provide competition, but can also substantially undercut the existing providers. This will be achieved partially by lower costs associated with the new technology, but also the ability to unbundle services that are currently sold together. For example, in the blockchain environment, custody need not be necessarily paired with lending. That said, it should be noted that the current banking regulation in Bermuda requires licence holders to offer a full range of retail banking services. Such rules do protect the average consumer from being frozen out of the financial system, but they may be worth reconsidering in an age of more agile services.
I hope to have shown that Bermuda has positioned itself to be a centre for the financial technology of the future. In so doing it has left the risks and rewards within the private sector, providing a place for entrepreneurs to innovate and see what works and does not, while protecting investors and consumers. Once again, Bermuda has shown its capacity for regulatory innovation, sailing “whither the Fates lead”, as in our national motto.
[i] S. 2(2) DABA 2018
John Gibbons is Trust Manager at Harbour Trust Company Limited in Bermuda.