Bermuda’s nascent fintech sector has experienced its fair share of failures in the past four years and is now feeling the effects of the high-profile collapse of FTX, the world’s second-largest cryptocurrency exchange. Sam Strangeways reports on whether the potential for jobs and investment outweighs the risks of embracing an industry which includes the volatile virtual currency

January 21, 2022 was a big day for BlockFi International.

The crypto lender had two major achievements that day. It incorporated in Bermuda and it obtained a full digital asset business licence from the Bermuda Monetary Authority, allowing it to provide a range of virtual currency services to international customers.

David Burt framed the situation as he had done before when financial technology companies obtained licences from the regulator or proposed coming here: as a win for the island.

BlockFi’s decision to get licensed here was, the Premier said, a “testament to the regulatory clarity and flexibility that the Bermuda Government and the Bermuda Monetary Authority have been able to establish here”.

BlockFi founder Zac Prince described his company as the "most trusted financial service provider in crypto“, promising that it would open an office here and hire locals. And it did.

But just ten months on, after the dramatic collapse of Bahamas-based FTX Trading, the world’s second-largest crypto currency exchange, BlockFi International has filed a petition with the Supreme Court of Bermuda for liquidators to be appointed.

Its parent company, digital asset lender BlockFi Inc, and eight of its affiliates have filed for bankruptcy in New Jersey, with 100,000 creditors and debts of more than $1 billion. Financial commentators predict that customers are unlikely to get their money back.

Mr Burt, who is also the Minister of Finance, was thrilled that BlockFi chose to come to Bermuda and get licensed under the Digital Asset Business Act 2018.

Developing a thriving fintech sector to help to diversify Bermuda’s ailing economy and create “meaningful jobs” for locals has been one of the key goals of his premiership and he pushed DABA and related legislation through Parliament within a year of the Progressive Labour Party’s 2017 return to power. He acted faster even than the Bahamas.

But should the island have been so quick to welcome BlockFi and should it continue to try to entice other firms dealing in virtual currencies, “certain” of which come with “significant risks”, according to the BMA itself?

Are the failures of so many companies in the fintech space the normal growing pains of a burgeoning new area of finance or evidence that crypto, at least, attracts irresponsible risk takers and bad actors and is close to impossible to regulate?

The latter two questions have come up repeatedly in the four-and-a-half years since DABA was passed, as crypto companies who have stated an intention to set up in Bermuda and hire staff have landed in hot water.

Another question has been asked too: is the due diligence carried out by the BMA and its subsequent oversight of these firms as rigorous as Mr Burt and Next, the recently formed digital assets industry forum, insist?

In an opinion piece published in today’s Royal Gazette, Martin Walker, from the Centre for Evidence-Based Management, asks: “Why is the crypto industry so keen to move to offshore centres and even help draft crypto-friendly legislation?”

He warns of the “exceptionally volatile” nature of crypto and explains that major economies have been slow to bring in regulations because of confusion around the concept and the challenge of so many new products.

Mr Walker argues that when crypto companies talk of wanting “regularity clarity”, what they really want is legitimisation to keep attracting investors.

He further argues: “Legitimisation is clearly easier to obtain in smaller, more flexible jurisdictions.”

The Premier and his chief fintech adviser, Denis Pitcher, are keen to point out — often in tandem on social media — that embracing innovation comes with risk, that such risks help the island to develop its regulatory regime, and that not all fintech is crypto.

Last month, after the FTX fallout, Mr Burt tweeted: “Innovation does not come risk-free and regulation is not a panacea, but strong, experienced oversight is still needed.”

Mr Pitcher tweeted that Bermuda, with its shrinking insurance industry, needed to develop new economic pillars.

“ … if we want to attract other financial services, we have to find and embrace new risks,” he wrote. “What attracts new risks? Disruptive technology.”

He added: “If Bermuda wants economic diversification, we need to be enable [sic] the industry to experiment while managing the risks.”

Mr Pitcher later wrote about a Bermudian reinsurer embroiled in a fraud case in the 1980s as the island’s reinsurance sector was forming.

He tweeted: “Bermuda similarly had a whole host of issues with captives writing unrelated risks. Bermuda learned and adapted.”

And they also argue that Bermuda’s regulator, the BMA, has a hard-earned global reputation for rigorous vetting and due diligence.

BlockFi, a crypto company, is one of 16 firms presently licensed by the BMA to carry out business activities involving digital assets. Many of those companies, though not all, work with virtual currencies.

Four of the companies — those trying out their products and services in the regulatory “sandbox” — have test or T Class licences, four who are developed beyond that stage have modified or M Class licences, and eight have full or F Class licences.

Within three weeks of BlockFi being incorporated by the Registrar of Companies and obtaining its F Class licence from the BMA, its American parent company was charged by the US Securities and Exchange Commission with failing to properly register its products and misleading investors about the risk level in its loan portfolio and lending activity.

Gurbir S. Grewal, the director of the SEC’s division of enforcement, said: “Adherence to our registration and disclosure requirements is critical to providing investors with the information and transparency they need to make well-informed investment decisions in the crypto asset space.”

The self-styled “most trusted financial service provider in crypto” struck a deal with the regulator to pay $100 million in penalties and, according to last week’s bankruptcy filing, still owes $30 million to the SEC.

Four months later, in May, BlockFi Inc suffered an $80 million loss from the bad debt of crypto hedge fund Three Arrows Capital, which imploded after the collapse of the TerraUSD stablecoin.

Soon after, FTX committed $250 million to a bailout of BlockFi Inc.

FTX collapsed spectacularly last month, placing the Bahamas and its crypto laws centre stage in the global media. BlockFi’s bankruptcy filing listed FTX as its second-largest creditor, owed $275 million.

The Royal Gazette could not reach BlockFi for comment on how many jobs would be lost in Bermuda or how BlockFi International clients would be affected. Its lawyers, Walkers, did not respond to a request for BlockFi International’s share register and list of directors and officers.

A statement on BlockFi’s website said the bankruptcy filing would enable it to stabilise the business and provide the “opportunity to consummate a reorganisation plan that maximises value for all stakeholders, including our valued clients”.

BlockFi is not the first digital asset firm licensed by the BMA whose parent or sister company has run into trouble with US authorities.

Bittrex Global (Bermuda), which was granted a full DABA licence in September 2020, has the same owners as Bittrex Inc, a virtual currency exchange based in Bellevue, Washington. Mr Pitcher has been a member of the board of directors and risk committee of Bittrex Global (Bermuda) since April 2021.

In October, the US Department of the Treasury’s Office of Foreign Assets Control (Ofac) and the Financial Crimes Enforcement Network announced settlements for more than $24 million and $29 million, respectively, with Bittrex Inc.

It was Ofac’s largest virtual currency enforcement action to date and arose after the two bodies, working together, "found apparent violations of multiple sanctions programmes and wilful violations of the Bank Secrecy Act’s anti-money laundering and suspicious activity report reporting requirements“.

Bittrex Global (Bermuda) issued a statement distancing itself from the American company but its CEO, Oliver Linch, agreed in an interview with the Gazette that Bittrex Inc and Bittrex Global (Bermuda) shared the same beneficial owners.

“We weren’t involved in that at all,” he said. “We didn’t even exist at the relevant time, in 2016-17.”

Mr Linch said the firm’s technology back then had failed to screen out users in sanctioned jurisdictions but was now much more robust.

He said he viewed the “really important thing” coming out of the settlements as being Opac’s view that the company was “fully compliant, in terms of the services provided to customers now”.

In October 2018, a fintech company called Uulala was the first company given permission to launch an initial coin offering on the island. Mr Burt recorded a video for the company, which appeared on its website.

Three months later, the Miami-based Offshore Alert news and data website reported that one of its founders, Oscar Garcia, was a “multilevel marketer who has lurched from one failed venture to another, leaving behind a trail of personal and corporate debts and angry investors, clients, and business partners”.

Offshore Alert editor David Marchant told The Royal Gazette that he wrote directly to Mr Burt and Wayne Caines, then national security minister, telling them he had worrying information about the financial history of the Uulala founder as well as about those behind another Bermuda-registered fintech firm, the now infamous Arbitrade.

“The questions I had itemised the plethora of litigation both of those companies had been involved with …” he said. “What I found particularly curious is that I received no responses to my questions.

“There could be reasons for not answering the questions but to not even inquire as to what I’m referring to … instead they just didn’t respond.”

The BMA had vetted Uulala as part of the ICO licence application process and, apparently, found nothing of concern.

Meanwhile, Arbitrade was able to incorporate here and acquire Victoria Hall, an office block in Hamilton, claiming it held billions of dollars worth of gold bullion.

Arbitrade group has completed the acquisition of the Victoria Hall Building located at No 6. Victoria Street, Hamilton, Bermuda, which will serve as Arbitrade Ltd. Bermuda World Headquarters. https://t.co/Jbs1fwpYGk#Bermuda#VictoriaHall$DIG

— Arbitrade Exchange | Official (@ArbitradeX) October 31, 2018

Mr Burt told Parliament that Arbitrade was subjected to “enhanced due diligence” before it was given a licence to purchase property and that he, as finance minister, asked his ministry to check “additional background information on the company, its principals and its beneficial owner”.

The OA article stated that it “took only a few hours of database research to uncover a plethora of red flags regarding Uulala and Arbitrade”.

Mr Marchant alleged: “Anyone with half a brain would know that Arbitrade was a joke and that Uulala was a joke if anyone had done some basic research.”

In August 2021, Uulala’s parent company in the US, Uulala Inc, settled fraud charges laid against it by the SEC.

The US regulator alleged that Mr Garcia and cofounder Matthew Loughran defrauded more than 1,000 investors in an unregistered offering of digital asset securities that raised more than $9 million and that Uulala and Mr Garcia engaged in a second fraudulent offering of convertible notes.

The SEC said that without admitting or denying the allegations, Uulala, Mr Garcia and Mr Loughran agreed to permanently disable their company’s digital tokens, remove them from digital asset trading platforms and pay civil fines of more than $500,000 in total.

Uulala is no longer on the BMA’s list of DABA-licensed companies. Arbitrade never was.

Those behind Arbitrade incorporated five companies in Bermuda between May and September 2018 with the help of lawyers Trott & Duncan.

In September, the SEC filed charges against one of the Bermuda-registered companies for violating the anti-fraud and securities registration provisions of the US federal securities law with an alleged “pump-and-dump scheme” involving a crypto asset.

Mr Burt did not respond, via the Department of Communications, to a question about why he did not ask Mr Marchant to share the information on Uulala and Arbitrade or whether he thought the benefits to Bermuda outweighed the risks of getting involved with companies dealing in virtual currencies.

A Cabinet Office spokeswoman said the Government was "very encouraged" with the progression of Bermuda’s fintech industry. She said with 16 licensed digital asset businesses and seven licensed digital asset insurers, the island was “home to companies that have fulfilled their regulation obligations. These companies are actively investing in creating jobs for Bermudians”.

The spokeswoman would not provide a figure for the number of jobs created or for the amount of public money spent on developing the sector so far.

Mr Pitcher, who was formerly a paid adviser to the Premier, now gives his services for free and the spokeswoman said there was one other employee, reassigned from another government department, in the Cabinet Office’s fintech unit.

Mr Burt has been on several trips to promote Bermuda as a fintech centre — the Government’s travel calendar, last updated in June, lists spending of almost $20,000 since 2019 on such overseas visits by him.

The government-powered fintech.bm website appears not to have been updated since 2020.

The publicly funded Bermuda Business Development Agency (BDA), which helps fintech companies to set up here, said it spent about $50,000 this year on the sector — $40,000 on its heavily sponsored Bermuda Tech Summit and $10,000 on staff travel to overseas fintech events.

A BDA spokesman said of the tech summit: “The immediate economic impact of this event, which had over 300 delegates — nearly 80 from overseas — including lodging, transportation, food and beverage, retail and recreation was estimated at $527,000 and supported 115 local jobs.”

Stafford Lowe, from Next, estimated that DABA-licensed firms had created about 50 jobs. Last year’s official Employment Survey put the number of jobs “related to fintech and operations under” DABA as 16, 12 of them held by Bermudians.

Mr Burt, Mr Pitcher and crypto companies have all trumpeted Bermuda’s “regulatory clarity”, enforced by a single, experienced oversight body.

But the Arbitrade charges were perhaps a reminder to those who choose to base themselves in offshore jurisdictions because of that “clarity” of SEC chairman Gary Gensler’s warning that the US regulator could still take enforcement action against them if they had US clients and breached regulations.

Today The Royal Gazette reports that a fintech company given an M Class DABA licence in April was cofounded by a New York-based businessman, Logan Sugarman, who was pulled from a deal to buy the Bermuda Commercial Bank after his financial history was also outed by Offshore Alert.

The company, Blockchain Triangle Systems, says it is not a crypto firm and there is no suggestion that it has breached local digital asset regulations or any regulations in the US.

The BMA said it was not able, under the law it is governed by, to comment on whether it missed any red flags with BlockFi or whether it took Mr Sugarman’s financial history into account when it issued a licence to Blockchain Triangle.

A spokeswoman for the regulator said: “The BMA is recognised for having high vetting and supervisory standards across all sectors and has a track record of evolving its regulatory frameworks and supervisory approaches to address evolution in the financial services sectors.”

After the FTX crash, as the Bahamas Government scrambled to defend its regulatory regime, Mr Burt tweeted that he was "greatly saddened“ that many innocent people had been hurt.

The Premier wrote: “Regulation plays a role in providing checks and balances. Under the right supervision, risks can be reduced but not eliminated. Disclosures are essential so that those risks are clear, and prudential oversight is essential to ensure the risks are reasonably controlled.”

Next spokesman Mr Lowe told The Royal Gazette: “The rules here are a lot clearer than elsewhere. The standards are higher.”

He said: “What’s exciting for me about the Bermuda fintech industry is it’s advancing the people who want to do it properly and move the ball forward.”

Former BDA chief executive Ross Webber, who worked for DABA-licensed Apex Fund Services, said: “I am a huge supporter for promoting the jurisdiction as a fintech hub, nurturing the development and use of technology platforms and innovation to make us more efficient and competitive in financial and professional services.

“This is very different to marketing the island as a crypto centre.”

Note: This article has been edited to clarify that Bittrex Inc is not the parent company of Bittrex Global (Bermuda). The beneficial owners of both entities are the same.