Liquidity risks associated with cryptocurrency exchange services

In light of recent cryptocurrency market turmoil, MAS released a consultation paper in October 2022 outlining its proposed regulatory changes for digital payment token (DPT) service providers. 

In this paper, it sets out observations, policy considerations, and proposed regulatory measures in key areas: (a) consumer access; (b) business conduct; and (c) technology. MAS reaffirms that it aims to develop a responsible digital asset ecosystem but discourages retail cryptocurrency speculation. 

Read more about the proposed regulatory changes here. This Q&A focuses on the specific measures relating to customer assets and market integrity.

---

Segregation of Customers’ Assets and Risk Management Controls

According to MAS (Consultation Paper)
last revised 26 October 2022

4.5 MAS proposes that DPTSPs should ensure that customers’ assets are segregated from the DPTSPs’ own assets, and held for the benefit of the customer. The recent failure of several firms in the DPT industry underscores the importance of DPTSPs having effective and robust arrangements in place for the identification and segregation of customers’ assets. In addition to minimising the risk of loss or misuse of customers’ assets during the ordinary course of business, these arrangements facilitate the return of customers’ assets in the event of the DPTSP’s insolvency.

4.6 Globally, there has been some early discussions that in order to further protect customers’ assets, it could be useful to require DPTSPs to appoint an independent custodian to hold customers’ assets. However, it was noted that this involves a broader scope of coverage as compared to similar requirements in the capital markets, where an independent custodian requirement is typically imposed on fund management companies, but not necessarily on other types of securities intermediaries, such as securities brokers. MAS also notes that activity on DPT custody will only be covered in Phase 2 of the PS Act amendment. Nevertheless, MAS would like to seek views on whether having an independent custodian would be appropriate in the context of the DPT sector, and whether there are other more effective measures to address concerns over customers’ assets such as in the event of DPTSP’s insolvency.

4.7 Customers should be properly informed of the arrangements and risks involved in having their assets held by DPTSPs. To this end, MAS proposes that DPTSPs should provide written disclosures to customers, which may include: (a) the terms and conditions, including the arrangements for receiving instructions from the customers and providing information to the customers, and applicable fees and costs;

Market Integrity

According to MAS (Consultation Paper)
last revised 26 October 2022

6.1 While DPTs are represented on a blockchain, most DPT transactions are in fact conducted through providers that facilitate trade matching (also known as “centralised exchanges” or CEX), without being recorded on the blockchain (off-chain transactions). Customers who transact DPTs through centralised exchanges expect DPT quotations displayed by the DPT trading platforms to reliably represent the prevailing market supply and demand, their orders to be matched on an equitable basis, and their counterparties not to have an unfair advantage.

6.2 However, DPT markets have been susceptible to unfair trading practices of market manipulation, misleading conduct and insider trading by nefarious actors. Such unfair trading practices distort the price discovery process and undermine customers’ trust and confidence in the functioning and integrity of DPT markets. Examples of unfair trading practices include:

(a) wash trading, which is the buying and selling DPTs with no change in beneficial ownership, to create a false or misleading appearance of active trading. This may be carried out through the creation of “ghost accounts” or other deceptive means, which seek to inflate trading volumes to give the appearance of rising popularity41;

(b) pump-and-dump, which is to induce an increase in the price of a DPT (“pump”) through the dissemination of false or misleading information, such as deceitful marketing and promotional ploys, before selling off their own holdings of the DPT (“dump”), ahead of other participants who would have been misled into buying the DPT;

(c) cornering, which is to use a dominant controlling position in a DPT to influence the price of the DPT and profit from that activity; (d) trade spoofing, which is to place orders with the intention of cancelling them prior to being fulfilled, often by deploying trading bots and algorithms, to push the market price in a particular direction. These orders give the market a false sense of supply or demand; and (e) insider trading, which refers to the buying or selling DPTs while possessing material non-public information, such as an upcoming announcement of a listing decision.

⋮

6.5 MAS encourages DPT trading platform operators to put in place good industry practices to detect and deter unfair trading practices in DPT markets. Examples of good industry practices include:

(a) putting in place effective systems, procedures and arrangements to promote fair, orderly, and transparent trading of DPTs traded on their trading platform. As a baseline, DPT trading platform operators could set out, disclose, and enforce rules governing the trading activities that take place on their DPT trading platforms. MAS notes that these practices are similar to regulatory proposals put forward in other jurisdictions such as in Hong Kong and EU; and

(b) monitoring trading activities that take place on their DPT trading platforms, such as employing real-time surveillance systems. MAS is cognizant that the commercial availability of technological solutions for real-time DPT surveillance may presently be limited. In this regard, DPT trading platform operators could conduct market surveillance in a manner that is commensurate with the nature, scale and complexity of their businesses.