Bahrain and Abu Dhabi are racing to become the Gulf region’s leading hub for cryptocurrencies, decentralized digital currencies that utilize blockchain ledgers. Both have developed cryptocurrency regulatory frameworks, licensed cryptocurrency exchanges and brokerages, and invested in cryptocurrency-related startups. The Central Bank of Bahrain and Abu Dhabi Global Market, a financial free zone, are leading actors in the rapid development of the region’s cryptocurrency sector. Policymakers in other Gulf Arab locations have been more cautious regarding the integration of cryptocurrencies within their economies. High hopes that cryptocurrency development will support economic diversification efforts must be balanced against the risks of investing in a fast-evolving technology dependent upon a delicate regulatory balance.

The heightened interest in cryptocurrencies across the Gulf is taking place alongside global efforts to both regulate digital assets and attract cryptocurrency firms. The expensive financial centers of New York and London apply traditional financial service regulations to the cryptocurrency space. Cheaper, less-regulated jurisdictions provide fewer protections for investors. Bahrain and Abu Dhabi are attempting to chart an alternative course that combines strong regulatory security with attractive investment incentives. ZPX, a Singapore-based cryptocurrency firm, estimated that setting up a firm in Bahrain would cost around $200,000, whereas similar setup costs in London could reach $750,000. Crypto-asset exchanges in Abu Dhabi Global Market must pay an initial authorization fee of $125,000 and annual supervision fees of $60,000.

Economic policymakers in Bahrain are pushing to portray the country as the Middle East’s premier cryptocurrency hub. On July 31, the Bahrain-based cryptocurrency exchange Rain announced that it had become the first fully regulated, onshore cryptocurrency exchange in the Middle East and North Africa and had closed a $2.5 million funding round. Rain acquired a Crypto-Asset Module regulatory license from the Central Bank of Bahrain, following graduation from the central bank’s Regulatory Sandbox program (a virtual space for licensed financial institutions and other firms to test their tech-based solutions), and received a sharia-compliance certificate. Rain operates within Bahrain FinTech Bay, a financial technology-focused co-working space and accelerator that receives funding from Bahrain’s Economic Development Board, the country’s central bank, and around 35 private backers. Bahraini government regulators work closely with entrepreneurs: Personnel from the central bank have offices in Bahrain FinTech Bay.

Abu Dhabi Global Market is spearheading cryptocurrency policy and regulation in the United Arab Emirates through the financial free zone’s Financial Services Regulatory Authority. In May and June, the authority granted various cryptocurrency exchanges – such as BitOasis, MidChains, and Arabian Bourse – with in-principle approval to operate. BitOasis, the most established of the UAE’s exchanges, has been operating for approximately four years in a relatively unregulated environment. MidChains is based in Hub71, Abu Dhabi Global Market’s accelerator and a counterpart to Bahrain FinTech Bay. Initiatives to bolster the fintech credentials of Abu Dhabi are strongly supported by the wealthy emirate’s government and investment vehicles. Mubadala, a state-owned holding company, invested in MidChains through Mubadala Ventures, a subsidiary fund that hopes to expand its asset portfolio to about $1 billion by 2021.

As a financial free zone, Abu Dhabi Global Market’s regulatory approach to cryptocurrencies diverges from the central bank-driven model in Bahrain. The former permits crypto-asset activities in an offshore environment, but free zone regulations do not necessarily apply to the UAE’s onshore environment nor the wider Gulf Cooperation Council market. The latter approach adopted by Bahrain allows cryptocurrency firms to operate within the country’s onshore economy. A license from Bahrain’s central bank also reduces barriers for firms seeking to expand operations into neighboring GCC countries.

The UAE hosts two other regulatory bodies charged with overseeing cryptocurrencies, but these authorities have not been as proactive as the Financial Services Regulatory Authority. The Securities and Commodities Authority, which oversees digital securities and commodities across the country but not within the financial free zones, only recently recognized cryptocurrencies and other crypto-assets. In February 2018, the Securities and Commodities Authority issued a warning against cryptocurrencies but then abruptly changed its position in October 2018 with the announcement of a forthcoming plan to regulate crypto-assets. The Dubai Financial Services Authority oversees financial service regulation in the Dubai International Financial Centre. In September 2017, the Dubai Financial Services Authority issued a general investor statement that cryptocurrencies “have their own unique risks, which may not be easy to identify or understand,” warning that these “offerings should be regarded as high-risk investments.”

Other Gulf Arab countries have taken a cautionary, wait-and-see approach to cryptocurrencies. The Ministry of Finance in Kuwait does not recognize cryptocurrencies for official commercial transactions, and the country’s central bank prohibits trading in cryptocurrencies. In February 2018, Qatar’s central bank prohibited local banks from dealing with cryptocurrencies. The Central Bank of Oman has not issued any policies or guidelines to regulate cryptocurrencies; rather, the country’s central bank urged its citizens to exercise caution with respect to the broader category of crypto-assets.

Saudi Arabia’s policymakers have expressed concerns over cryptocurrencies like Bitcoin, but the country has simultaneously experimented with other forms of digital currency. In 2018, the Saudi Arabian Monetary Authority and the Central Bank of the UAE launched Aber, a common digital currency project to facilitate financial settlements between the two countries. The project will issue the digital currency on a probationary basis between a limited number of banks, underscoring the slow pace of the initiative.

Global cryptocurrency and other fintech firms have not been deterred by the reticence of some Gulf Arab governments. In his book “Money, Markets, and Monarchies: The Gulf Cooperation Council and the Political Economy of the Contemporary Middle East,” Adam Hanieh estimated the collective value of disposable wealth and foreign assets of Gulf Arab governments, sovereign wealth funds, private firms, and individuals in 2016 at around $6 trillion. These assets have encouraged cryptocurrency firms and startups to actively market their platforms and applications within the Gulf region. Ethereum, a popular cryptocurrency and decentralized software platform, partnered with finance experts in the Gulf to demonstrate alignment with the principles of Islamic finance and attract interest from regional sovereign wealth funds. A Swiss fintech developer, X8 AG, received a certification by Bahrain’s Shariyah Review Bureau for its Ethereum-based stablecoin – a digital currency backed by a basket of currencies and gold in order to reduce volatility and speculation concerns.

Cryptocurrency development in the Gulf faces other hurdles. Both governments and investors are concerned about the reputational and infrastructural vulnerabilities associated with financial technologies. Strong corporate governance models can help prevent high-profile scandals from tainting the region’s nascent industry. The spectacular collapse of Dubai-based Abraaj, for example, has been a nightmare for private equity firms in the Gulf region. Cyber security remains essential for the industry’s long-term sustainability. A cyberattack targeted Bahrain’s National Security Agency, Ministry of Interior, and first deputy prime minister’s office on August 5, and additional cyberattacks in July affected the country’s critical infrastructure.

Effective anti-money laundering and know-your-customer procedures are critical for ensuring that malign actors do not leverage Gulf-based cryptocurrency platforms to exploit the global financial system. BitOasis delisted Zcash and Monero, two privacy-oriented cryptocurrencies offering near total anonymity, following pressure from the UAE’s regulators. Governments in the United States and Europe will take convincing that state-sanctioned cryptocurrencies will adhere to the same rigorous standards applied to more traditional segments of the financial system. Many of these standards, which have evolved over decades, are considered effective means for combating money laundering, terrorism financing, sanctions and tax evasion, and other illicit activities.

For Gulf Arab governments to strike the right regulatory balance and prioritization of governmental support for cryptocurrencies will be a challenge. Bahrain and Abu Dhabi are the leading shapers of regulating cryptocurrency activities in the region. Neighboring Gulf Arab governments have been more comfortable experimenting with other digital currencies and narrow blockchain applications – two areas over which it is easier to extend governmental control. Meanwhile, the growth potential of the Gulf’s cryptocurrency industry is uncertain: Much of the industry’s available value might accrue to only one or two of the region’s firms. It remains to be seen whether the gamble on quickly evolving financial technologies will pay off.