In Brief:
- The cryptosphere is continually developing and evolving at a rapid pace.
- Regulations need to keep pace with both the technical and legal aspects in order to be able to provide suitable, appropriate regulation.
- The UAE is at the forefront globally in relation to the regulation of cryptoassets
DeFi, the Metaverse, NFTs… the cryptosphere just keeps evolving, churning out new definitions and concepts on what seems like a daily basis.
DeFI
DeFi is currently a hot topic and rife with discussion regarding the extent to which regulation should play a part.
DeFi refers to decentralized finance and is an umbrella concept relating to using blockchain technology to replace traditional intermediaries (such as banks or brokers), in a financial system. It is important to note that DeFi doesn’t change the nature of financial services or the risk element – it is simply changing the way those services may be delivered.
One is aware of the ever increasing space DeFi is beginning to occupy as reflected by the recent announcement that Tesla obtained USD 7.8 million in financing using MakerDAO – an example of decentralized applications wrapped around centralized services or ‘real world assets’.
This is also symbolic of the shift one is seeing towards stablecoins being backstopped by ‘real world assets’, rather than cryptoassets. There is a difference of opinion regarding these approaches - with one viewpoint being stablecoins should be backed by cryptoassets in order to keep the system decentralized; with others viewing the backstopping of stablecoins with real world assets as a less volatile option - noting that generally, the cryptomarket moves as a whole and hence having a real world asset involved removes some of the volatility.
Metaverse and NFTs
There are many explanations and definitions for what constitutes the metaverse- but at its simplest, it refers to an integrated network of 3D virtual worlds, underpinned by blockchain technology, focused on social connection. On June 21, 2002 a number of tech giants including Meta, Microsoft, Nvidia, Unity and others announced the formation of a Metaverse Standards Forum, a group founded to foster the development of industry standards that would enable the companies’ digital worlds to be compatible with each other.
NFTs refer to non-fungible tokens and are unique certificates of ownership that exist on a blockchain, which are created when a digital file is minted.
The interaction between the metaverse and NFTs is only just beginning but can already be seen, for example, in the context of an art gallery- some museums are placing NFT artwork in metaverses such as Cryptovoxels, powered by the Ethereum blockchain.
Cryptocurrencies
Moving onto cryptocurrencies - to the surprise of many - the Central African Republic (CAR) approved Bitcoin as legal tender in April this year - becoming only the second country in the world to do so (El Salvador approved it in 2021). There does not appear to be significant (publicly available) justification for the decision and reports also suggest that there has not been an increase in demand of outlets in the country suddenly accepting Bitcoin as a means of payment.
Indeed, accordingly to estimates, an overwhelming majority of the population of CAR do not have access to the internet - obviously an essential prerequisite for using Bitcoin (or other cryptocurrencies) - and to many, the concept itself of cryptocurrencies may be one which has not been substantially explained and understood. It remains to be seen how successful this decision to adopt Bitcoin will be.
This leads into a global challenge generally in connection with the cryptosphere - a lack of proper understanding as to the concepts and a rapidly changing environment in which new concepts and definitions appear- creates unease for many investors in terms of deciding whether or not to invest in, or use, cryptoassets. The lack of regulation - both in terms of no regulations at all, or regulations which do not sufficiently cover the applicable cryptoassets- also acts as a deterrent for many investors in moving into the cryptosphere.
Conversely, of course, the rapid expansion of so many assets within the cryptosphere highlights the existence of a very real global demand. The increasing number of outlets worldwide that accept Bitcoin as a means of payment illustrates not only the increasing acceptance of this method of payment but also the shift from seeing Bitcoin simply as a store of value or investment to a form of payment for day to day services. Cynics point to the recent steep decline in crypto prices as reflective of a loss of faith in cryptoassets but that is also countered by arguments that these prices are reflective of prices in the macroeconomic market generally and cryptoassets should be seen as part of the macro environment. Interestingly, that argument gives rise to the notion that cryptoassets are potentially going to become less decentralised if they are increasingly backstopped by real-world assets; are valued as part of the global macro environment and increasingly, subject to calls for regulation in order to increase investor appetite. Investors are, globally, asking for more transparency in relation to their investments - including cryptoassets. Like all investments, advocates for cryptoassets highlight that a long term investor view needs to be adopted in relation to cryptoassets and not an immediate, reactionary one.
The regulatory position in the UAE
The UAE is one of the forerunners globally in the path to regulation of cryptoassets. There are now a number of ‘onshore’ and ‘offshore’ regulations in the UAE, governing various cryptoassets. The ADGM is also the first jurisdiction globally to provide a framework for the regulation of spot virtual asset activities.
When looking to establish a crypto business or conduct activities in relation to cryptoassets in the UAE, key factors to consider include:
- the regulatory framework;
- the regulator;
- the nature of the activities to be carried out;
- the scope of the customer base; and
- applicable fees and the timing process.
The key regulatory frameworks in the UAE
DIFC
The Dubai Financial Services Authority (DFSA) is the regulator of the Dubai International Financial Centre (DIFC). Its most recent consultation paper relates to the regulation of crypto tokens (CP 143). This leads on from their last consultation paper on the regulation of investment tokens (CP 138).
As an acknowledgement of the increasing use of crypto tokens as a medium for financial transactions, CP 143 is wide ranging in its scope and includes the DFSA’s view of what constitutes a crypto token and how they can be marketed (by way of financial promotion), together with the regulatory, conduct, prudential and market abuse requirements applicable to them.
The DFSA’s regulatory framework in relation to investment tokens notes that any person carrying on certain activities relating to investment tokens, in or from the DIFC, will require DFSA approval or authorization. The activities include, without limitation, carrying on a financial service which relates to an investment token (for example, operating a facility on which investment tokens are traded or cleared), making a financial promotion relating to an investment token, making an offer to the public of an investment token, or applying for a security token to be admitted to the official list of securities.
An investment token will therefore, depending on the nature of the rights and obligations it confers, fall into one or more existing categories of a security or derivative. The key difference however, between a conventional security or derivative and an investment token, is that an investment token confers rights on holders that are issued, stored and transferred using cryptography and digital ledger technology.
The deadline for comments on CP 143 has now passed and hence one is awaiting the DFSA to produce legislation where applicable.
ADGM
Regulation of cryptoassets in the ADGM is regulated under the Financial Services and Markets Regulations 2015 (FSMR). The regulator in this regard is the Financial Services Regulatory Authority (FSRA). Under the FSMR, a “Virtual Asset” “means a digital representation of value that can be digitally traded and functions as (1) a medium of exchange; and/or (2) a unit of account; and/or (3) a store of value, but does not have legal tender status in any jurisdiction. The FSRA issued Consultation Paper No. 1 of 2022 earlier this year to seek views on significant proposed enhancements to its capital markets regulatory framework, noting that its proposed amendments are wide ranging and affect activities across a range of areas including Virtual Assets. The deadline for comments on this paper has also passed and hence this space is one to watch.
Onshore UAE
Most recently, on 28 February 2022, the Emirate of Dubai issued Dubai Law No. 4 on Regulating Virtual Assets in the Emirate of Dubai (DVAR).
The DVAR applies to “Virtual Asset” services provided throughout the Emirate of Dubai, including special development zones and free zones, with the exception of the DIFC. Pursuant to this Law, a public corporation named the Dubai Virtual Assets Regulatory Authority (VARA) is established, which is affiliated to the Dubai World Trade Centre Authority (DWTCA), the entity that oversees the Dubai World Trade Centre free zone. VARA will streamline regulatory application and operating licensing approvals for Virtual Assets including digital assets, products, operators, and exchanges - enabling the DWTCA to become a new dedicated zone for regulated Virtual Assets businesses. Under the DVAR, it is prohibited for any person in Dubai to engage in Virtual Asset related activities (as defined therein) without prior authorization from the VARA.
The DVAR is in addition to SCA Decision No. 23 of 2020 concerning Crypto Assets Activities Regulation (CAAR). This regulation aims at regulating the offering, issuing, listing and trading of cryptoassets in the UAE and related financial activities. The CAAR defines a cryptoasset as “a record within an electronic network or distribution database functioning as a medium for exchange, storage of value, unit of account, representation of ownership, economic rights, or right of access or utility of any kind, when capable of being transferred electronically from one holder to another through the operation of computer software or an algorithm governing its use”.
The CAAR is designed to regulate and license key aspects of dealing in crypto assets, from issuance and promotion thereof, provision of crypto asset custody services, operating exchanges and fundraising platforms. The CAAR applies to most forms of cryptoassets whether securities or otherwise, which are listed and available for trading on a recognised market. The CAAR is not intended to include items regulated by the Central Bank such as currencies, virtual currencies, digital currencies, stored-value units, payment tokens and payment units(s).
There is some overlap with the activities regulated under the DVAR with activities currently regulated by the Securities and Commodities Authority (SCA) and the UAE Central Bank (UAECB) and hence it remains to be seen the extent to which VARA, the DWTCA, SCA and UAECB will interact.
In May this year, the VARA announced its entry into the Metaverse with the establishment of its Metaverse HQ in the dynamic virtual world of ‘The Sandbox’, becoming the world’s first regulator to debut in the Metaverse.
It is clear that the cryptosphere will continue evolving, that blockchain is here to stay and will be used for a multitude of other sectors other than cryptocurrencies and that regulation of cryptoassets is welcomed by many.
In that respect, those looking to set up crypto entities or businesses in the UAE will be rewarded with one of the most innovative jurisdictions in the world in relation to the regulation of the cryptosphere.
For enquiries in relation to the regulation of cryptoassets in the UAE, please contact the Banking & Finance team.