Regulation of new financial tools for cryptocurrencies, creation of more liquid platforms at the expense of institutional exchanges, securities tokenization, corporate rights, and enterprises operation – it is not a complete list of innovations we expect from the regulators of the cryptocurrency market. The Juscutum team has prepared a large detailed article concerning all the important changes expected in 2019.
Over the past year, we have observed an active position of regulators in relation to the ICO and the introduction of new legislation in many countries. These include Malta, Switzerland, France, Gibraltar, the Isle of Man and Lithuania. Almost every financial supervisory authority has issued warnings about the risks of investing in ICO- and crypto-assets. This trend strongly contributed to the fact that the public ICO market falls quarterly into the abyss. According to TokenData’s analytical data, the companies managed to raise only $ 181 million, compared to $ 2.4 billion in January. But the market for venture investment in blockchain projects shows rapid growth and has already doubled its annual performance with a bright peak in the second quarter of 2018.
Suffice it to recall the recent transactions of two world venture funds Andreessen Horowitz and Union Square Ventures. Andreessen Horowitz acquired shares in Dfinity ($61 million), Harbor ($28 million). Union Square Ventures in 2018 was included in equity AlGorand for $4 million and PROPS by You Know for $17 million.
Investment methods have been changing, as well as the market itself. Commonly fundraisers choose a strategic way of investing with the help of hybrid models (venture investment, public ICO, and STO). Market institutionalization leads to clear and understandable proposals for traditional investors, full legal protection of investors, relatively cheap entry into the market for an STO-company unlike IPO companies, as well as token divisibility compared to traditional securities such as a share.
Switzerland. This year FINMA (Financial Market Supervisory Authority of Switzerland) has expanded its special regulation and at the beginning of the year issued a Directive with the principles of legislation application during consideration of requests from ICO organizers. Moreover, the regulator has provided several types of tokens, to which different regulation is applied:
- payment tokens — analogous to cryptocurrency, they do not have additional functions;
- utility tokens – designed to provide digital access to the application or service;
- asset tokens — their economic nature is similar to shares, bonds or derivatives;
- hybrid tokens — contain features of several types of tokens.
Malta. In July 2018, the Parliament of Malta adopted three bills that regulate activities in cryptocurrency and blockchain field, namely:
- The Malta Digital Innovation Authority Act/MDIAA);
- The Innovative Technology Arrangements and Services Act/TAS;
- The Virtual Financial Assets Act/VFAA, it regulates the procedure for ICO and provision of other VFA-services.
Thus, Malta became the first country in the world to present a clear regulatory framework for ICO, token and cryptocurrency turnover.
In parallel with these laws adoption, the Malta regulator is very friendly in relation to various cryptocurrency projects. Projects representatives were invited to Malta already at the beginning of the year.
To date, these two factors – the regulator’s loyalty to crypto-projects and the invitation to their representatives to come to the country, have made Malta a leader in the number of crypto-currency companies willing to conduct business there. Among such companies, for example, are Binance, OKex, ZB.com, Bitbay.
Gibraltar. On January 1, 2018, the regulations on blockchain companies licensing came into force in Gibraltar. Under the new regulation, the companies providing services using blockchain technology (DistributedLedgerTechnology) are required to obtain an appropriate license from the Financial Services Commission (GFSC). Such seemingly simple regulations turned out to be difficult to adhere to in the implementation.
Therefore, at the beginning of the year, the news hype around Gibraltar, as a new cryptocurrency harbor, was not justified. By the end of 2018, very few companies managed to obtain licenses in Gibraltar, among them: CFE Limited, Covesting International Limited, eToro X Limited, GBX Limited, and Huobi Technology (Gibraltar) Co.Ltd.
Republic of Belarus. Decree No. 8 “On the development of the digital economy”, which was adopted at the end of 2017 and entered into force at the end of the 1st quarter of 2018, has not only legalized the activities of the cryptocurrency exchanges in the Republic of Belarus, cryptocurrency exchange operators, bitcoin mining, smart contracts, blockchain, tokens. It released VAT operations with tokens from income tax payment until January 1, 2023: mining, storage on accounts, purchase, exchange, bequeathal.
However, this Decree applies only to members of the Hi-tech Park. (Belarusian analogue of Silicon Valley in the USA).
At the end of November 2018, the Belarusian regulator issued additional regulation of requirements for companies that want to open a business focused on the cryptocurrency market. New rules set forth requirements to the authorized capital, reputation of a company’s personnel and owners, verification of assets origin and requirements for cybersecurity, operational activities, audits, and many others.
USA. The USA Securities Commission (SEC) has had an active year in collaboration with the ICO projects. Many people probably remember what effect caused the SEC report on the DAO project on the regulation of the cryptocurrency market last year. This report had become a decisive starting point while all other regulators also started talking about the need to register tokens as securities if they have characteristics of securities.
This year we had several significant and illustrative SEC cases, during which the Commission moved from words to deeds at last and tried to explain its position to other similar companies by the example of particular fined ICO projects. The most significant cases were as follows:
- AriseBank case — in early 2018 the SEC suspended the activities of a project, which attracted a total of about $600 million, accusing it of fraud. This case attracted public attention in many ways by the fact that the Commission had given the whole market a clear understanding: if the project builds its campaign to attract investment through the use of social networks and celebrities, such persons will also be responsible in case of violation of the laws.
- in the cases against AirFox and Paragon the Commission recognized project tokens as securities and ordered the company to pay fines and carry out the procedure of their tokens issues, in accordance with the securities laws of the United States.
In addition, we have quite fresh news that the USA has developed draft Federal laws that will regulate the cryptocurrency turnover, including raising funds through ICO – “Virtual Currency Consumer Protection Act of 2018″ and “The U.S. Virtual Currency Market and Regulatory Competitiveness Act of 2018″.
France. In September 2018, the legislative system for ICO was launched in France. From now on, in order to hold an initial coin offering (ICO), a company has to request permission from the Financial Markets Authority of France (AMF). This audit is designed to protect investors and reduce the risk of funds loss, money laundering, and terrorist financing. Projects that need to conduct fundraising have to submit their whitepaper for review with required data as follows:
- project description and its “road map”;
- the rights granted by the token;
- competent court proceedings in case of disputes arising;
- economic purpose and further use of funds collected by ICO.
France probably has a goal of becoming an attractive country to start a cryptocurrency business, and through the issuance of a set of regulations the country is trying to attract foreign investors. ICO Visa project confirms it. This visa grants a green light to banks for operations with crypto-projects, so it cannot be applied for by foreign companies.
Canada. This June, the government of Canada released a statement that all companies trading digital currencies would be regulated as Money Service Businesses (MSB). In November, the Finance Committee in the House of Commons of Canada introduced a proposal for mandatory separate licensing of cryptocurrency exchanges and exchanges, which will require mandatory verification of clients. The same applies to crypto-wallets — the document requires crypto-wallets to apply KYC and AML banking standards so that to identify and confirm a user’s identity.
Australia. Back in 2017, the Canadian regulator obliged cryptocurrency companies to identify their customers and take other anti-money laundering measures (KYC/AML procedures) established by the Australian Transaction Reports and Analysis Centre (Austrac). This year the Australian Securities and Investments Commission (ASIC) has announced its intention to tighten up its approach to ICO regulation. The regulator has presented its corporate agenda for 2018-2022, which focuses on “monitoring threats from new products”, such as ICO and cryptocurrency.
Singapore. On November 30, 2018, the Monetary Authority of Singapore (MAS) issued new rules for ICO project stakeholders. According to new regulations, the ICO organizers are required to obtain a license to provide services in the capital markets. They should also take measures to combat money laundering and terrorist financing (AML/CFT). Persons who provide financial advice on ICO tokens are required to obtain a license of a financial advisor.
Together with the new regulations as for ICO, MAS regulations, released in 2017, are still in force, concerning ICO-projects tokens fall under securities legislation. However, the updated rules stipulate that if a token is not a security, it may still require a license that confirms its compliance with the AML and CFT regulations.
In addition, such states as Japan, South Korea, Malaysia, and others, have publicly announced their intention to issue a special regulation for ICO market in the near future.
According to the latest Coin Market Cap report, the offer of crypto-exchange services exceeds their demand. In 2017, transaction fees were the main source of exchange profits. During this year, exchanges are trying to add new sources of income, such as listing new tokens, launching new trading products for institutional investors, as well as other services.
Global trend against money laundering and countering terrorism financing, AMLD 5
The latter, 5th Directive on the fight against money laundering sets forth a definition of cryptocurrency, cryptocurrency exchanges, and crypto-wallets. This means that such crypto-players are now subject to Customer Due Diligence requirements and are required to report suspicious transactions to Financial Intelligence Units (FIUs). These authorities are empowered to access various cryptocurrency wallets and exchanges, they are allowed to identify bitcoin address holders. The information obtained can also be used by the tax authorities to combat tax evasion. The Directive explains the rationale for such regulation as follows: “This will ensure a balanced approach to this area, ensuring technological progress and a high degree of transparency in the field of alternative financing and social entrepreneurship.”
New regulation covers two types of cryptocurrency business:
- “Providers participating in the exchange services between virtual currencies and cash currencies”, i.e. cryptocurrency exchange.
- “Custodian wallets providers”, i.e. cryptocurrency wallet services (where the service has the private keys of their users).
These business categories will become “obligated legal entities” under the new AML/CTF legislation. In accordance with the Directive, such persons are required to implement anti-money laundering measures, conduct CDD (Customer Due Diligence), monitor transactions and notify the supervisory authorities of suspicious transactions.
Most of the companies, which business falls under the regulation of the AML Directive in the EU have already been implementing comprehensive AML policy and controls for AML/CTF.
The global trend on the introduction of registration rules for cryptocurrency exchanges and crypto-wallets
While 2017 was named the “year of the ICO”, 2018 was the year of regulation. Malta, Gibraltar, and Estonia can boast of the loudest innovations introduced in this area in 2018.
- Malta. In 2018, the Maltese Parliament passed three new legislative acts laying the groundwork for Malta’s so-called “Innovative technologies” sector and now this country is one of the few jurisdictions worldwide having a fully regulated DLT sector.
Virtual Financial Assets Exchange is one of the services for which provision a company needs a license obtained from the Malta Financial Services Authority (MFSA). The Malta Virtual Financial Assets Act (VFA) emphasizes licensing requirements and sets out procedures for applying for and granting these licenses. One of these requirements is that the application for a license in accordance with VFA Law should be implemented only through a VFA agent.
- Estonia. Over the past year, the Estonian government has issued more than 900 licenses related to crypto assets. Thus, the Ministry of Finance of Estonia intends to amend the AML-legislation to tighten compliance for crypto-exchanges and custodian wallets. In 2019, we will see in practice how the financial supervisory authority will audit crypto business registered in Estonia.
- Gibraltar. The government of Gibraltar is seeking to strengthen its position as a global leader by exploring further cryptocurrency regulation. In 2018, the regulations came into force, according to which Gibraltar companies that provide services using blockchain technology are required to obtain a corresponding license from the Financial Services Commission (GFSC).
It is important to mention that the regulation adopted in 2018 is already being implemented, as the cryptocurrency GBX and Huobi exchanges have already received an official license for the exchange of virtual assets from the state financial regulator.
In the U.S., DEX is equated to conventional exchanges.
By the end of the year, the SEC has debunked all myths about the inapplicability of the usual requirements of U.S. securities trading legislation to DEX (decentralized exchanges).
Through the EtherDelta case the Commission has showed: any platform that falls under the definition of “exchange” and trades securities, shall be registered as a national securities exchange (or apply to the SEC for exemption from registration). For the Commission it does not matter whether the platform is centralized and managed, or decentralized, and operating independently of its creators, based on built-in algorithms. The SEC focuses on the fact that the analysis of the platform, in order to determine whether such a platform is an exchange within the meaning of U.S. laws, is carried out regardless of how the platform is identified and what technologies or algorithms it applies. What is important is that the platform, which operates in accordance with its algorithms or smart contracts, has provided its users with the opportunities to trade securities, combining buyers and sellers orders. From now on cryptoanarchists will not be able to escape from the regulator under DEX guise.
STO service providers and ST stock exchanges (security tokens)
In 2018, due to the STO trend, a large number of platforms that provide infrastructure solutions for STO, as well as acting as platforms for security tokens trading, were put into operation.
From a legal point of view it is most interesting to consider the platforms and exchanges on which the secondary sale/purchase of security tokens will be carried out.
Securities trading is a strictly regulated activity and for its implementation platforms need not only to carry out inflexible KYC/AML procedures but also to have the necessary licenses/authorizations of the local regulator.
At the moment, among the platforms that have been already operating with security tokens, as well as platforms that announced their intentions to work with such types of assets, we can conditionally distinguish 3 main groups.
1) “Traditional exchanges” – established and registered as a stock exchange yet before the ICO and the STO hype, and engaged in traditional securities trade
Traditional exchanges do not need to obtain any additional licenses and permits, they only need to prepare all the necessary internal infrastructure for trading.
Plans for listing and sale of security tokens in 2018 were announced by the following exchanges:
- SIX Swiss Exchange
In June 2018, the Swiss exchange announced the beginning of activities on the creation of a solution for security tokens trading and custodial storage of virtual assets. Bidding is scheduled to open in mid-2019.
- Malta Stock Exchange
In September 2018, the Maltese exchange signed a Memorandum with one of the world’s largest crypto–exchanges, that is Binance. The platforms agreed to cooperate to launch a new exchange for ST trading in 2019.
- Gibraltar Stock Exchange (GSX)
It is quite natural that after the creation of regulation of the DLT area in Gibraltar, GSX could not help but consider establishing of a platform for security tokens trading on the basis of its exchange. In the summer, the exchange announced such intentions. They plan to start trading in 2019.
- Also at the moment London Stock Exchange and Australian Securities Exchange have announced their plans to develop infrastructure for security tokens trading.
Thus, at least five traditional and world-famous securities exchanges have joined the STO race. Most likely, in the future, the number of traditional exchanges interested in ST trading will only grow.
2) Platforms registered as Alternative trading systems and having brokerage licenses (for the USA)
ATS (Alternative Trading Systems) platforms in the U.S. or MTF (Multilateral Trading Facility) in the EU may become an alternative to traditional exchanges in the market of security tokens. It is easier to obtain ATS status than go through all the procedures of securities exchange registration, but it is necessary to take into account that in order to acquire such status, the company has to obtain also a brokerage license.
As an example, we can cite the Templum and tZero platforms, which have brokerage licenses, and they are also ATS platforms, authorized in the SEC.
3) Platforms that have decided to obtain the necessary licenses and permits by acquiring companies that already have the relevant documents
- These platforms include Coinbase, which in the summer announced its intention to expand ST trade.
The exchange decided to avoid undergoing long and complicated process of obtaining the appropriate licenses and permits necessary to carry out such activities, and immediately buy companies that already have the necessary licenses. In July FINRA approved the purchase of Keystone Capital Corp. companies, Venovate Marketplace and Digital Wealth LLC, thus Coinbase became the owner of brokerage and ATS licenses.
- Financial tools and cryptocurrency
In 2018, the trend that has started last year continued. Cryptocurrency has been entering the global financial system on a large scale, respectively, many traditional financial tools enter the cryptocurrency market (futures contracts, options, etc.).
In 2017, the world experienced the launch of bitcoin futures on the U.S. CBOE exchange. CBOE was the first regulated exchange to receive permission from the U.S. Commodity Futures Trading Commission (CFTC) to place such positions. It turned a new page in cryptocurrency history. Next year, the largest U.S. exchanges NASDAQ and New York Stock Exchange (NYSE) plan to launch bitcoin futures trading, subject to approval by the Commodity Futures Trading Commission.
In 2018, the entire cryptocommunity was awaiting the Bitcoin-ETF launch. To launch such a product, American exchanges need to obtain SEC permission. Throughout the year, different platforms have tried in vain to obtain such permission, whereas the SEC constantly postponed the date of consideration of such applications or even denied their satisfaction. Most likely, the cryptoindustry will be able to enjoy the launch of Bitcoin-ETF only next year.
While in the U.S. the SEC has been considering applications for ETF launch, an analogue of the U.S. Bitcoin-ETF – cryptocurrency exchange product Amun Crypto ETP came to life at the end of November on the Swiss stock exchange SIX Swiss Exchange. Amun Crypto ETP under Hodl stock ticker will monitor five crypto-currencies with the largest capitalization in the market, and its pricing will be similar to the index pricing.
In December 2018, the OKEх cryptoexchange, located in Malta, launched its new product – Perpetual Swap bitcoin. A virtual derivative is a mutual offering that aims to empower traders who are able to speculate on the price direction of digital assets such as Bitcoin and Ethereum to provide access to a risky but highly profitable cryptocurrency market.
Compared to futures contracts, swaps do not have expiration dates and settlements are conducted on a daily basis. Pricing is based on the base value they represent, allowing traders to assume the direction prices can go without risking their actual assets. Each contract will have a notional value of $ 100. Users will have the right to choose from two strategic positions, they can take a long position, which will allow them to profit from the rise in the price of digital assets or a short position and profit from the decline in the price of digital assets.
Cryptocurrency market forecasts for 2019
In terms of strategy, global regulatory approaches follow three directions:
- Reducing the barrier to enter crypto-projects and attracting investments (Malta, Gibraltar, Switzerland)
- Using regulatory policy and national technological investments to protect state influence (China, Russia)
- Compliance with sustainable practices and laws to maintain financial stability and consumer rights protection (US, WB)
Strengthening of AML/KYC compliance at the national level for all market participants.
- Creation of STO-infrastructure and licensing of such activities.
- Development of hubs and sandboxes with local regulators.
- Implementation of risk analysis by banking associations for opening accounts for crypto-projects.
- Development and regulation of new financial tools for cryptocurrency.
- Development of global principles of cryptocurrency regulation by international and regional organizations.
- Synchronization of services, storage of traditional assets and cryptoassets.
- Creation of more liquid platforms at the expense of institutional exchanges.
- Tokenization of securities, corporate rights and business operations.
Authors: Julia Shtabskaya, the head of Blockchain Practice, Nikita Novikov, a lawyer of Blockchain Practices and Aleksandr Sinitsa, a lawyer of Blockchain Practice of Juscutum Law Firm.