15 Feb 2023
Over the past year, stories about cryptocurrencies like Bitcoin and Ethereum have dominated the news. Every regulator is probably thinking about how and if to regulate such cryptocurrencies. The Dubai Financial Services Authority (DFSA), which oversees the Dubai International Financial Centre (DIFC), took its first action in October 2021 when it unveiled a new system for the control of Security Tokens entering and leaving the DIFC. The DFSA's Digital Assets regime's initial phase is represented by this. The DFSA's goal is to govern "tokens," which are built on the same technology as cryptocurrencies but do not aim to control actual coins. The Glossary Module defines tokens as "A cryptographically secured digital representation of value, rights, or responsibilities, which may be issued, transferred, and stored electronically, utilizing Distributed Ledger Technologies (DLT) or other comparable technology”. A second consultation document that the DFSA plans to release is expected to address cryptocurrencies and so-called stablecoins. Because the DFSA views tokens as a type of financial instrument, regulation of them is justified. The DFSA is consequently gravely concerned about investor protection, (ii) market integrity, and (iii) disclosure and conduct standards by service providers of such tokens. The underlying technologies are still developing, and as a result, the DFSA acknowledged in the Consultation Paper that announced the recent modifications that they should avoid adopting an excessively prescriptive or restrictive approach.
Types of Regulated Tokens
Security tokens and derivative tokens are both included in the Investment Tokens category of regulated tokens that have been established by the DFSA. These include a security or derivative that is a token, a token that grants rights and responsibilities that are substantially similar to those granted by a security or derivative, or a token that serves a purpose or has an impact that is substantially similar to that of a security or derivative. A DFSA authorization is required in order to conduct a financial service involving investment tokens. Absent an exemption, the DFSA's Markets Law 2012 mandates that a prospectus be published before making an offer of Security Tokens in the DIFC or adding such securities to a local exchange or trading platform.
What Are Crypto Tokens?
The system primarily deals with cryptocurrency tokens (e.g. cryptocurrencies and stable coins). A token is deemed a crypto token by the DFSA if it satisfies one of the following criteria:
- it is used, or is intended to be used, as a medium of exchange, for payment or investment purposes; or
- it confers a right or interest in another token that satisfies the criteria in (a).
Certain tokens, such as "investment tokens," "NFTs," "utility tokens," and digital currencies issued by any government, government agency, central bank, or other monetary authority, are not considered crypto tokens under the guidelines.
In the DIFC, only recognized crypto tokens may be utilized. In general, financial services, public offerings, or financial promotions in the DIFC may only be associated with Crypto Tokens that have been "recognised" by the DFSA. They are known as "Recognised Crypto Tokens". Within 30 days of November 1, 2022, the DFSA is required to release an initial list of recognized tokens. A current or applicant-authorized person, an issuer or developer of the Crypto Token, or the DFSA must submit an application for recognition before it can recognize another Crypto Token.
Investment Tokens, a subcategory of regulated tokens that includes both security tokens and derivative tokens, was formed by the DFSA. These include securities or derivatives that take the form of tokens, tokens that grant rights and obligations that are substantially comparable to those granted by securities or derivatives, or tokens that serve similar purposes or have similar effects to securities or derivatives. It will be necessary to obtain DFSA authorization or permission in order to conduct a financial service involving investment tokens. A prospectus must be published per the DFSA's Markets Law 2012 to make an offer of Security Tokens in the DIFC or to allow such securities to be listed on an exchange or trading platform there, lacking an exemption.
What does the Crypto Token Regime aim to achieve?
The DFSA unveiled its regulatory framework for investment tokens in October 2021. According to its Consultation Paper Number 138 ("CP 138"), the DFSA's Digital Assets regulation was in its initial phase at the time. This made the DFSA's regulatory framework more explicit and expanded it to include Security Tokens or Derivative Tokens (collectively known as Investment Tokens). Investment Tokens are essentially digital assets that are identical to or strikingly comparable to the pre-existing categories of traditional, regulated investments in terms of their function or impact. With the implementation of the Crypto Token Regime, a wider range of crypto assets will fall under the regulatory purview of the DFSA and those who engage in certain activities related to them. The DFSA views this as essential in order to reduce the risks posed by crypto assets, including those related to consumer protection, market integrity, secure custody, and the sufficiency of a service provider's financial resources. These concerns extend beyond AML threats.
Examples of Crypto Tokens
The phrase "crypto tokens" has been defined to include both cryptocurrencies like Bitcoin, Ethereum, and Solana, stablecoins whose value is based on fiat money (referred to as "Fiat Crypto Tokens" of this kind), and Tokens that claim to benchmark their worth against other assets. Utility tokens fall under the definition of crypto tokens even though they are often not subject to financial services regulation under the crypto token regime since they have relevant hybrid elements that go beyond the purview of a pure utility token. For access to goods, services, or discounts offered by their issuer (or a member of the issuer's group), Pure Utility Tokens function in a closed environment. Relevant hybrid elements may include, for instance, the Utility Token being utilized as a more generally recognized medium of exchange or the development of a secondary market, which goes beyond a pure utility use case. The Basic Attention Token and Filecoin were two popular hybrid Utility Tokens mentioned by the DFSA when consulting on the Crypto Token Regime.
How Does a Cryptocurrency Token Become "Recognized"?
The DFSA recommends that only Crypto Tokens certified as Recognised Crypto Tokens will be eligible for use in the supply of financial services in or from the DIFC, similar to certain other crypto regulatory regimes, including that already in place in the Abu Dhabi Global Market ("ADGM"). Upon payment of the necessary fee, either the issuer/developer of the Crypto Token or a DFSA-authorized person (or applicant for authorization) may submit an application for recognition. The applicant will need to present an evaluation of the cryptocurrency token against predetermined standards (discussed below). After considering such evaluation, the DFSA will decide whether to classify it as "recognised." It's interesting to note that, unlike the ADGM regime, once a Crypto Token is deemed "recognised," it will be added to a centralized register managed by the DFSA and will be accessible to anybody with the necessary rights to conduct regulated services in respect of that Crypto Token. For each person offering pertinent regulated services, the ADGM's regime now entails maintaining a separate list of accepted crypto assets, allowing only that person to use the crypto assets on that list. When the DFSA receives a request for the recognition of a certain Crypto Token, it usually posts a notification on its website. If, after reviewing an application, it decides not to recognize a particular Crypto Token, it will also publish a notification. As mentioned above, to coincide with the implementation of the Crypto Token Regime, the DFSA intends to issue an initial list.
It is important to remember that offering financial services in relation to a derivative of a crypto token will only be allowed when the derivative references a crypto token that has been recognized. Similarly to this, only Recognized Crypto Tokens will be eligible for investment by Funds in the DIFC. Funds created outside the DIFC that invest in Crypto Tokens (whether recognized or not) are not permitted to be offered, marketed, or managed by a DFSA-authorized fund manager within the DIFC or from there.
Types of Regulated Activities Which Are Permitted
In regard to crypto tokens, the following services will be allowed:
- Investment business as principal
- Dealing as an Agent in Investments
- Organizing Investment Deals
- Managing Resources
- providing financial product advice;
- Offering Custody
- Setting up Custody
- a clearing house to operate;
- and running a different trading system.
In general, carrying out permissible actions in relation to Crypto Tokens will be governed by the rules already in place that is relevant to those financial services, modified to reflect the risks and features unique to Crypto Tokens. However, no authorized person will be allowed to offer services concerning both Crypto Tokens and Excluded Tokens to maintain a clear line between regulated and unregulated crypto-asset activity. The only situation where this statement is not true is while providing custody. A company that has been granted custody authority may do so in relation to a Crypto Token (recognized or not), NFT, or Utility Token. In the same way that other designated financial products are covered, the financial marketing regime will also be expanded to cover cryptocurrency tokens. Financial advertisements for anonymous or "unrecognised" crypto tokens, private tokens, and algorithmic tokens are illegal. If you have any queries reach out to well-qualified lawyers.