Dubai Financial Services Authority Releases New Regime to Regulate Crypto Tokens | Latham & Watkins LLP

The regime is introducing rules on various crypto tokens, including cryptocurrencies and stablecoins, in the international financial center of Dubai.

On November 1, 2022, the Dubai Financial Services Authority (DFSA) crypto token regulatory regime came into effect.

The rules extend the DFSA framework for regulating investment tokens established in 2021 (the 2021 rules). The Dubai International Financial Center (DIFC) scheme defines a token as a cryptographically secure digital representation of value, rights or obligations that can be issued, transferred and stored electronically, using ledger technology distributed (DLT) or other similar technology. The 2021 rules regulated only investment tokens, which included security tokens and derivative tokens (in essence, token equivalents of conventional securities and derivatives, respectively) (investment tokens). Under the 2021 rules, persons engaging in certain activities with investment tokens (e.g. issuing, offering, holding, promoting, trading, advising, trading) must obtain DFSA approval and comply with certain obligations.

On March 8, 2022, the DFSA released its Consultation Paper 143 (the Consultation Paper), setting out regulatory proposals for other types of tokens, in particular cryptocurrencies, payment tokens, and hybrid utility tokens ( for example, which provide additional rights to tokens). holders, such as discounts).

The consultation document invited the market to provide comments on the planned regime by May 6, 2022 and, on October 18, 2022, issued a feedback statement regarding the comments received (the statement). The Statement did not anticipate major changes to the proposals outlined in the consultation document.

DFSA Key Definitions

A Encryption token is a token if it: (a) is used, or is intended to be used, as a medium of exchange or for payment for investment purposes; or (b) confers a right or interest in another token that meets the requirements of clause (a) above.

The scheme defines a Fiat Crypto Token (e.g., stablecoin) as a type of cryptographic token in which price and volatility are determined, in whole or in part, by reference to a fiat currency or a combination of fiat currencies.

A token is not a Crypto Token (and falls outside the scope of the new regime) if it is (i) an Investment Token (or any other type of investment) or (ii) an Exclud Token. The first type of token is governed by the 2021 rules.

Tokens excluded

  • Non-fungible tokens (NFT) are unique and non-fungible tokens. They relate to identified assets and prove ownership or provenance of those assets. In the view of the DFSA, no financial services are provided via NFTs and therefore these tokens should be outside the scope of the new rules.
  • Utility Tokens are tokens that can only be used by the holder to pay, benefit from a discount or access a product or service provided by the issuer or an entity of its group. The DFSA suggested continuing to monitor developments around these tokens to determine if they should be regulated.
  • CBDC refers to digital currency issued by any government, government agency, central bank or other monetary authority. The DFSA viewed these tokens as similar to fiat currencies.

Excluded tokens generally fall outside the scope of the new regime. However, the DFSA noted that certain issuers and service providers of NFTs or Utility Tokens must be registered as Designated Non-Financial Businesses and Professions (DNFBPs) in order to comply with anti-money laundering rules, and submit suspicious transaction reports in the UAE. authorities.

Prohibited tokens

  • Algorithmic tokens are Crypto Tokens using an algorithm of increasing or decreasing the supply of Crypto Tokens to stabilize the price or reduce its volatility.
  • Privacy tokens are Crypto Tokens intended to allow the holder to hide, anonymize, obscure or prevent the tracking of:

Prohibited tokens cannot be used in the DIFC. The DFSA banned them due to a lack of transparency regarding the algorithms used and the transactions made with the use of these tokens.

Regulated activities within the scheme

Persons need permission from the DFSA to engage in dealing (as principal or agent), arrangement, management, advice, negotiation, clearing, provision of custodial services and conducting certain other activities with respect to Crypto Tokens (Authorized Persons). Certain activities are expressly prohibited:

  • An Approved Person is not permitted to engage in any activity related to a utility token or an NFT (to separate activities regarding regulated and unregulated tokens).
  • The use of Crypto Tokens by money service providers is generally not permitted, except where such tokens are Fiat Crypto Tokens used solely for the purpose of transferring money or performing a payment transaction, and provided that these tokens are in the name of the money service provider (not its client).
  • Crowdfunding operators are not permitted to operate platforms that facilitate investments in Crypto Tokens. It is also prohibited to organize commercial facilities related to Crypto Tokens.

Approved Persons must comply with a number of requirements, depending on the exact scope of their activities. These requirements may include obligations for reporting, disclosure, ensuring information security, or stating certain mandatory terms in customer agreements.

Recognition of cryptographic tokens

Regulated activities cannot take place in the DIFC with Crypto Tokens, unless the DFSA recognizes the tokens (Recognized Crypto Tokens).

Recognition of tokens by the DFSA is based on a number of criteria (which the DFSA assesses cumulatively), including regulatory status in other jurisdictions, adequacy of transparency and technology used, risk mitigation and size, as well as market liquidity and volatility.

The DFSA has determined the initial list of recognized crypto tokens, namely recognized Bitcoin (BTC), Ethereum (ETH), and Litecoin (LTC). An authorized person, an applicant for the relevant DFSA approval, or an issuer or developer of the crypto token may file an application with the DFSA for recognition of specific crypto tokens.

The DFSA may revoke Recognized Crypto Token status if the affected crypto token becomes unsuitable for use in the DIFC. Approved Persons must notify the DFSA of material events or developments that reasonably suggest the crypto token no longer meets the criteria.

Summary

The new regime represents a step forward on the part of the DFSA in regulating tokens in the DIFC-free zone. It aims to establish the DIFC as a hub for Virtual Asset Service Providers (VASPs), similar to the Abu Dhabi Global Market (ADGM) (which, since its introduction in 2018, has run its own regulatory framework for virtual assets) and the recent established the Dubai Virtual Asset Regulatory Authority (DVARA), which regulates the activities of VASPs in the Emirate of Dubai outside the geographical area of ​​the DIFC.

The regulatory approach taken is generally consistent with that of the ADGM and the approach taken at the federal levels of the United Arab Emirates and the Emirates. (Read this Latham blog post for more information.)

Questions remain as to what further steps the DFSA will take to regulate the crypto industry and how the DIFC regime will interact with rules promulgated outside the DIFC at the individual Emirati and federal level. The DFSA announcements set expectations for further consultations on crypto tokens, which will focus, among other things, on decentralized finance (DeFi).

Latham & Watkins will continue to monitor developments related to virtual assets in the Middle East, including additional upcoming rules and regulations.

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