United Arab Emirates: The Dubai Financial Services Authority introduces a regulatory framework for recognized crypto tokens

In short

Over the past few years, the UAE has taken steps to regulate the volatile crypto industry, as seen during the recent crypto winter, and to anticipate global developments in crypto regulation. cryptography, including in the United States and the United Kingdom, which have been called upon to regulate the sector. through regulations rather than law enforcement, to protect retail investors who ultimately bore the brunt of the crypto winter (a prolonged period of declining cryptocurrency asset prices).

In 2020, the Financial Services Regulatory Authority (FSRA) of the Abu Dhabi Global Market (ADGM) issued guidelines regarding the regulation of digital securities activities within ADGM, followed in 2022 by the publication guidelines on the regulation of virtual assets. Activities. The Securities and Commodities Authority (SCA) also issued the Crypto Assets Activities Regulation (CAAR) in 2020 which regulates key aspects of trading crypto assets in the UAE, from issuance and promotion to operation. of an exchange and custody. In early 2022, the Emirate of Dubai also introduced the Virtual Assets Act and established the Virtual Assets Regulatory Authority (VARA) as Dubai’s main virtual asset regulator.

The Dubai Financial Services Authority (DFSA) of the Dubai International Financial Center (DIFC) had begun its foray into crypto industry regulation by introducing investment tokens in September 2021. The spotlight is now on the DFSA as it seeks to make sweeping changes to its regulatory regime regarding recognized crypto tokens effective November 1, 2022.

This Client Alert provides an overview of the different categories of crypto tokens and the expectations of businesses dealing with crypto tokens in light of the impending DFSA regulations.

What are investment tokens vs crypto tokens?

An investment token (“Investment token“) is either a security token (such as a stock, debenture, warrant, certificate, unit or structured product) or a derivative token (such as an option or future).

A crypto token (“Encryption token“), on the other hand, is defined by the DFSA as a token that has one of the following characteristics:

  1. It is used, or is intended to be used, as a medium of exchange or for payment or investment purposes.
  2. It confers a right or interest in another token that meets the requirements of (a).

It might also be useful to determine a crypto token via negativa (i.e. by determining what it is not), i.e. whether a token is one of the following:

  1. Token excluded
  2. Investment Token (as defined above)
  3. Another type of investment

Simply put, a Crypto Token is not one of the following:

  1. A security
  2. A derivative
  3. A non-fungible token (NFT)
  4. A utility token
  5. A digital currency from the UAE Central Bank (CBDC)

A cryptographic token is also not an unrecognized token or a forbidden token (which are privacy tokens or algorithmic tokens).

More importantly, only recognized crypto tokens can be processed in or from the DIFC in accordance with DFSA regulations.

What are Recognized Crypto Tokens and how will they be assessed by the DFSA?

The DFSA’s assessment of recognized crypto tokens will be somewhat similar to the FSRA’s assessment of accepted virtual assets. The DFSA may recognize a Crypto Token based on the following criteria:

  1. The Crypto Token’s regulatory status in other jurisdictions, including whether it has been assessed or approved for use by a regulator in another recognized jurisdiction.
  2. Is there adequate transparency regarding the Crypto Token, including enough details about its purpose, protocols, consensus mechanism, governance arrangements, founders, key people, miners, and significant holders?
  3. The size, liquidity and volatility of the Crypto Token market globally.
  4. The suitability and appropriateness of the technology used in connection with the Crypto Token.
  5. If the risks associated with the Crypto Token are sufficiently mitigated, including risks related to governance, legal and regulatory issues, cybersecurity, money laundering, market abuse and other financial crimes.

The most common types of crypto tokens are cryptocurrencies and stablecoins (i.e. crypto tokens that aim to maintain a stable price with their value determined by reference to the value of a currency, d a commodity, gold or other asset). Cryptocurrencies generally do not provide their holder with a set of rights similar to those generally attached to investments. More generally, cryptocurrencies serve as virtual currency to their native blockchain, where validation of transactions occurs through various forms of decentralized consensus mechanisms.

It is important to note that derivative products, such as futures or options, can also be issued in the form of cryptocurrencies. However, these derivatives will be considered Investment Tokens rather than Crypto Tokens. Similarly, if the arrangements relating to a token constitute a mutual fund, then the token will be considered a unit and therefore a security, rather than a Crypto Token.

What are the financial activities that could be carried out with Investment Tokens and Crypto Tokens in or from the DIFC?

Investment tokens can be traded on a trading platform or cleared through a clearinghouse. They could be traded by a broker acting as principal or agent, or arranged by a financial advisor in arranging investment transactions in relation to investment tokens or in asset management.

Recognized crypto tokens can be traded by a principal or agent or taken into account in arranging investment transactions. They may also be managed by asset managers or advised by financial advisors and may be retained. Trading recognized crypto tokens requires an MTF (Multilateral Trading Facility) license and DFSA approval. They can also be traded through a clearing house.

However, crypto tokens cannot be offered by a crowdfunding operator, cannot be used by money service providers in the course of their money services business, except in limited circumstances, and cannot be traded. on an organized trading facility (OTF) or promoted by a representative office. .

What are prohibited tokens and excluded tokens and related financial activities that cannot be conducted in or from the DIFC?

Financial promotion in connection with Crypto Tokens that are not considered DFSA Recognized Crypto Tokens is prohibited. Algorithmic tokens and privacy tokens are considered prohibited tokens.

A privacy token is a prohibited cryptographic token where the technology used has functionality to conceal, anonymize, obscure, or prevent the tracking of information about the identity of the holder, cryptographic keys, parties and transaction value, or beneficial owners.

An algorithmic token is also a prohibited crypto token that uses an algorithm to increase or decrease supply to stabilize or reduce price volatility.

Staking in crypto tokens and decentralized finance (DeFi) must be given proper consideration by licensed companies, as staking can only be offered to non-retail customers and the loan is only for the participating borrower to the proof-of-stake mechanism. .

NFTs and utility tokens are considered excluded tokens. However, issuers of these tokens will be considered Designated Non-Financial Businesses and Professions (DNFBPs) and will be subject to UAE anti-money laundering law and regulations.

What should companies that intend to trade recognized crypto tokens under DFSA regulations do?

From November 1, 2022, all companies that currently provide or wish to provide financial services in relation to recognized crypto tokens in or from the DIFC will need to obtain the appropriate license from the DFSA. To qualify, companies will first need to submit a pre-application to the DFSA via the DFSA website. For the avoidance of doubt, this applies to existing DFSA-licensed businesses that wish to obtain a variant of their license to include trading recognized crypto tokens.

To talk to us about DFSA regulations regarding recognized crypto tokens, or any fintech and financial services regulatory questions or issues, please contact Mazen Boustany.

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