Position Paper on Crypto Assets

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Position Paper on Crypto Assets

• 25 April 2020
• Tax Administration
• SARS

Important: This Position Paper on Crypto Assets was published in response to the consultation paper on crypto assets that was first issued by the IFWG on 16 January 2019. 

1. Introduction 

1.1 Background

1.1.1 The initial public statement on crypto assets was issued by National Treasury (NT) in 2014 as a joint initiative with the South African Reserve Bank (SARB), the Financial Services Board (now the Financial Sector Conduct Authority (FSCA)), the South African Revenue Service (SARS) and the Financial Intelligence Centre (FIC) (hereinafter referred to as ‘regulatory authorities’). The public statement warned members of the public about the risks associated with the use of crypto assets for the purpose of transacting or investing, and advised users to apply caution in this regard. The cautionary tone was directly linked to the fact that no specific legislation or regulation existed for the use of crypto assets. Therefore, no legal protection or recourse was being offered to users of, or investors in, crypto assets.

1.1.2 Following the user alert, the SARB, through its National Payment System Department (NPSD), issued a position paper on crypto assets in 2014. The position paper highlighted the risks surrounding crypto assets, such as money laundering and the financing of terrorism (ML/TF). It noted the lack of a legal and regulatory framework, the absence of consumer protection laws, and the inability to enforce the principle of finality and irrevocability as required in existing payment systems as well as the circumvention of the Exchange Control Regulations. The position paper stated that the SARB did not oversee, supervise or regulate the crypto assets landscape, systems or intermediaries. Therefore, all activities related to the acquisition, trading and/or use of crypto assets were done at the end users’ sole and independent risk, with no recourse to the SARB. The SARB stated that it would continue monitoring activities and developments in this area.

1.1.3 In 2016, the Intergovernmental Fintech Working Group (IFWG) was established, comprising members from NT, SARB, FSCA and FIC. The National Credit Regulator (NCR) and SARS joined the IFWG in 2019. The aim of the IFWG is to develop a common understanding among regulators and policymakers of financial technology (fintech) developments as well as the regulatory and policy implications for the financial sector and the economy. Additionally, the IFWG aims to assist in developing and adopting a coordinated approach to policymaking in respect of financial services activities emanating from fintech. The overall objective of the IFWG is to foster fintech innovation by supporting the creation of an enabling regulatory environment and reviewing both the risks and the benefits of emerging innovations, thus adopting a balanced and responsible approach to such innovation.

1.1.4 At the start of 2018, a joint working group was formed under the auspices of the IFWG to specifically review the position on crypto assets. The members of the IFWG are represented on this working group, referred to as the Crypto Assets Regulatory Working Group (CAR WG). The objective of the CAR WG is to formulate a coherent and comprehensive policy stance on crypto assets, while ensuring the continued integrity and efficient functioning of financial markets, maintaining financial stability, protecting the rights and interests of customers and investors, and combating illegitimate cross-border financial flows, ML/TF.

1.1.5 The CAR WG released a consultation paper at the start of 2019, which provided an overview of the perceived risks and benefits associated with crypto assets, discussed some of the available regulatory approaches, and presented initial recommendations to industry participants and stakeholders. The consultation paper offered an opportunity for industry participants and stakeholders to provide input to formulating a revised policy position on crypto assets. The regulatory authorities considered these comments carefully in drafting the position paper.

1.2 Problem statements

1.2.1 The need to develop a regulatory and policy response to crypto asset activities in South Africa is driven by the following:

1.2.1.1 Crypto assets are a form of fintech innovation that may impact on the financial sector of the country: Fintech is defined as technology applied to financial services, resulting in new business models, applications, processes, products and services with an associated disruptive effect on financial markets and institutions. This definition emphasises the focus on technology-driven innovations that could potentially reshape how the financial services industry operates as it evolves. Given the wide range of innovations across financial services, the existing regulatory architecture should be assessed to determine its appropriateness and effectiveness, and if any enhancements are required. Crypto assets are regarded as an innovation that could materially affect financial services, as some view crypto assets as a new form of money or currency (albeit privately issued) that has a direct impact on economic activities such as payments, investments and capital raising, among other things.

1.2.1.2 Crypto assets operate within a regulatory void as no globally harmonised approach or position has been reached as yet: Regulators have not yet sufficiently addressed the phenomenon of crypto assets, and have not yet settled on a collective approach to this innovation. From conceptualisation to the definition and potential usage, it remains an area that requires further clarity for regulators. Various approaches have been adopted. Some countries have issued communications declaring restrictions or a downright ban on the use of crypto assets. Others have stated that they regard crypto assets as intangible assets exempt from tax. Whilst others have issued statements indicating that crypto assets are not recognised forms of legal tender, without outright declaring them to be illegal. However, the Financial Action Task Force (FATF) recently provided direction on the treatment of crypto assets by amending FATF Recommendation 15 (on New Technologies). This amended Recommendation 15 now requires jurisdictions to regulate crypto assets and crypto asset service providers (CASPs) for anti-money laundering and combatting the financing of terrorism (AML/CFT). Further, jurisdictions must now ensure that CASPs are licensed or registered, and subject to effective AML/CFT systems for monitoring and supervision.

1.2.1.3 Crypto assets may create conditions for regulatory arbitrage while posing risks: The financial sector and its participants operate in a highly regulated environment, which assists in ensuring a sound and safe financial system. However, crypto assets perform similar financial service activities but operate without similar regulatory safety mechanisms. In the case of peer-to-peer trades, financial transactions are concluded without the need for third-party intermediaries. In other cases, newly created intermediaries (such as crypto asset trading platforms) are participating in financial transactions, but these entities operate outside of a regulatory framework. This leaves the crypto asset environment exposed to risks such as financial and consumer risks. Some of the perceived risks of crypto assets include an increase in undetected illegitimate cross-border financial flows, ML/TF, and consumer and investor protection concerns, including market manipulation and tax evasion. Other areas of risk include the circumvention of exchange controls and balance of payments reporting requirements, data- and cybersecurity risk, as well as financial stability risk.

1.2.1.4 Crypto assets may become systemic, as interest, investment and participation in crypto assets continually grows: Financial institutions, new technology firms and big techs, as well as individuals, have been showing an ever-growing interest in crypto asset activities. There are more than 5 300 different crypto coins and tokens in circulation. This number keeps increasing as new schemes, through initial coin offerings (ICOs), are continually launched. The available measures to determine the exact size of the crypto asset market are limited. A tool often used by industry players is the price-checking website Coinmarketcap, which indicates a perceived market capitalisation of about US$210 billion for all crypto assets. In South Africa, there are approximately 12 different crypto asset trading platforms, with a market capitalisation value of approximately R6.5 billion. A complete list of the crypto asset trading platforms operating in South Africa will be pursued.

1.2.2 In summary, crypto assets and the various activities associated with this innovation can no longer remain outside of the regulatory perimeter. Clear policy stances on the variety of emerging use cases must be taken in order to deepen regulatory certainty.

1.3 Approach by the Crypto Assets Regulatory Working Group

1.3.1 The CAR WG is following a structured approach in developing recommendations. Its approach can be illustrated in terms of three pillars.

(i) Pillar 1: The descriptive characterisation of crypto assets and related activities. This was achieved through the issuance of a consultation paper to the industry at the start of 2019. It has been noted that, due to the evolving nature of crypto assets, continuous analysis is required to identify and investigate other developing crypto asset activities.

(ii) Pillar 2: The identification of the critical areas of risk, and the development of mitigating measures to address these areas of risk through regulatory intervention. This position paper highlights these critical risk factors and the recommendations towards a regulatory framework.

(iii) Pillar 3: The continuous monitoring of crypto assets and related activities, and the identification of the evolution of channels for the possible transmission of risks to the financial sector and the economy. A monitoring programme should be implemented by the regulatory authorities for crypto assets.

1.3.2 In order to develop regulatory and policy responses to the emergence of crypto assets in South Africa, the CAR WG conducted a functional analysis of crypto assets. This means that the economic function of crypto assets was assessed, rather than the specific technology applied or the entity involved. From this viewpoint, the following five crypto asset specific use cases were identified:
(i) purchasing/buying and/or selling;

(ii) payments;

(iii) capital raising through ICOs;

(iv) crypto asset funds and derivatives; and

(v) market support.

1.3.3 It is acknowledged that new use cases may arise as the crypto asset market is a rapidly evolving market. Similarly, the underlying economic function and related activity will be assessed.

1.3.4 The functional approach is consistent with the approach adopted across a number of jurisdictions, and the use cases should be read collectively. A number of the recommendations might therefore have broader application and cut across the different use cases.

1.3.5 The CAR WG conducted an in-depth analysis of the applicable use cases to determine the purpose, processes, relevant role players or participants, and the function that each role player fulfils. The consultation paper that was issued in 2019 focused on two of these use cases, namely (i) the buying and selling of crypto assets, and (ii) making payments using crypto assets. This position paper includes recommendations for all five use cases.

1.3.6 This position paper highlights the implicit risks of each of the use cases, and determines the most appropriate policy recommendation that aims to mitigate the identified risks involved. Applicable standards and guidance from international standard-setting bodies were considered, along with the approaches taken by various other jurisdictions.

1.4 Purpose and scope of the position paper on crypto assets

1.4.1 The purpose of this position paper is to present the South African policy position on crypto assets. Such policy stances should enable the development of a regulatory framework, including suggestions on the required regulatory changes to be implemented.

1.4.2 This position paper focuses exclusively on non-government, or non-central-bank-issued, crypto assets. It does not address central-bank-issued digital currencies, including central-bank crypto currencies.

1.4.3 The position paper focuses on all five of the aforementioned crypto asset use cases, namely:

(i) the purchasing/buying and/or selling of crypto assets by consumers and legal persons;

(ii) using crypto assets to pay for goods and services (payments);

(iii) ICOs;

(iv) crypto asset funds and derivatives; and

(v) crypto asset market support services.

1.4.4 The CAR WG acknowledges that this list of use cases is not necessarily exhaustive. This position paper is based on the definition and classification of crypto assets as provided below. The use cases flow from, and are limited to, this specific definition. The paper represents a policy position at a specific point in time, in a rapidly evolving field.

2. Defining and classifying crypto assets

2.1 Defining crypto assets

2.1.1 From a regulatory perspective, having clarity on the term ‘crypto assets’ is fundamental as it directly influences the term’s classification and concomitant regulatory treatment. Various naming conventions have been adopted in just a few years, from ‘digital tokens’ and ‘digital assets’ to, most recently, ‘crypto tokens’ and ‘crypto assets’ (CPMI, 2015; FSB, 2018; BIS, 2018; Carney, 2018a). Despite the various terminology used, the crypto phenomenon is commonly based on decentralised technology such as blockchain and distributed ledger technology (DLT). The definitions used generally focus on its electronic nature, its potential role as a medium of exchange, and its perceived role as a representation of value. Some jurisdictions have classified it as a unit of account, while others have rejected it as a financial instrument such as a security or other financial product. Central banks, in particular, have been reluctant to refer to the phenomenon as ‘currency’ as it is not deemed to be a form of legal tender nor fiat currency. Annexure 2 describes the regulatory positions that have been adopted by some jurisdictions.

2.1.2 The regulatory authorities have taken a functional approach, focusing on the economic activities being performed, compared to a more generic, ‘all-encompassing’ classification. It is acknowledged that crypto assets may perform certain functions similar to those of ‘traditional’ currencies, securities or financial products and commodities.

This article first appeared on sars.gov.za.

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