As technology continues its hasty integration into every aspect of our lives, regulators across the globe struggle to keep up with the maddening pace of balancing state of the art technology with the use of traditional regulatory schemes.
The technology sector exists in a constant state of growth and improvement; thus, it is essential for regulators to consistently monitor and apprehend market dynamics in order to tailor traditional infrastructure to best suit the needs of the industry. While the financial sector is no stranger to technological development, utilizing the logic behind inventions dating as far back as 1300 BC with the abacus, the sudden popularity of technology like blockchain and cryptocurrencies has forced financial institutions to quickly face the evolutionary era of financial technology (“FinTech”).
In this article, we will take a look at one of the most prominent technologies to emerge from the FinTech sector, cryptocurrencies, by providing a snapshot of the current state of legislation with regard to cryptocurrencies in both the international arena and in Turkey and exploring the hurdles faced by regulators when developing such legislation.
Blockchain & Distributed Ledger Technology
In order to fully grasp cryptocurrencies, we must first explore the heart of any FinTech transaction: Blockchain. Blockchain is a type of Distributed Ledger Technology (“DLT”), which is a blanket term encompassing all types of technology used to facilitate exchanges of value between users on a given platform, and is essentially a decentralized database system that collects digital information stored in the form of a block. In blockchain, users create blocks of data containing information such as the participants involved and the time and date the transaction took place, which is then recorded across a peer-to-peer network using a cryptographic trust and assurance mechanism.1 This block of data is subsequently connected to other users’ data blocks, thus creating a chain. Each block in the chain is given a unique identifier called a “hash”, which operates like a fingerprint as it is used to differentiate the data stored in that particular block from other blocks in the chain.
Blockchain technology is known for its added security benefits, quick transaction time, cost efficient nature, and decentralized networks. In this article, we will focus on one of the most discussed forms of blockchain: Cryptocurrencies.
One of the most unique characteristics of cryptocurrencies is that they operate without a central regulatory authority. Traditional banking runs the risk of slow approval processes and high fees for transactions that may take days to complete. Decentralization allows for financial transactions to take place nearly instantaneously with little to no fees, mitigates bank failures and collapses, and offers the benefit of utilizing wallets that store cryptocurrencies offline (cold storage), further safeguarding consumers from data breaches.
However, this does not mean that cryptocurrencies should go unregulated. Due to these unique attributes, regulators around the world are trying to figure out how to best apply regulations to cryptocurrencies. In some countries like Switzerland and Malta, legislation has already been implemented which has set the legislative framework for other nations building their own cryptocurrency regulations, like the United States and China whose legislation needs further refining, while for many others, such as Turkey, regulations do not yet exist.
Regulation is important for several reasons. Regulators rightfully have an interest in monitoring the use of cryptocurrencies to minimize risks such as market manipulation, breaches in customer security, and the use of cryptocurrencies in illicit activities, among others. As such, regulators are working to determine the best method that strikes a balance between reducing the risks associated with utilizing cryptocurrencies without minimizing the benefits of the mechanism.
How to Regulate
Currency, Security, Commodity, or Something New?
When it comes to deciphering the appropriate regulations for this unprecedented phenomenon, many regulators look to preexisting categories of assets to shed light on the appropriate oversight by asking the question: Should cryptocurrencies be classified as a currency, security, or commodity? The answer will considerably influence how regulatory agencies in different jurisdictions oversee cryptocurrency activities.
Given that cryptocurrencies are often used in place of traditional currency as an exchange for goods or services, there is an argument to be made that cryptocurrencies should be classified as a currency and would therefore be regulated by a state’s central bank, but some authorities have found that cryptocurrencies fail to fit the legal definition of a currency.2 For example, in 2015, the European Central Bank published a report titled “Virtual Currency Schemes” which argues that cryptocurrencies cannot be classified as currencies because they are merely a digital representation of value and are not issued by a central bank credit institution or e-money institution.3 However, a decision rendered by the European Court of Justice dated 22 October 2015 stated that for tax purposes, virtual currencies (including cryptocurrencies) should be treated as currencies.4 It is clear that experts are still at odds with one another over whether a cryptocurrency may qualify as a currency in certain circumstances, but where do they lie in terms of viewing cryptocurrencies as securities?
Securities are essentially tangible proof of ownership or debt that has been assigned a value and may be sold, including shares and debt instruments. In the US, the Chairman of the Securities Exchange Commission (“SEC”) stated in an interview with CNBC that cryptocurrencies do not qualify as securities because they do not represent ownership in an entity. 5 Furthermore, he stated that securities are funded by public investors with a promise of a future reward (i.e., ownership in a company for economic gain), whereas Bitcoin was funded through research funding and donations.6 Should other regulators adhere to this interpretation, there is one final traditional regulatory scheme left to consider — commodities.
Commodities can be defined as raw materials sourced from the earth such as gold, silver, oil, natural gas, copper, as well as agricultural products such as corn, coffee, and sugar that can be used and exchanged. Regulators strictly following this conventional definition may have a hard time incorporating cryptocurrencies under the same umbrella as agricultural products and natural resources, particularly since cryptocurrencies merely hold exchange value and are not considered valuable for the underlying product itself. In the United States, the Commodity Futures Trading Commission (“CFTC”) stated in a press release on 8 October 2018 that cryptocurrencies are in fact commodities in certain instances, and some exchanges, such as the Chicago Mercantile Exchange (“CME”), have already begun offering Bitcoin futures.7 In China, courts have already declared that cryptocurrencies are in fact commodities, indicating that there may be a strong case for cryptocurrencies to be housed under commodities regulations.8
In light of the trends we’ve seen from regulators around the world, the EU has announced that an outline for the framework for the regulation of cryptocurrencies is planned to be published later in 2020 which may either wedge cryptocurrencies into the an existing subset or create an entirely new set of rules.9 As there appears to be no perfect fit for cryptocurrencies under these existing regulatory schemes, some leading countries in the crypto space such as Malta and Switzerland have already taken on a new way of looking at cryptocurrencies.
Maltese and Swiss Regulations
Malta was the first EU Member State to enact a comprehensive legal framework regulating DLTs, Virtual Financial Assets (“VFAs”), and entities providing certain services related to VFAs.10 In 2018, the Maltese parliament issued three Acts that were the first of their kind: the Malta Digital Innovation Authority Act, the Innovative Technology Arrangements and Services Act, and the Virtual Financial Assets Act (“VFA Act”).11 Together, this triad of legislation provides a model framework for the industry regarding DLT software, the offering and issuing of VFAs, and the provision of certain services connected to VFAs. The VFA Act qualifies all forms of cryptocurrencies as DLT assets and defines such as assets that are “intrinsically dependent on, or utilizes, Distributed Ledger Technology.”12 DLT assets can either be:
Virtual Tokens, also known as utility tokens;
Virtual Financial Assets;
Electronic Money; or
The VFA Act also outlines the Maltese Financial Instruments Test, which is used to determine under which category a DLT asset falls and must be performed by all companies issuing DLT assets in or from Malta as well as persons conducting activities that fall within the scope of the VFA Act or other DLT related legislation.14
In Switzerland, in its explanatory report on the DLT Draft Law, the Swiss Federal Council stated that the current best approach is to rely on categories of tokens, which were introduced by the Swiss Financial Market Supervisory Authority (“FINMA”) in its Guidelines issued on 16 February 2018.
The categories of tokens include: 1) Payment tokens, 2) Utility Tokens, and 3) Asset tokens.15 Payment tokens, which FINMA has stated are synonymous with “pure cryptocurrencies”, involve cryptocurrencies that are intended to be used as a means of payment to acquire goods or services.16 When compared to traditional financial instruments, these most closely correspond with currencies. Utility tokens on the other hand include tokens that are intended to provide digital access to an application or service by means of a blockchain-based infrastructure. Finally, asset tokens, also referred to as stable coins, represent assets such as debt or equity claims against the issuer and are analogous to equities, bonds, or derivatives. FINMA also stated that tokens enabling physical assets to be traded on a blockchain-infrastructure also fall within this category.17
The United Kingdom and Germany are among the other countries who have also implemented legislation categorizing cryptocurrencies under different groups of tokens. We continue to monitor whether this modern take on banking techniques will catch wind in other European countries, including Turkey.
Turkey’s Efforts to Keep Up with Global Trends
As of the date of this article, no legislation or regulations explicitly permitting, prohibiting, or classifying cryptocurrencies exists in Turkey. Various official institutions have made statements and issued press releases to shed light on the Turkish government’s approach to cryptocurrencies and to provide insight on potential future approaches.
The Banking Regulation and Supervision Agency of Turkey (“BRSA”) confirmed in a press release dated 25 November 201318 that Bitcoin and other cryptocurrencies are not considered “currencies” or “virtual currencies” within the framework of Law No. 6493 on Payment and Securities Reconciliation Systems, Payment Services, and Electronic Money Institutions19 as they are not issued by an authorized institution.
The press release itself was of a cautionary nature, reminding cryptocurrency users of the potential dangers associated with using alternative payment methods that are not subject to the authority of the BRSA.
In a letter addressed to the Turkish Capital Markets Association, the Capital Markets Board of Turkey (“CMB”) made it clear that the performance of spot and derivatives transactions made based on
cryptocurrencies are not explicitly allowed under the Turkish Capital Markets Law20 and are therefore prohibited.21 The CMB also stated that cryptocurrencies cannot be classified as securities as they are not tangible property.
With regard to the abovementioned statements from the BRSA and the CMB, it can be inferred that the current inclination of Turkish officials is to classify cryptocurrencies as commodities.
However, VAT is applicable to cryptocurrency purchases in Turkey. We assume that Turkish authorities may also need to decide on and determine the tax regime applicable to cryptocurrencies. Until then, the official treatment of cryptocurrencies remains unclear.
Consolidating the Patchwork Legislation
In line with the seemingly global trend, regulations covering blockchain and cryptocurrencies in Turkey are very sparse. We believe that the governmental institutions are closely monitoring Turkish users’ attraction to the rapid development of these new technologies and currencies.
The Financial Stability Committee, in its meeting dated 10 January 2018, resolved to form a working group to draft a regulation on cryptocurrencies.22 At the beginning of January 2020, news agencies reported that the CMB has commenced work on a new regulation for cryptocurrencies.23
As the use of cryptocurrencies in place of traditional banking and financing mechanisms is spreading far and wide, regulators may soon consider shedding further light on these ubiquitous ambiguities and issuing legislation that best suits the unique aspects of the sector in order to safeguard consumers and financial institutions alike.
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