DFSA Consults on the Regulation of Crypto Tokens - Consultation Paper 143

In Scope

Investment Token

Security Token

Derivative Token

Accepted Crypto Token

Defined based on an eligibility criterion and application process

Excluded Token

·         Non-Fungible Token (NFT)

·         Central Bank Digital Currency

·         Utility Token

Prohibited Token

·         Privacy Token

·         Algorithmic Token

Financial Services that can be conducted with Accepted Crypto Tokens

·         Authorised Market Institutions

·         Multi-Trading Facility

·         Dealing as Principal

·         Dealing as Agent

·         Asset Manager

·         Fund Manager

·         Providing Custody

·         Arranging Custody

·         Arranging Deals

·         Advising

Definitions

Crypto Token

Token that is used, or intended to be used, as a medium of exchange or for payment or investment purposes but excludes Investment Tokens, any other investment or Excluded Tokens.

Cryptocurrency

Type of crypto token to be used as a medium of exchange, giving the holder either no, or limited rights for a claim against the creator/offeror.

Definitions

The DFSA proposes to provide:

·         a broad definition of a Crypto Token

·         a list of Excluded Tokens

·         a list of Prohibited Tokens

Accepted Crypto Token Process

The proposals set forth an approach to seek approval for tokens to be treated as Accepted Crypto Tokens based on acceptability factors proposed by the DFSA which considers a number of factors as part of an Acceptance Application Process for Crypto Tokens and related financial services. The criterion to be considered as part of the application for Accepted Crypto Token includes:

·         Regulatory status of Crypto Token in other jurisdictions and appropriateness of centralized or decentralized governance

·         Size, liquidity and volatility of Crypto Token

·         Sufficient transparency around the technology, protocols and significant stakeholders in the ecosystem around the Crypto Token

·         Adequacy and suitability of the technology used in relation to the Crypto Token

·         Risks associated with the use of the Crypto Token and appropriateness of controls to mitigate these risks

·         Adequacy arrangements around the reserves, stabilization and redemption mechanisms of a Crypto Token that purport to be used as a Fiat Crypto Token

Financial Promotions

To address global concerns about the marketing practices relating to crypto, the DFSA proposes amendments to the Financial Promotions regime to:

·         Enhance Financial Promotion controls around Crypto Tokens

·         Prohibit Financial Promotions that are not Accepted Crypto Tokens, not Algo Tokens and not Privacy Tokens

·         Expand the definition of financial product to include Crypto Token

Governance and Substance

To recognise the risks across Crypto Tokens, certain enhancements to the legal form and management of Applicants are proposed:

·         Applicants intending to offer financial services in relation to Crypto Tokens must be established as legal entities in the DIFC (no branches will be permitted)

·         Day to day management of such businesses must be in the DIFC

Restriction on offering both Accepted Crypto Token and Excluded Tokens

·         Authorised persons are not to be permitted to offer both Accepted Crypto Tokens and Excluded Tokens from the same legal entity - the position remains open to discussion with regards to custodians as to whether they should be permitted to service bother Crypto Token and Excluded Tokens

Trading Venues and Related Controls

·         Permit direct access to Crypto Token trading venues

·         Annual technology audit for assurance relating to the trading venue

Collective Investment Funds

In the context of collective investment funds, a number of enhancements and controls are proposed to ensure funds are marketed and managed appropriate to the risks associated with Crypto Tokens:

·         Funds can only hold themselves out as being Crypto Token Funds if the main purpose of investing is in Accepted Crypto Funds

·         Additional disclosures relating to the Crypto Token as well as disclosures relating to the DLT used to issue, store or transfer the Accepted Crypto Token as well as wider issues in relation to the DLT to be provided in the relevant investor disclosures/offer documents;

·         Details of valuation, including the price information provider details to be used to support the valuation of the Crypto Tokens to be disclosed until more guidance can be developed through regulation

·         Self-custody will not be permitted in the case of Crypto Tokens;

·         Crypto Funds cannot be managed by external fund managers, nor through an external fund

·         Foreign funds that are Crypto Tokens cannot be marketed in or from the DIFC

Digital Wallets & Custodians

·         Enhanced governance and technology requirements are proposed to apply to digital Wallets and custodians, including further detailed information in related client agreements

Conduct & Disclosure

·         Enhanced risk warnings to be provided as part of disclosure and conduct requirements

·         Requirement to provide a Key Features Document (KFD) on each Accepted Crypto Token to be offered setting out minimum information being proposed in the regulations

Retail Clients

A number of additional safeguards are proposed in relation to retail clients, including consideration of whether holdings of Crypto Tokens should form part of the assessment of net assets as part of the client classification process:

·         With regards to client classification, the proposed approach is to allow Crypto Tokens to contribute to a net asset test if they are i) Accepted Crypto Tokens and ii) subject to an 80% haircut and monitoring how the knowledge test will apply in respect of Crypto Tokens given it is a nascent industry with limited widespread knowledge in this area, at this point

·         Further consultation is sought with regards to the scope of and extent of application of Crypto Tokens to retail clients

·         Enhancements to appropriateness assessments before allowing retail clients to transact with a Crypto Token

·         Prohibit use of credit cards by retail clients to fund their accounts

·         Restrict leverage offered to retail clients in relation to Crypto Tokens Derivatives

·         Prohibit offering incentives linked to Crypto Tokens to retail clients

Base Capital & Custodians

·         The DFSA proposes that custodians that provide Crypto Token custody should be subject to a higher base capital requirement of USD1 million