Regulation of Crypto Tokens

Nadim Bardawil Partner nadim.bardawil@bsabh.com

Marina El Hachem Associate marina.elhachem@bsabh.com

Introduction
The UAE has long positioned itself at the forefront of innovation in the region and is now strengthening its status by becoming the hub for crypto investors in the Middle East. Following the footsteps of the regulators in the ADGM, DMCC and mainland, the DFSA has published its Regulation of Crypto Tokens (the “Crypto Token Regime”) which sets out a regulatory regime for persons seeking to provide financial services in respect of Crypto Tokens. This regime came into force on November 1st, 2022, presenting an additional jurisdiction in the UAE in which cryptocurrency trading and exchange activities may take place. 

The Crypto Token Regime aims to set guidelines that ensure investors are adequately protected while “providing an advanced virtual asset ecosystem in terms of organization, governance and security”. Below is an overview of the main provisions introduced by this legal and regulatory framework. 

Classification of Tokens
For the purposes of this regulation, the DFSA defines a Crypto Token as a token that:

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





Not all types of tokens are regulated by the Crypto Token Regime. In fact, the DFSA has classified tokens into several categories:

       - Recognized Crypto Tokens: A Crypto Token is recognized by the DFSA if (a) it is included on the pre-recognized list of Crypto Tokens published by the DFSA or (b) it has been specifically recognized by the DFSA following a recognition application process.

       The DFSA has introduced the list of pre-recognized Crypto Tokens that will not need to go through the formal recognition process to be accepted and as of today, this list includes Bitcoin (“BTC”), Ethereum (“ETH”) and Litecoin (“LTC”). 

This means that funds which invest in Crypto Tokens will be limited to the sale of Recognized Crypto Tokens only. While BTC and ETH remain the largest tokens in terms of market cap, we expect applications to be submitted by authorized firms or new applicants to the DFSA requesting that additional tokens be considered. This includes existing DFSA authorized firms that wish to obtain a variation of their license to include crypto tokens. 

       - Fiat Crypto Tokens: must undergo a recognition process as well as meet additional criteria for them to be permitted to be used in the DIFC. Financial services and activities can only be carried out in relation to Fiat Crypto Tokens that are recognized.

       - Prohibited Tokens, Unrecognized and Derecognized Tokens: carrying out any financial service or other activity with Prohibited Tokens (Privacy Tokens or Algorithmic Tokens), Unrecognized Tokens (Crypto Tokens not assessed by the DFSA) and  Derecognized Tokens (Crypto Tokens that were recognized but no longer meet the criteria) is strictly prohibited.

       - Excluded Tokens: Non-fungible Tokens (“NFT”) and Utility Tokens (“UT”) are outside the scope of regulation under the Crypto Token Regime but will be required to register with the DFSA as a Designated Non-Financial Business or Profession (“DNFBP”) as well as comply with Anti Money Laundering (“AML”) requirements from the commencement date of the Crypto Token Regime or face potential enforcement action. 

One of the deciding factors to determine whether a Token is an NFT is the unique and non-fungible nature of the Token, which must relate to, and represent, an identified asset, such as art, music, or another collectable item. The DFSA will take a substance over form approach in determining whether a certain Token is an NFT. 

Recognition Process
Recognition applications will be submitted to the DFSA which will issue a notice on its website in this regard. The application process is made on the DFSA website www.dfsa.ae/innovation where a General Enquiries Contact Form must be completed. The DFSA will review each application on a case-by-case basis and will not set a specified timeframe for the review as this will greatly depend on the quality of the information and analysis presented by the applicant.

Recognized Jurisdictions
The DFSA may recognize another jurisdiction as having a regulatory regime for Crypto Tokens that is equivalent to that of the DFSA. A list of recognized regional and foreign jurisdictions will be published on the DFSA’s website as having an equivalent regulatory regime. 

A list of recognized jurisdictions may have several practical implications for example:

When considering whether an existing authorized firm, operating as a branch in the DIFC should be permitted to provide certain Financial Services with Crypto Tokens without having to establish a legal entity in the DIFC, the DFSA has indicated that it will look to see whether the parent institution of the branch is authorized for Crypto Token business in its home jurisdiction. 

Transition Period
The DFSA has introduced a six-month transition period starting 1 November 2022 for authorized firms already providing services related to Crypto Tokens to comply with the requirements of this regime. One of the consequences of this transitional arrangement is that authorized firms may continue providing that same service with Crypto Tokens for only six months. Firms should allow sufficient time to submit their Crypto Token recognition applications and have them assessed by the DFSA before the transitional period ends, or they will be required to cease offering any products and services relating to those Tokens.

Conclusion
The DFSA is planning to explore other policies relating to Crypto Tokens such as Staking, Decentralized Finance activities and AML/CTF issues. In the meantime, we expect this regime to be met with considerable interest from both local and international players who will be looking to set up their Financial Services license in the DIFC. 

  1. The words of his Highness Sheikh Mohammed Bin Rashid Al Maktoum, Vice President and Prime Minister of the United Arab Emirates and the Ruler of Dubai.