dubai and tech

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After a year of chaos in the crypto sphere, the Virtual Asset Regulatory Authority’s framework represents a shift in the regulatory approach to virtual assets. John Everington reports.

After a comparatively slow start in the crypto asset space – at least compared with some of its near neighbours in the Middle East – Dubai made headlines in early February 2022 with the birth of the Virtual Asset Regulatory Authority (Vara), a body described as the world’s first independent regulator for virtual assets. 

At a time when bitcoin was worth around $42,000 and crypto firms spent lavishly on advertising for the Super Bowl, Vara and Dubai welcomed the industry’s largest names, granting several high-profile minimal viable product (MVP) licences to the likes of Binance, FTX (subsequently withdrawn in November), Crypto.com, OKX and others, even as its rulebook was still being written. 

One year on, several bankruptcies and the destruction of billions worth of global crypto asset values later, Vara’s newly-published regulatory framework signifies a shift in the regulatory approach to virtual assets. While some had initially hoped for a light-touch, start-up-friendly approach, the regulator’s new Full Market Product (FMP) regulations, published on February 7, puts risk management at the heart of Dubai’s cryptocurrency ecosystem

“Vara’s initial approach in early 2022 appears to have been focused on attracting a larger number of global participants to operate as early-stage MVP licensees (albeit with restrictions on full access to the retail market), observe how they operated, and build a regulatory framework around the MVP experience, which would ensure that the final regulatory framework addressed specific local operating conditions,” says Samir Satchu, senior vice-president for public policy and expansion at BitOasis, a Dubai-based virtual assets platform. 

“Unsurprisingly over the past months, given global market failures including but not limited to FTX, Vara has adopted a more cautious approach, with more scrutiny about how firms are mitigating risk and protecting consumers, which has sensibly affected the scale at which the MVP and full licensing programme will be rolled out.” 

The FMP regulations cover seven distinct activities, namely advisory services, broker-dealer services, custody services, exchange services lending and borrowing services, payments and remittances services, and management and investment services. 

“The new regulations set very high standards of principles-based regulation while being quite compact, modular and user-friendly,” says Matthew Shanahan, a financial services and regulations lawyer with Norton Rose Fulbright in Dubai.

A clearer picture

The regulator’s clear approach to activities such as staking has drawn appreciation from market participants, weeks after crypto exchange Kraken announced it was abandoning the practice in the US and would pay a $30m fine to the country’s Securities and Exchange Commission amid a crackdown on the practice by the regulator. 

“Under the new [FMP] regulations, staking is named as a service that is permitted as an investment management activity, whereas under other regulatory regimes there is far less clarity on how and when it can be offered,” says Mr Satchu. 

The regulations also provide a degree of clarity regarding the various crypto regimes that had existed previously in Dubai, with differing approaches for firms conducting business ‘onshore’ to those operating in the emirate’s numerous free zones. The FMP regulations stipulate that Vara’s jurisdiction extends throughout the emirate and all its free zones, with the exception of the Dubai International Financial Centre, the emirate’s main financial free zone. 

“The [new regulations] clearly speak to Dubai’s ambition in becoming a global hub for blockchain and digital assets as part of its long-term economic strategy,” Binance’s Dubai general manager Alexander Chehade told The Banker

“Binance welcomes this new set of transparent regulatory guidelines that focus on safeguarding users and investors while supporting the development of blockchain-enabled solutions and encouraging innovation in the Web3 ecosystem.”

The degree of safeguarding required by the new regulations has taken many in the industry by surprise, however, with governance and reporting requirements that go beyond those of other jurisdictions. 

The majority of activities that fall under the new regulations require companies to have established entities on the ground in Dubai with an independent board of directors and several appointments related to governance. Vara mandates a twice-yearly audit of client assets for many activities, compared with an annual audit mandated by other jurisdictions. 

And with the recent implosion of FTX still front and centre in people’s minds, the new regulations require virtual asset exchanges to have three audit committees. 

“The FTX situation has thrown into sharp focus for Vara the importance of exchanges not only having the appropriate policies in place, but being able to demonstrate that you have robust structures in place to enforce those policies,” says a second Dubai-based lawyer, who asked not to be named. 

“Regulators like Vara and the emirate’s business development are increasingly making it clear that they’re favouring larger, more established players in the crypto ecosystem over smaller firms.” 

To small to play?

While Binance and other large players will be able to put in place the necessary regulatory and compliance requirements with minimal disruption, the regulations may prove too much for smaller firms wishing to base themselves in Dubai. 

“There was an early perception among many firms that Dubai had adopted a more open stance towards crypto activity, whereas it was more of an interim period where the regulations were being finalised,” says Irina Heaver, a partner at Keystone Law Middle East.

“Many smaller firms are going to find the new Vara regulations too prescriptive and may decide they need to shift their activities to another jurisdiction instead.”

Established just over a year ago, Vara faces strong regional competition from more established regional virtual assets hubs such as Bahrain and Abu Dhabi Global Market, the UAE capital’s free zone, both of which have developed expansive virtual asset regulations over a period of several years. 

Another of the UAE’s seven emirates, Ras Al-Khaimah, is also set to enter the fray. The RAK Digital Assets Oasis free zone, described as “the world’s first free zone solely dedicated to digital and virtual asset companies innovating in new and emerging sectors of the future including metaverse, blockchain, gaming, NFTs, DAOs, DApp, and other Web3-related businesses”, is set to launch in the second quarter of 2023. 

Amid such competition, Vara and Dubai will need to strike a difficult balance between innovation, access and compliance, while demonstrating their competence to would-be partners. 

“While it’s great in theory to have detailed regulations and compliance requirements, companies will be asking themselves whether these are obligations they will be realistically able to meet,” says the Dubai-based lawyer. 

With Vara a little over a year old, it makes sense for the regulator to focus on the larger players in the shorter term as it builds up its capacity, he said. 

“Even well-established regulators have limited bandwidth. For Vara, which is still establishing itself, it makes sense to prioritise its efforts initially at the higher end of the market to ensure that its time is well spent on larger firms that are likely to more easily meet the licensing requirements, rather than smaller firms that may struggle.” 

Vara did not respond to requests for comment. 

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