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Crypto assetsNovember 10 2022

New crypto rules grant DIFC innovation boost

The Dubai International Financial Centre’s new crypto regime aims for a careful symmetry between the cutting edge and investor protection. James King reports.
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New crypto rules grant DIFC innovation boostImage: Bloomberg Mercury

On November 1, the Dubai Financial Services Authority (DFSA) launched its “Crypto Token regime” in the Dubai International Financial Centre (DIFC), representing a significant milestone for the DFSA’s regulatory ambitions for the sector.

This builds on an existing set of requirements for “investment tokens” introduced in 2021, and positions the DIFC among a top tier of financial centres that boast a comprehensive set of rules governing the use of specific digital assets. 

Speaking at the framework’s launch, DFSA chief executive Ian Johnson underscored the need to balance innovation and investor protection: “As a progressive regulator, the DFSA recognises the growing interest in innovative financial products. Our work to develop a comprehensive Crypto Token regime has taken into account feedback from a broad range of stakeholders.”

Mr Johnson added that “it aims to strike a balance between encouraging innovation in the DIFC and protecting the consumers of these financial products”.

A considered approach

The DFSA’s new regime is not the region’s first attempt to regulate the sector, with the likes of Bahrain and Abu Dhabi among the initial wave of jurisdictions creating frameworks governing the oversight and conduct of crypto-linked activities. But the rules that now prevail in the DIFC have been welcomed by market participants for their sophistication. 

“I think the DFSA has been more cautious in the way they have approached crypto tokens and investment tokens,” says Hardeep Plahe, a partner with global law firm Gibson Dunn. “But at the same time, I think their regulation is much more thoughtful with regard to their client base.” 

Under the DFSA Rulebook, crypto tokens are deemed as such if they are used as – or are intended to be used as – a medium of exchange, or for payment or investment purposes. The label is also applied in instances where a token “confers a right or interest in another token” that meets the first criterion. 

As a result, non-fungible tokens (NFTs) and examples of so-called “utility tokens”, including central bank digital currencies, are excluded from the framework. 

Not always by the same token

Moving forward, the DFSA will only permit the use of tokens that it deems valid within the DIFC – “recognised crypto tokens”. To achieve this status, crypto tokens will be subject to the DFSA’s review following an application process. 

“The DFSA has provided some guidance as to what they need to be satisfied with in order to recognise tokens as being suitable for use in the DIFC. For example, they will look at the regulatory status of a particular coin or token in other jurisdictions, whether there is adequate transparency in relation to the token, as well as the size, liquidity and volatility of a particular token,” says Mr Plahe.

In conjunction with the launch of the regime, the DFSA announced that cryptocurrencies bitcoin, Ethereum and litecoin had all achieved recognised crypto token status within the DIFC. The regulator is required to provide updates when a new token has been recognised. 

Notably, this approach differs from that taken by Abu Dhabi Global Market and its Financial Services Regulatory Authority, whereby “accepted virtual assets” will not be added to an overt register.

Investor protections

Meanwhile, the DFSA’s new rules also introduce a series of measures to shield retail investors from risks linked to specific tokens and services. According to a client alert issued by Gibson Dunn, this imposes obligations on DFSA-authorised firms to carry out detailed assessments on an individual investor across a range of different metrics.

DeFi, and even crowdfunding platforms, are things that the DFSA are concerned about

Hardeep Plahe

In addition, authorised firms are prohibited from offering a credit facility to a retail client when it comes to the trading of crypto tokens. 

These measures are among a range of other guardrails put in place by the DFSA to protect retail investors. But their implications are potentially far-reaching, particularly in the context of decentralised finance (DeFi).

“What the DFSA is trying to do is [determine] where a retail investor can lose their money. This can happen by investing in crypto tokens that aren’t recognised, or by [having a poor] understanding of an investment,” says Mr Plahe. “So I think DeFi, and even crowdfunding platforms, are things that the DFSA are concerned about with respect to crypto activity.

“For example, crowdfunding operators may not facilitate investment in crypto tokens through their platforms. With regard to DeFi, the DFSA will consult on a framework in the future. In the meantime, under the new rules, firms may not facilitate [the] staking of crypto tokens by retail clients,” he adds.

The DFSA’s new regulatory regime comes as the Middle East and north Africa emerged as the fastest growing region in the world in terms of cryptocurrency transaction volumes, according to research from Chainalysis. 

Between July 2021 and June 2022, the region recorded a 48% increase in year-on-year crypto transactions, easily outpacing the next-best-performing region, Latin America, which registered 40% growth over the same period.

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