As technology continues its hasty integration into every aspect of our lives, regulators around the world struggle to keep pace with balancing cutting-edge technology with the use of traditional regulatory schemes.
The technology sector is constantly growing and improving; therefore, it is essential that regulators consistently monitor and seize market dynamics in order to adapt traditional infrastructure to better meet industry needs. Although the financial sector is no stranger to technological development, using the logic behind inventions dating back to 1300 BC with an abacus, the sudden popularity of technologies such as blockchain and cryptocurrencies has forced financial institutions to quickly confront the evolving era of financial technology ("FinTech").
In this article, we'll take a look at one of the most prominent technologies emerging in the FinTech industry, cryptocurrencies, providing a snapshot of the current state of legislation regarding cryptocurrencies in the international arena and turkey and exploring the obstacles faced by regulators in developing such legislation.
Blockchain Technology and Distributed Ledger
To fully understand cryptocurrencies, we must first explore the heart of any FinTech: Blockchain transaction. Blockchain is a type of Distributed Ledger Technology ("DLT"), which is a generic term that covers all types of technology used to facilitate value exchanges between users on a given platform and is essentially a decentralized database system that collects digital information stored in the form of a block.
On the blockchain, users create blocks of data containing information such as the participants involved and the time and date the transaction occurred, which are written to a peer-to-peer network using a trust and assurance cryptographic mechanism. This data block is later connected to other users' data blocks, thus creating a chain. Each block in the chain receives a unique identifier called "hash", which operates as a fingerprint because it is used to differentiate the data stored in that specific block from other blocks in the chain.
Blockchain technology is known for its additional security benefits, fast transaction time, economic 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 features of cryptocurrencies is that they operate without a central regulatory authority. The traditional banking system runs the risk of slow approval processes and high rates for transactions that can take days to complete. Decentralization allows financial transactions to occur almost instantly at little or no fee, mitigates bankruptcies and bank failures, and offers the benefit of using wallets that store offline cryptocurrencies (cold storage), further protecting consumers from data breaches.
However, this does not mean that cryptocurrencies should not be regulated. Because of these unique attributes, regulators around the world are trying to figure out how best to apply the regulations to cryptocurrencies. In some countries such as Switzerland and Malta, legislation has already been implemented that has defined the legislative framework for other nations that create their own cryptocurrency regulations, such as the United States and China, whose legislation needs to be refined, while for many others, such as Turkey, the regulations do not yet exist.
Regulation is important for a number of reasons. Regulators have a legitimate interest in monitoring the use of cryptocurrencies to minimize risks such as market manipulation, customer security breaches and the use of cryptocurrencies in illicit activities, among others. As such, regulators are working to determine the best method that finds a balance between reducing the risks associated with using cryptocurrencies without minimizing the benefits of the mechanism.
How to regulate
When it comes to deciphering the appropriate regulations for this unprecedented phenomenon, many regulators look to pre-existing asset categories to shed light on proper supervision, asking the question: Should cryptocurrencies be classified as a currency, title or commodity? The response will greatly 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 therefore would be regulated by the central bank of a state, but some officials have found that cryptocurrencies do not fit the legal definition of currency.
For example, in 2015, the European Central Bank published a report entitled "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 electronic currency institution.
However, a decision issued by the European Court of Justice, dated 22 October 2015, stated that for tax purposes virtual currencies (including cryptocurrencies) should be treated as currencies. Of course, experts are still at odds with each other about whether a cryptocurrency can be qualified as a currency in certain circumstances, but where do they meet in terms of seeing cryptocurrencies as securities?
Securities are essentially tangible evidence of ownership or debt to which a value has been assigned and can be sold, including shares and debt instruments. In the United States, the President of the Securities Exchange Commission ("SEC" said in an interview with CNBC that cryptocurrencies do not qualify as securities because they do not represent the ownership of an entity.
In addition, he stated that the bonds are financed by public investors with the promise of a future reward (i.e. owned by a company for economic gain), while Bitcoin was financed through research and donation funding.6 If other regulators adhere to this interpretation, a final traditional regulatory scheme remains to be considered - commodities.
Commodities can be defined as raw materials from the land, such as gold, silver, oil, natural gas, copper, as well as agricultural products such as corn, coffee and sugar, which can be used and exchanged.
Regulators who strictly follow this conventional definition may have difficulty incorporating cryptocurrencies under the same umbrella as agricultural products and natural resources, especially since cryptocurrencies only hold exchange value and are not considered valuable to the underlying product itself.
In the United States, the Commodity Futures Trading Commission ("CFTC") stated in a press release on October 8, 2018, that cryptocurrencies are in fact commodities in certain cases, and some exchanges, such as the Chicago Mercantile Exchange ("CME"), have already begun offering Bitcoin futures.
In China, courts have already ruled that cryptocurrencies are actually commodities, indicating that there may be a strong argument for cryptocurrencies to be housed under commodity regulations.
In light of the trends we have seen from regulators around the world, the EU has announced that a draft for the framework for cryptocurrency regulation is planned to be published by the end of 2020, which can insert cryptocurrencies into an existing subset or create an entirely new set of rules.
As there does not seem to be a perfect fit for cryptocurrencies under these existing regulatory schemes, some leading countries in the crypto space, such as Malta and Switzerland, have already adopted 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 VFAs-related services. In 2018, the Maltese parliament issued three acts that were the first of its kind: the Malta Digital Innovation Authority Act, the Innovative Technology Services and Arrangements Act, and the Virtual Financial Assets Act (VFA Law). , the supply and issuance of VFAs and the provision of certain VFAs-related services.
The VFA Act qualifies all forms of cryptocurrencies as DLT assets and defines as assets that are "intrinsically dependent on, or use Distributed Ledger Technology". DLT assets can be:
- Virtual tokens, also known as utility tokens;
- Virtual financial assets;
The VFA Act also describes the Maltese Financial Instruments Test, which is used to determine in which category a DLT asset falls and should be carried out by all companies using DLT assets in or from Malta, as well as persons conducting activities that fall under the VFA Act or other DLT-related legislation.
In Switzerland, in its explanatory report on the DLT Bill, the Swiss Federal Council stated that the best current approach is to rely on token categories, which were introduced by the Swiss Financial Market Supervisory Authority (FINMA) in its Guidelines published on February 16, 2018.
Token categories include 1) Payment tokens, 2) Utility tokens, and 3) Asset tokens. Payment tokens, which FINMA has declared to be synonymous with "pure cryptocurrencies", involve cryptocurrencies that are intended to be used as a means of payment to acquire goods or services. When compared to traditional financial instruments, they correspond more closely to currencies.
Utility tokens, on the other hand, include tokens that are intended to provide digital access to an application or service through a blockchain-based infrastructure. Finally, asset tokens, also called stable currencies, represent assets such as debts or property rights against the issuer and are analogous to stocks, securities or derivatives.
The UK and Germany are among the other countries that have also implemented legislation that categorizes cryptocurrencies into different token groups. We continue to monitor whether this modern approach to banking techniques will gain momentum in other European countries, including Turkey.
Turkey's efforts to keep up with global trends
On the date of this article, no legislation or regulations explicitly allowing, prohibiting or classifying cryptocurrencies exist in Turkey. Several official institutions have made statements and issued press releases to shed light on the Turkish government's approach to cryptocurrencies and provide insight into possible future approaches.
The Turkish Banking Regulation and Supervision Agency ("BRSA" confirmed in a press release dated November 25, 201318 that Bitcoin and other cryptocurrencies are not considered "currencies" or "virtual currencies" under Law No. 6493 on Payments and Securities Reconciliation Systems, payment services and electronic money institutions, as they are not issued by an authorized institution.
The press release itself was preventive in nature, reminding cryptocurrency users of the potential dangers associated with the use of alternative payment methods that are not subject to BRSA's authority.
In a letter addressed to the Turkish Capital Markets Association, the Turkish Capital Markets Council ("CMB") made it clear that the performance of spot transactions and derivatives made on the basis of
cryptocurrencies are not explicitly permitted by the Turkish Capital Market Act20 and are therefore prohibited. The CMB has also stated that cryptocurrencies cannot be classified as securities as they are not tangible property.
In relation to the statements of BRSA and CMB mentioned above, it can be inferred that the current trend of Turkish officials is to classify cryptocurrencies as commodities.
However, VAT is applicable to cryptocurrency purchases in Turkey. We assume that the Turkish authorities may also need to decide and determine the tax regime applicable to cryptocurrencies. Until then, the official treatment of cryptocurrencies remains unclear.
Consolidating Patchwork Legislation
In line with the seemingly global trend, the regulations covering blockchain and cryptocurrencies in Turkey are very sparse. We believe that government institutions are closely monitoring the attraction of Turkish users for the rapid development of these new technologies and currencies.
The Financial Stability Committee, at its meeting of January 10, 2018, decided to form a working group to draft a regulation on cryptocurrencies. In early January 2020, news agencies reported that the CMB began working on a new regulation for cryptocurrencies.
As the use of cryptocurrencies in place of traditional banking and financing mechanisms is spreading widely, regulators may soon consider shedding more light on these ubiquitous ambiguities and issuing legislation that best suits the unique aspects of the industry in order to protect consumers and financial institutions alike.