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Regulatory Memo (CICs)
Sempo is issuing this memo to provide general information on certain factors that should be considered to determine whether fiat-related legislations apply to any entity that utilizes crypto asset-based Community Inclusion Currencies (CICs). Below is the non-exhaustive list of the potential classifications that such a product could fall under.
Ethereum Blockchain is a decentralized, public and ethereum blockchain that create a record of transactions maintained across several computers that are linked in a peer-to-peer network.
Community Inclusion Currencies (CICs) are tradeable e-Vouchers built using open-source blockchain technology that act as a medium of exchange backed by social capital and a crypto reserve using an on-chain bonding curve. CICs tackle multiple Sustainable Development Goals and create a replicable mechanism for communities to eradicate poverty by creating connected, inclusive, and sustainable local economies.
Crypto Synthetic Stablecoins are ERC-20 stablecoins on the Ethereum blockchain to facilitate Transactions. These stablecoins are backed by over-collateralized with a digital asset such as Ethereum tokens (ETH) but are designed to track a national fiat currency (such as USD or kSH).
“E-money” generally means monetary value that can be stored electronically, issued against receipt of national currency and accepted as a means of payment by persons other than the issuer. This puts most of the stable coin-type synthetic assets under this definition and means that involved entities may be considered e-money issuers, therefore the regulator would expect an application for authorization (i.e. license, disclosure, registration, etc.).
It also implies establishing a local and incorporated entity, opening a bank account and undergoing scrutiny such as proving financially soundness, experience and technical qualifications, minimum systems and controls, appropriate audit in place, and compliance with the applicable provisions of the ruling Proceeds of Crime and Anti-Money Laundering Act.
If the nature of CICs implies investment of money and expectation of profits, it is quite possible that such assets may be considered to be securities or derivatives and the platform would be deemed to be a securities trading platform and would be subject to securities legislation. In some cases, the synthetic asset is clearly a security, for example, a tokenized security that carries rights traditionally attached to common shares such as voting rights and rights to receive dividends.
In other cases, the crypto asset is a derivative, for example a token that provides an option to acquire an asset in the future. Securities legislation may also apply to platforms that facilitate the buying and selling of CICs, including crypto assets that are commodities, because the user’s contractual right to the crypto asset may itself constitute a derivative.
Platforms would not generally be subject to securities legislation if:
- the underlying synthetic assets are not securities or derivatives; and
- the assets are delivered immediately to the user’s wallet (non-custodial solution).
The reason behind this logic is that following the immediate delivery of the asset, the user is not exposed to insolvency risk, fraud risk, performance risk or proficiency risk posed by the platform. In addition, without the immediate delivery, the used does not technically possess the asset, rather a right to the asses, which in turn is a definition of a derivative.
It should be noted that many jurisdictions agree that accepting and transmitting anything of value that substitutes for currency normally makes a company a money transmitter, or a money service business. Overall, in many countries, given the broad wording and conservative reading of the money transfer legislation, and the wide interpretative powers of regulators in regards to what money or monetary value mean, there are always risks that issuing and using CICs may be seen as carrying on a licensable activity. Generally, it would entail obtaining a security consisting of a surety bond, getting ready for an on-site visit, passing the Fit and Proper test for key senior officers, and ensuring operations manuals are all in place (Accounting procedures, Management Information System, internal audit and controls, Anti-Money Laundering and Counter-Terrorism Financing (AML/CTF), data protection, risk management policies, etc.).
In general, MSBs must comply with verification, record keeping, reporting and transaction monitoring requirements under the local regulations. Examples of these requirements include the filing of reports relating to currency in excess of USD$10,000 equivalent received in a trade or business, whenever applicable, general record keeping maintenance, and filing suspicious activities to the regulator.
In the absence of specific legislation or a well-defined guidance by a regulator, there is always some residual risk that the company may be seen by specific local regulators as engaging in a licensable activity by offering the CICs. If the regulatory position remains uncertain, it may be prudent to seek a ‘No action letter’ or ’Request for ruling’ from the respective regulator on the specific requirements by analyzing its business plan, and evaluating the flow of funds, as well as who has custody of the funds along the way. As an alternative, where licensing is required, it may be a good idea to obtain the applicable licenses or offer CICs through licensed third parties, and monitor the ever-changing regulatory landscape.
Finally, the exchange of a CIC to and from any other fiat or digital currency may be seen by the local governing body as providing a foreign exchange business. It is quite possible that a central bank or another regulator in charge at their discretion may designate cryptocurrency as a foreign currency and apply the existing fiat-based regulations to the selling, buying or converting of the CICs.
In such cases, the business should expect that in addition to obtaining the mandatory license and paying levies, at a minimum, its volumes, spreads, limits and destinations of funds will have to be approved by the Central Bank or other local regulator. Like in any other instance, the company will have to have appropriate, sound and adequate internal control mechanisms and compliance programmes to comply with the requirements of the local AML/CTF regulation and other statutory obligations.
As mentioned above, when dealing with CICs and other synthetic assets it is hard to avoid complying with the AML/CTF requirements. What it means is that the business should at least self regulate by following the best practices in preventing money laundering and terrorism financing. This means implementing a comprehensive and effective compliance program for meeting all of the reporting, record keeping, client identification and know-your-client requirements under the local Proceeds of Crime and AML/CTF associated regulations.
There are generally five required elements of a compliance program:
- The appointment of a person who is responsible for the implementation of the compliance program - compliance officer;
- The development and application of written compliance policies and procedures that are kept up-to-date, that includes:
- Know your client requirements - verifying client identity, and ensuring all required sanction and terrorist list screens have been implemented, (this can include using e-Verification services such as Trulioo, Jumio etc).
- Ongoing monitoring and other special measures are implemented based on the business risk assessment (enhanced measures to verify the identity, enhanced measures to conduct ongoing monitoring and any other enhanced measures to mitigate the risks identified).
- Record keeping requirements.
- Transaction reporting requirements, including all applicable report types, including, for example, the filing of suspicious transaction reports, terrorist property reports and large cash transactions reports.
- A risk assessment of your business activities and relationships,
- The development and maintenance of a written ongoing compliance training program for employees, agents, and others authorized to act on your behalf; and
- The institution and documentation of an effectiveness review of your compliance program (policies and procedures, risk assessment and training program) on a regular basis for the purpose of testing its overall effectiveness.
The level of detail and sophistication of your compliance program must reflect the size, complexity, structure and risk of exposure of your business to money laundering and terrorist activity financing as determined by the senior executives together with the risk or compliance officer.
We encourage all CIC and platform operators to consult with their legal counsel on the application of the mentioned legislations and to contact their local regulatory authority to discuss whether any additional rules apply to their activities and, if so, the appropriate steps to comply with the requirements.
Quite often, in the absence of the ruling law that would apply specifically to the synthetic asset businesses, regulators organize Regulatory Sandboxes - an initiative to support fintech businesses seeking to offer innovative products, services and applications in the respective jurisdiction. It allows firms to register and/or obtain exemptive relief from certain requirements, under a faster and more flexible process than through a standard application, in order to test their products, services and applications throughout the local.
DISCLAIMER: The material included in this memo is produced by Sempo. It is designed and intended to provide general information in summary form on the topic of Community Inclusion Currencies and open-source software under GPL-v3 License, for general informational purposes only.
The contents do not constitute legal advice, are not intended to be a substitute for legal advice and should not be relied upon as such.
You should seek legal advice or other professional advice in relation to any particular matters you or your organisation may have.
Date last updated: 26th March 2020