Regulatory overview of crypto assets in UAE

The federal government initiated Blockchain Strategy 2021, with a purpose of capitalizing blockchain technology to transform 50% of government transactions through blockchain technology. Favorable tax regime, Special financial free zones and governmental support for blockchain and DLT technologies are highly promising Virtual assets business in the country. The article will discuss the current state of legislative measures in both onshore and offshore UAE, and the governments’ plans to make the country a global crypto-hub.

Legislative overview

The civil law system in the UAE is largely influenced by shariah law and there are several legislative codes including the Civil Transactions Law, the Commercial Transactions Law, the Penal Code and the Commercial Companies Code. The industry of financial and capital market is overseen by UAE central bank and Securities and Commodities Authority (hereinafter: – “SCA”). UAE federal government consists of seven emirates, (Dubai, Abu Dhabi, Sharjah, Ajman, Umm Al Quwain, Ras Al Khaimah and Fujairah). In addition to UAE federal Law, each one of the seven emirates has its own laws and policies in certain industries where the federal law is absent.

UAE Central Bank introduced an amended Stored Value Facilities Regulation, concerning legality of virtual assets in the country, as they are incorporated under the definition of stored-value facilities (SVFs). SVF issuance and operation in the UAE requires a prior license from the UAE Central Bank (CB) unless a firm is operating a single-purpose SVF. Meanwhile, SVF regulations exclude two freezones, in particular ADGM and DIFC from the regulative scope.

It was followed by the issuing and offering Crypto Assets regulation by SCA in November 2020, (hereinafter: – “ICAR”), which laid down significant principles in relation to offering, issuing, listing and trading crypto-assets in onshore UAE. It covered the key issues:

the creation, issuing and marketing of crypto-assets within the region;
the licensing of crypto markets, crypto fundraising platforms and activities relevant to virtual assets such as custody services.

In addition to common operational rules for virtual-asset service providers and individuals engaged in these activities must adhere, crypto-assets activities regulation sets forth further AML/CFT, KYC provisions. these provisions necessitates to establish sound compliance network, in particular it requires:

deposits and withdrawals to be made only from and to a designated bank account that is in the name of the client;
the account should be with an authorized financial institution. The institution can be in the UAE or a foreign financial institution, if it is foreign financial institution, the institution must have explicit approval from the SCA.

Moreover, the regulation examines the traceability of virtual assets, with the purpose of establishing legitimate transaction history. If a virtual asset is not properly traceable, it may not qualify for funding accounts or making transactions through a licensed entity, as the control mechanism of financial crime includes, inter alia, depositing and withdrawing fiat currencies through accounts in designated banks.

ICAR is designed for delivering firm investor protection, as well as to monitor acts of money laundering. While ICAR is applicable to any financial activity with cryptocurrencies in the UAE, it is not enforceable within UAE free financial zones. However, it is noteworthy that federal criminal legislations, such as anti-money laundering and countering terrorist financing laws are enforceble in both in onshore and offshore UAE.

Free zones

Moreover, there are free economic zones (often referred as – “offshore UAE”) in every emirate that have limited independence from the government and federal law, that is directly applicable to foreign investment restriction and customs. While some of the free zones, such as Dubai International Financial Center (hereinafter: “DIFC”), Abu Dhabi Global Market (Hereinafter: – “ADGM” and the Dubai Multi Commodities Center (hereinafter:- “DMCC”) have established their own progressive legislative frameworks. Specifically, DIFC and ADGM were established in accordance with UAE constitution and federal laws, being completely separate jurisdictions for the purposes of civil, commercial and financial laws from the remaining part of UAE. DIFC applies a common law-based, parallel legal system, modeled on English common law and its main regulator is Dubai Financial Services Authority (hereinafter: – “DFSA”). ADGM, on the other hand, directly applies English common law, with several English statutes and court decisions being directly enforceable within the zone. The main financial regulator of ADGM is – the Financial Services Regulatory Authority (hereinafter: – “FSRA”).

Several financial free zones in the UAE already started issuing licenses for VASPs. Specifically, ADGM is believed to issue 6, DMCC 22 licenses, and Dubai Silicon Oasis authority has been reported to have obtained one license. In December 2021, Binance signed a memorandum of understanding with the authority of the Dubai World Trade Center to create a global hub for cryptocurrency.

ADGM

ADGM is often called as a pioneer in forming a regulatory framework in relation to virtual assets industry and relevant activities. FSRA has issued comprehensive guidance on regulation of digital securities and crypto asset activities.

Besides, the FSRA also introduced a supplementary guidance on the regulation of Initial Coin/Token Offerings and Virtual Currencies under Financial Services and Market Regulations (FCMR), which provided a an official comment on initial coin offerings (ICOs), through which the cryptocurrencies are made available to general public. The guidance establishes that FSRA will determine the legal status of a token being a security or a commodity, based on a case-by-case analysis to identify whether an ICO will be subject to Financial Services and Market Regulations, or remain unregulated.

On June 25 June 2018, FSRA published regulation of crypto assets that initiated regulated activity called – “operating a crypto asset business” which incorporated crypto-asset exchange business, while excluding ICO issuances, virtual securities. Business entities planning to start virtual asset exchange services must be authorized by FSRA as a financial service provider conducting a regulated activity in relation to virtual assets before pursuing registration. Applicants must fill out registration forms and submit necessary documents, which will subsequently enable FSRA to make conformity assessments in respect of certain regulated activity. FSRA thoroughly reviews applicants’ technology and relevant infrastructure during the application process.

Business entities which consider to operate as virtual asset exchange in ADGM by obtaining multilateral trading facility (MFT) using virtual assets have to pay official fees:

an application fee – USD 125,000 (EUR 112,056);
annual supervision fee- USD 60,000 (EUR 53,782).

Licensed entities must maintain minimum regulatory capital in fiat currencies at the standard of a recognised investment exchange that equals to 12 months’ operational expenses. The rate might be higher in cases when FSRA determines that the virtual asset exchange is high-risk.

Moreover, FSRA mandates Crypto-exchanges to comply with Anti-Money Laundering and Sanctions Rules and Guidance, referred as AML rulebook, which augments the application of federal laws. The AML rulebook provides detailed KYC requirements, to avoid risk of money laundering and to better control risks, as such it requires authorized entities to:

provide of detailed and comprehensive virtual asset compliance policies;
appoint an anti-money laundering reporting officer in charge of overseeing compliance requirements.

Licensed virtual asset exchanges are regulated as multilateral trading facility under FSMR, thus they must fully oversee processes of:

market surveillance, particularly with regard to market abuse, transaction reporting and misleading impressions;
settlement processes;
transaction recording;
transparency and public disclosure mechanisms; and
exchange-like operational systems and controls.

Since the introduction of a clear legislative position, ADGM has been the prosperous jurisdiction to carry out the virtual assets services business.

DIFC

Considered as the Middle East hub for the majority of Wall Street banks and being home to NASDAQ DUBAI (largest stock exchange in the region) and DIFS still lacks specific regulation addressing virtual asset exchanges. DFSA has not introduced any legislation, nor issued any license to fully operational VASPs. While exchange operations, multilateral trading facilities and trading platforms are considered to be licensed activities in DIFC under relevant regulations. This might however change soon, as DFSA issued a consultation paper on the regulatory framework for security tokens in March 2021. It proposes that trading facilities or exchanges intending to deal with security tokens might have to comply with the same regulations as authorized market institutions and authorized firms operating an alternative trading system, whilst also be subject to new rules of dealing with specific security token and DLT risks. Consequently, DFSA proposed IT relevant requirements for facility operators, along with technology audits.

DMCC

The Dubai Multi Commodities Center (DMCC) proposed a “proprietary trading in crypto-commodities”, which made cryptocurrency trading regulated activity within its jurisdiction, by treating them as commodities. Nevertheless, business entities licensed to carry out this activity can only trade on their own behalf, using their own finances for trading. Setting up a fully fledged crypto-exchange trading platform and Initial Coin Offering is not covered within the purview of the DMCC license, thus remains unregulated in this zone.

Although DMCC is still trying to become favorable crypto jurisdiction, in particular free zone authority has entered into partnership agreement with CV VC AG, to foster the development of blockchain ecosystem, similar to Switzerland’s Crypto Valley. Besides, another important step has been taken by signing Memorandum of Understanding with SCA in March 2021, to establish a comprehensive regulatory framework for the Fintech industry. It is still yet to be seen how the DMCC regulation will be aligned under federal legislation.

Taxation

In this line, it is worth discussing the taxation of transactions with virtual currencies. There is no corporate or income tax rate in the UAE. Absence of capital gains and withholding taxes and/or foreign exchange controls affecting cross-border crypto transactions can make UAE a perfect tax haven.

While the issue about value added tax (VAT) is still unclear, as there has not been any official guidance by federal tax authority to identify if the sale of cryptocurrencies can be taxable under VAT law.

Hopes for the future

It has been reported that, United Arab Emirates is developing a federal legislative framework for issuance of licenses to Virtual Asset Service Providers (VASPs). At the time of writing, the SCA is believed to be in its final stage of amending the proposed bill. UAE lawmakers are applying recent Financial Action Task Force (FATF) guidelines and considering best regulatory practices applied by the UK, US and Singapore. SCA will most probably be responsible for regulatory oversight of the crypto industry and will take a hybrid approach to supervision. There is also a possibility of special financial zones to implement their licensing procedures. Along with providing sufficient conditions for cryptocurrency trading, the government also intends to regulate the mining industry.

In 2021, the federal government conducted its crypto-asset risk evaluation, which included14 public sector agencies and 16 public sector entities private sector. The government concluded that proper regulation as opposed to a complete ban, can better mitigate the risks attached to virtual tokens. The UAE government anticipates that a nationwide crypto-licensing scheme will attract fintech companies to the region and serves a purpose of building a crypto ecosystem.

The content of this article is intended to provide a general guide to the subject matter, not be considered as a legal consultation.

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