The United Arab Emirates Approves Digital Asset Legislation
The Securities and Commodities Authority (SCA) of the United Arab Emirates (UAE) approved legislation for the regulation of digital assets back on November 1 of 2020, effectively recognizing them as securities and taking the first steps on the creation of a regulatory framework for cryptocurrencies.
The move comes at a time when the UAE continues its plan to expand its economy, while cryptocurrencies continue growing in popularity as users and investors move away from traditional assets for investing and hedging.
As one of the first countries to establish a legal framework for digital assets and its prominent place in the tech world, the second-biggest economy in the Arab world is sure to be a dominant player in the future of cryptocurrencies.
Regulation and the Success of Digital Asset are not Opposite
The regulation of digital assets has been one of the most debated topics when it comes to cryptocurrency since the launch of Bitcoin, with arguments having been made both in favor and against it.
Those who oppose regulations over digital assets are afraid that innovation will come to a halt under a strict legal framework, which would effectively undermine the benefits of cryptocurrencies over Fiat.
On the other hand, advocates of regulation look at it as a means to gain the trust of individual and institutional investors, creating a stronger and more stable ecosystem.
While it is commonplace for people to think of this topic in a binary manner, the truth is that crypto regulation has already been put in place by platforms and governments alike, as the cryptocurrency ecosystem is not entirely independent of the existing financial sector.
It is also important to note that countries like Switzerland have already created legal frameworks for digital assets while keeping a crypto-friendly attitude. According to a report by CV VC, the number of blockchain companies in Switzerland and Liechtenstein increased to 4784 during the first half of 2020, with the top 50 being valued at $37.5B.
Switzerland is not the only country that has seen successful by regulating digital assets while remaining open to it, as countries like Singapore, Malta, Estonia, Japan, and China have experienced similar trends.
Now that the United Arab Emirates has followed their example, it is likely that other nations will start working on their own frameworks, as was the case of Argentina in late November.
The Potential of Tokenization and Digital Assets
The Dubai Future Foundation published its “Tokenization and Digital Assets: A Transformative Approach Towards Investments” report back on November 18 of 2020, in which it explores the benefits of harvesting these new technologies to improve capital markets in the UAE.
The report is the result of a collaboration between the foundation, the World Economic Forum, and Acceliance to identify novel opportunities for economic and social advancement, resulting from the fourth industrial revolution.
The biggest innovations in the financial systems have all been a natural consequence of the need for more accessibility, which can be seen in the apparition of tradable securities and electronic records. Now, tokenization is offering new opportunities to revolutionize these financial systems on what experts call the “third wave of accessibility”.
By streamlining existing infrastructure and creating new solutions, it will be possible to integrate global markets and investment opportunities in an unprecedented way.
The ability of digital tokens to fractionize and represent any kind of assets such as real estate, commodities, or bonds, provides a level of versatility that traditional systems have not been able to achieve in a convenient manner.
The Impact of Tokenization Goes Beyond Cryptocurrencies
The idea of tokenization is usually associated with cryptocurrency. While it is true that cryptocurrencies are in fact tokens, it is just one of the many applications they can have.
Tokenization brings a myriad of possibilities to the table, which are sure to keep expanding as technology advances and new use cases emerge. At this time, the technology already has several applications that make it a natural match for financial systems.
Digital tokens can be classified into two main categories: Digital assets and Central bank Digital Currency (CBDC). The first category includes security, payment, utility, and hybrid tokens, which are traditionally associated with certain types of cryptocurrencies.
On the other hand, CBDCs include wholesale and retail CBDC, which are the digital version of fiat currencies being worked on by governments around the world.
These currencies were inspired by cryptocurrencies like Bitcoin and are still theoretical, as governments are still working on their legal frameworks and evaluating the technical specifications required for a successful transition.
This categorization of tokens, which are included in the UAE regulatory framework, ensure that legislation regarding digital assets also operates as a base for the eventual restructuring of national banks as they move toward digital currencies.
As the line between cryptocurrencies and fiat money continues to blurry on a technical aspect, crypto enthusiasts and investors will find it easier to take advantage of their assets as well as to interact with traditional financial markets.
Major Industry Players are Already Tokenizing
One of the main reasons for the increasing interest from governments in digital asset regulations is the increasing traction of tokenization. Major players in the real estate, financial services, commodities, and venture capital industries have started using this technology in their operations.
JP Morgan, one of the biggest financial institutions in the world, is already looking to tokenize gold bars and other commodities on their existing blockchain network, while Santander Group issued a $20 million tokenized bond on the Ethereum Network.
Real Estate companies like the Hotels & Resorts chain St. Regis have launched offerings for $18 Million in tokenized stakes in their St. Regis Aspen Resort.
Venture Capital funds have also been taking advantage of digital assets for a while, investing in cryptocurrencies and taking advantage of blockchain technology to improve their systems. ‘GO Philly Fund’ is currently planning on raising $35 million by selling fund tokens.
The implications of this growing interest in digital tokens are clear: the global economy is moving to an entirely digital system which governments won’t be able to take advantage of unless they can understand the tokenization process and blockchain technology to create a strong framework that allows the growth and transition for different industries.
Understanding the Regulatory Landscape
While few governments have taken action to legally ban cryptocurrencies as a whole, there have been moves aimed to ban or undermine specific coins like in the case of the American Internal Revenue Service’s (IRS) $625,000 reward for anyone who can crack Monero and Lightning’s privacy features.
However, most governments have taken a more passive approach as they wait to see the development of cryptocurrencies, as well as the results of measures taken by other governments.
The existing regulations taken by most governments are enacted to comply with the Financial Action Task Force (FATF), anti-money laundering (AML), and ‘know-your-customer’ (KYC) guidelines.
The UAE has now become one of the few countries to take an approach based on a dedicated regulatory framework instead of the retrofitted regulations that most countries have used to regulate cryptocurrencies so far.
It is expected that this move will pave the way toward further adoption of digital assets as well as further investment from crypto companies in the Arab country, as has been the case with Ripple’s new headquarters in Dubai.
The United Arab Emirates is Boosting Emerging Technologies
The UAE has been at the forefront of initiatives aimed to boost the development and adoption of new technologies in the Arab world, which is reflected by its national Fourth Industrial Revolution (4IR), National AI, and Federal Blockchain Strategies.
The active participation in technological development and the existence of an already solid pro-business regulatory framework has turned the UAE into one of the preferred destinations for tech companies and startups. In fact, the state was declared the most competitive economy in the Middle East and North Africa (MENA) region by the World Economic Forum.
It is thought that financial services and real estate are the two areas that show the most potential when it comes to the use of digital assets and tokenization. These two activities have been fundamental to the UAE’s economy, as they represent its major source of income right after oil-related activities.
Digital Assets and Financial Services Could Benefit the Most
The DFF’s report interviewed over 100 industry stakeholders across different industries in the private and public sector, with 88% of them agreeing that financial services have the most to win from the use of tokenization and digital assets.
The use of digital assets and tokens would allow the streamlining of back-office costs as well as improve the security, stability, and efficiency of existing financial infrastructure.
It is also believed that the use of security tokens would facilitate how investors connect with organizations looking for debt or equity financing, adding a new layer to the financial ecosystem. This has been demonstrated by blockchain projects that rely on decentralized governance, as their governance tokens work in a similar way to traditional shares.
By automating the lending and borrowing process and removing intermediaries, Decentralized Finance platforms have shown that the injection of capital can facilitate the injection of capital to companies that require it.
The added transparency that distributed ledgers provide, is also a perfect match for complex financial systems that requires the oversight of regulators, without affecting the users.
Small and Medium Enterprises (SME) make up 86% of the private sector’s workforce in the UAE, according to the Ministry of Economy. This makes it paramount for the government to find ways to alleviate the challenges these companies face, with financial liquidity being the most frequent one.
Opening the Doors of Real Estate to Small Investors
Real estate is one of the most important areas of the economy for the UAE as it represented 14.4% and 13.6% of Abu Dhabi and Dubai’s Gross Domestic Product (GDP) in 2018.
According to the survey’s stakeholders, the use of security tokens to improve liquidity and offer fractional ownership of properties would create a fertile ecosystem for the real estate industry as a result of new investment opportunities and inflow of new capital.
The real estate industry has been known to be the dominion of investors with access to large capitals, which closed the doors for small investors to take part in it. Fractional ownership would open the doors for small investors to take part in the real estate market, helping all the parties involved in the process.
The Government Also Benefits from Tokenization
One of the biggest lessons from the Decentralized Finance boom in 2020 was the potential of governance tokens and the digitization of financial services.
Countries like China and the United States, as well as the government of the European Union, are working on the technical aspects and regulatory frameworks for the creation of their Central Bank Digital Currencies (CBDCs).
While the use of wholesale and retail CBDC would be the biggest step toward a cashless society, multiple implications need to be considered by the governments working on them.
Governments would benefit from using digital currency due to the improved efficiency in distributing financial aid, increased efficiency in government services, improved restructuring or issuing of sovereign debt, and the tokenization of tax credits.
The tokenization of procedures in governmental entities like congress and councils’ voting has also proven to be a potential benefit, especially after the struggles experienced by democratic institutions during the pandemic.
Encouraging the Development of Digital Assets
The opportunities that tokenization and digital assets present to the public and private sector in the UAE and the world go beyond the application on existing industries, as they extend to attracting foreign investment, companies, and talent,
98% of the survey respondents believe that the UAE should keep an open and friendly attitude toward digital assets, focusing on encouraging and making sure it is fair for all parties involved.
This encouragement could be achieved by creating a “sandbox” with strict regulatory limits that allow for a creative testing environment. By setting these boundaries, the government would be able to decide the scope and general guidelines while allowing new use cases and methodologies to emerge.
Another option would be the creation of an incentive program for individuals and companies who explore the applications of these technologies and integrate them with their actual infrastructure.
These two approaches offer the benefits of having low costs, which has resulted in institutions like the Abu Dhabi Global Market (ADGM), Dubai International Financial Centre (DIFC), Financial Services Regulatory Authority (FSRA), and Securities and Commodities Authority (SCA), to start working on them by creating drafts for their proposal.
This would also allow the future development of further regulations as the progress of the technology can be assessed, as it is not possible to account for all the possible scenarios that could result in the technology and adoption progress.
The Future of Digital Assets in the UAE
The transition to a stable digital asset ecosystem that allows the UAE to take advantage of all its benefits and transform itself into a major player on the global scale will take three major steps to complete.
The first step is the creation of a comprehensive regulation that includes clear guidelines, frameworks, and compliance requirements that allow interested parties to enter and innovate in the ecosystem. While the UAE has already created legislation for digital assets, it is something that needs to be constantly evaluated as the technology and industries continue to develop.
Increasing the awareness and interest from companies interested in issuing tokens is the second step in the process. By making the use of digital assets and tokenization attractive to enterprises, adoption from them and users will increase as well as the benefits from it.
Lastly, the third step consists of the continued development of the digital asset ecosystem that comes with the proliferation of service providers. The ideal scenario for this would be the incentivizing of a positive feedback loop achieved by favorable regulation and the creation of market demand.
The Securities and Commodities Authority’s Legislation
The UAE SCA released the English version of the Arabic crypto assets legislation earlier in November of 2020. This legislation aims to regulate, “the offering, issuing, listing, and trading of crypto assets” and all related activities in the state, as well as the extent of the SCA’s oversight and responsibilities over them.
This legislation will apply to any person or entity that offers crypto-related services to third parties in the UAE but excludes any assets issued by the federal government or central bank, as well as digital securities that are not considered crypto assets.
The legislation described crypto assets as, “A record within an electronic network or distribution database functioning as a medium for exchange, storage of value, unit of account, representation of ownership, economic rights, or right of access or utility of any kind, when capable of being transferred electronically from one holder to another through the operation of computer software or an algorithm governing its use.”
Due to the interest of the real estate and financial service industries, the SCA also paid special attention to security tokens which are defined as any security that takes the form of a crypto asset to be issued, transferred, or traded.
The legislation makes it clear that while investors must be willing to lose their invested capital if a crypto asset’s value drops or the project does not succeed, as well as all the risks and complete responsibility on the investor’s side. The totality of Article 11 requires all crypto assets offered or issued in the UAE to include a specific disclaimer about these risks.
Crypto exchanges licensed by the SCA will also be required to comply with certain requirements to list crypto assets in their platform. This includes the submission of Offer documentation.
Other topics like regulation guidelines for crypto fundraising platforms and financial crime controls are also established in the legislation, which is scheduled to come into effect in December of 2020.