Currency or commodity?
Jersey's regulatory approach
Regulatory sandbox for exempt exchangers
The value and volume of virtual currency trading is skyrocketing globally, but regulating virtual currencies and those that provide virtual currency exchange services (exchangers) is challenging.
Exchangers operate at the interface between the physical and virtual value chains, exchanging virtual money (eg, bitcoin) into tangible, so-called 'fiat' money or vice versa.
The Proceeds of Crime (Miscellaneous Amendments) (Jersey) Regulations 2016, which came into effect on September 26 2016, have brought exchangers within the ambit of Jersey's anti-money laundering legislation. Like other financial services businesses, exchangers must comply with the island's laws, regulations, policies and procedures aimed at preventing and detecting money laundering and terrorist financing.
The regulations also make virtual currency exchange a supervised business and require exchangers to register with, and fall under the supervision of, the Jersey Financial Services Commission (JFSC).
However, in a nod to the island's burgeoning financial technology (fintech) sector, an innovative regulatory sandbox has been created, allowing exchangers with a turnover of less than £150,000 per calendar year to test virtual currency exchange delivery mechanisms in a live environment without the normal registration requirements and associated costs (for further details please see "Welcome to the virtual currency sandbox: let's play").
The regulations offer a measured approach to risk, create further opportunities for the fintech community and place Jersey at the forefront of regulatory development in this sector.
Fiat currency is a paper-based currency that a government, state or collection of countries (eg, the European Union) has declared to be legal tender, but which is not backed by a physical commodity. The value of fiat money is derived from the relationship between supply and demand, rather than the value of the material from which the money is made. Most modern paper/plastic currencies are fiat currencies; they have no intrinsic value and are used solely as a means of payment.
Virtual currencies, on the other hand, have no physical presence. They are, as the name implies, virtual, and exist only on a digital distributed decentralised network called a blockchain.
In essence, each virtual currency is a collection of concepts and technologies that form the basis of a digital money ecosystem. Each unit of virtual currency (eg, bitcoin, ether or ripple) is used to store and transmit value among participants in a particular blockchain.
Virtual currencies use cryptography for security, making them incredibly difficult to counterfeit or hack. Importantly, virtual currencies are not issued by any central authority, although this is likely to change in the future.
As interest continues to grow, the value and volume of virtual currency trading has increased substantially in recent years. For example, a recent study from Juniper Research(1) speculated that transaction values in bitcoin may triple to $92 billion in 2016. Meanwhile, Japan's leading bitcoin exchanger announced that it has surpassed 200,000 customers a month, rising tenfold in 12 months. Putting this in context, roughly Y430 billion ($4.25 billion) in bitcoin was traded in Japan in the first half of 2016, up approximately 50 times from the previous year.
The nature of virtual currencies is complex and presents challenges to regulatory systems. Regulation is needed to ensure that virtual currencies are not used to facilitate money laundering and terrorism activities and give regulators associated monitoring, investigatory and preventative powers.
However, regulating virtual currencies is difficult. How does a centralised government system regulate an application that exists on a decentralised, deliberately anonymous technology platform (blockchain) which has no obvious rules that govern it?
The starting point for addressing the question of regulation is determining the nature of the 'application' in this context. Should virtual currencies properly be regarded as a currency or a commodity?
Globally, there appears to be no consensus on the answer to this fundamental question. In the United States, for example, the US Treasury Department has historically taken the view that bitcoin is a form of currency, while a Florida circuit court judge recently held(2) that bitcoin is not "real money". In Europe, tax authorities in countries such as Sweden have previously argued that bitcoin should be treated like a commodity and thus subject to sales tax on transfer; however, in 2015 the European Court of Justice ruled(3) that for tax purposes, bitcoin must be treated like a currency and not a commodity, an approach also followed by the United Kingdom.
With this lack of consensus on the nature of virtual currencies, it is perhaps no surprise that a consistent approach to their regulation has yet to emerge. Two main possibilities persist:
- to categorise virtual currencies in a way that folds them into existing statutory regimes; or
- to introduce new regulations focusing specifically on virtual currencies.
Consistent with the European and UK approach, the regulations adopted in Jersey amend the Proceeds of Crime (Jersey) Law 1999 to categorise virtual currencies as a form of currency. Specifically, the regulations define 'virtual currency' broadly as any currency which (while not being issued by, or legal tender in, any jurisdiction):
- digitally represents value;
- is a unit of account;
- functions as a medium of exchange; and
- is capable of being digitally exchanged for money in any form.
By treating virtual currencies as a currency rather than as a commodity, Jersey's approach has been to regulate virtual currencies within the existing statutory regime. Exchangers will be subject to the existing Money Laundering (Jersey) Order 2008 and the Anti-money Laundering and Combating the Financing of Terrorism Handbook and must adopt normal policies and procedures to prevent and detect money laundering and terrorist financing. Similarly, businesses trading in goods worth at least €15,000 per transaction that receive payment in virtual currency have been brought within the same legislative regime applicable to so-called 'high value dealers' under the 1999 law.
Regulatory sandbox for exempt exchangers
However, in one important aspect, Jersey has combined the different regulatory approaches mentioned above by introducing a bespoke carve-out to the existing statutory regime for exchangers with a turnover of less than £150,000 per calendar year (exempt exchangers). Although the general rule is that exchangers must register with, and pay annual fees to, the JFSC, exempt exchangers will simply need to notify the JFSC that they are carrying on the business of virtual currency exchange.
As such, while the JFSC will still maintain overall supervisory and investigative powers in relation to exempt exchangers, Jersey has effectively created a safe harbour in which they can test innovative products, services, business models and delivery mechanisms in a live environment without immediately being subject to the usual costs associated with obtaining registered status. This is expected greatly to reduce the initial burden associated with developing a virtual currency exchange platform through the testing and start-up implementation phases.
The application of a 'regulatory sandbox' in this specific and evolving area of regulation is innovative. The establishment of a £150,000 economic threshold for exchangers creates a fair balance between giving innovators the chance to explore the opportunities created by virtual currencies and applying a measured regulatory approach.
A clear trend is emerging: virtual currency use is on the rise and becoming more mainstream. Jersey is an optimum jurisdiction from which to make that leap.
For further information on this topic please contact Sara Johns or Steven Meacher at Ogier by telephone (+44 1534 514 000) or email ([email protected] or [email protected]). The Ogier website can be accessed at www.ogier.com.
(1) W Holden, "The Future of Blockchain Deep Dive Data & Forecasting 2016-2021", published by Juniper Research, September 16 2016.
(2) Florida v Espinoza. July 22 2016 F14-2923, Circuit Court of the Eleventh Judicial Circuit in and for Miami-Dade County, Florida. Circuit Court Judge T Pooler.
(3) Opinion of Advocate General Kokott, July 16 2015. Digital reports (Court Reports - general). ECLI identifier: ECLI:EU:C:2015:498 "Sktteverket v David Hedqvist".