An extract from The Virtual Currency Regulation Review, 3rd Edition
Introduction to the legal and regulatory frameworki Virtual currencies
Virtual currencies are defined by the European Central Bank (ECB) as 'a digital representation of value, not issued by a central bank, credit institution or e-money institution, which, in some circumstances, can be used as an alternative to money'.2 It clarifies that even though they can be used as an alternative to money, virtual currencies are not money or currency from a legal perspective.3 It provides further clarification by proposing three subcategories of virtual currencies that are classified according to their interaction with legal tender (or similar instruments) and on their ability to be used to purchase tangible goods and services.4 These three subcategories are:
- Closed virtual currencies schemes: these are virtual currencies that have no interaction with the physical world. They cannot be obtained using legal tender (or similar instruments), nor can they be exchanged back into legal tender, and they cannot be used for purchasing goods and services in the physical economy. An example given by the ECB is World of Warcraft (WoW) gold, an in-game virtual currency that WoW players can use to better equip their avatars to reach higher levels in the game.
- Virtual currencies schemes with unidirectional flow: these are virtual currencies that can be purchased using fiat currency but cannot be converted back into fiat currency. Examples are Facebook credits or air miles in frequent flyer programmes.
- Virtual currencies schemes with bidirectional flow: these are virtual currencies that users can buy and sell according to an exchange rate with fiat currency, and that can be used to purchase physical goods and services. The most notable example of bidirectional virtual currencies are cryptocurrencies, which form the main subject of this chapter considering their increasing influence and controversy in today's economy.
Although Bitcoin6 is still by far the most well-known cryptocurrency with the highest market capitalisation, altcoins have emerged in the past few years, and they are bringing innovation to the first generation Bitcoin protocol. Several second (and even third7) generation cryptocurrencies and tokens have emerged over the past few years. One well-known example is Ether, the cryptocurrency for operating the distributed application platform Ethereum, an open-source, blockchain technology-based software platform that runs smart contracts. Ether has many uses; it provides software developers with incentives to write smart contracts and compensates them for their attributed resources;8 it can be used for executing smart contracts and for paying for goods and services on the Ethereum network. Ethereum, as a platform, is further used to develop other cryptocurrencies and tokens (i.e., ERC20 tokens such as Tron (TRX), Omisego (OMG), Icon (ICX)9) through initial coin offerings (ICOs) (see Section VII).
Recent years have shown the incredible potential of virtual currencies and tokens. Just as every new technology does, virtual currencies face obstacles and uncertainties that affect their market price substantially. As discussed in this chapter, the uncertainty about the legal framework that applies to virtual currencies and tokens is still a major hindrance to their development and adoption in the market.
Securities and investment lawsi Financial market regulators
The financial market in Belgium is regulated by two autonomous supervisory bodies, namely the Financial Services and Markets Authority10 (FSMA) and the National Bank of Belgium (NBB).11 The FSMA and NBB are in charge of supervising and monitoring companies operating in the Belgian financial market, and they each have clearly defined roles.
The FSMA protects the interests of Belgian financial consumers, and is responsible for supervising financial products, financial information published by companies and financial service providers.12 In the context of virtual currencies, the FSMA also 'warns consumers of the risks that using and holding virtual currencies entail'.13
The NBB is responsible for overseeing individual financial institutions (e.g., credit institutions, investment firms, payment institutions, electronic money institutions, insurance companies) and the proper functioning of the financial system as a whole.ii Regulatory framework governing financial markets
As there is no virtual currency-specific legislation on securities and investments in Belgium, we elaborate on the existing legal framework that applies to securities and investments. This framework governs financial instruments, investment instruments and financial products, and assesses if and to what extent it applies to virtual currencies and its market participants.Regulatory framework governing financial instruments and investment services
The Belgian legislation on financial instruments consists of the Act of 21 November 2017 regarding the infrastructures of the market for financial instruments, which transposes Directive 2014/65 into national law (the Act on Financial Instruments), and the Act of 25 October 2016 on access to investment services companies, and on the legal status and supervision of portfolio management and investment advice companies (the Act on Investment Services). The Act on Financial Instruments and the Act on Investment Services are the national laws implementing the second Markets in Financial Instruments Directive (MiFID II).14 This MiFID-based legal framework aims to foster investor protection and to cope with new trading technologies, practices and activities.Virtual currencies as financial instruments
MiFID II and the above-mentioned Acts implementing it apply to certain types of entities (such as investment firms or credit institutions) that offer investment services and activities15 relating to financial instruments. The core of this legislation revolves around the notion of financial instruments.16 The term financial instruments covers a wide range of instruments, including transferable securities and derivative products.17
It is essential for market participants to assess whether virtual currencies fall under the concept of financial instrument. For this assessment, the distinction made in Section I.i between unidirectional scheme virtual currencies and bidirectional scheme virtual currencies is relevant. The first two categories of virtual currencies, namely the closed and unidirectional scheme ones, should not be considered financial instruments. Closed scheme virtual currencies cannot be obtained using legal tender, and unidirectional scheme virtual currencies, although they can be obtained using legal tender, cannot be converted back into legal tender or similar instruments.18 Their (limited) transferability does not qualify them as investment.19
The situation for bidirectional scheme virtual currencies is less straightforward because not all virtual currencies that fall in this category have the same characteristics. Below, we distinguish the three different characteristics of bidirectional scheme virtual currencies. They are used:
- as a means of payment (coins or cryptocurrencies, allowing the owner to use them to pay for certain goods and services that are purchased on the internet (e.g., using Bitcoin to make an online purchase of a wellness session or appointment));
- as a means of investment (investment tokens, granting the owner an economic interest in the company behind the token, linked to the performance of the company); or
- for a utilitarian purpose (utility tokens, granting the owner access to certain goods or services that are offered on the platform of the issuer).20
In some specific cases, a token can even have a hybrid function: for example, Ether can be used in many ways on the Ethereum network, but it also functions as a means of payment for buying other tokens in the process of ICOs.21
If a bidirectional scheme virtual currency constitutes a means of payment only or has only a utility function, it seems unlikely that it can be considered a financial instrument under Belgian law. Cryptocurrencies and utility tokens are not included in the list of financial instruments in the Act on Financial Instruments, nor do they seem to fall under the scope of transferable securities, as they do not represent a certain right on the company that issued the token.22 However, the problem with cryptocurrencies and utility tokens is that apart from their principal use, they are being traded on virtual currency exchanges, and fluctuate in price just as other virtual currencies do, and therefore also seem to have some investment function. This can be illustrated by Siacoin.
Siacoin is a utility token that can be used on the Sia storage platform, a decentralised storage platform that:
- leverages under-utilised hard drive capacity around the world to create a data storage marketplace;
- allows users to obtain Siacoins when they make their laptops' hardware available for the benefit of the platform; and
- allows users to store files by paying Siacoins in return.23
There is no doubt that Siacoin is a utility token, but a person that bought US$1,000 of Siacoins on 7 January 2016 at a rate of US$0.000017 (to obtain roughly 59 million Siacoin tokens) and sold that same amount of utility tokens four years later on 7 January 2020 at US$0.00139 would have made approximately US$81.010 in profit in just four years.24 Even if the primary purpose of Siacoin is utilitarian, it has been functioning in practice as a means of investment.
Apart from this example, it is undeniable that certain bidirectional scheme virtual currencies can serve primarily as investments, especially if such currency is issued by a private company in the framework of an ICO and has characteristics that entitle investors to a share in the profits of the blockchain-based company that issues the virtual currency, that carries voting rights or that gives right to some kind of interest revenue.25 In these scenarios, the tokens convey a certain right to the issuer (as per transferable securities), and their value is linked to the success of the company's business. It seems likely that virtual currencies with these characteristics would be considered a financial instrument under Belgian law.Obligations under the Act on Financial Instruments and the Act on Investment Services
If bidirectional scheme virtual currencies were considered financial instruments under Belgian law, virtual currency market players providing investment services and activities26 relating to virtual currencies would have to comply with certain obligations on transparency or licensing, or both,27 that are imposed by the above-mentioned financial legislation, which includes obligations regarding rules of conduct:28 to act in an honest, fair and professional way that best serves the customer's interest; to provide customers with information that is clear, fair and not misleading; and to offer services specifically tailored to the customer's situation.The regulatory framework governing investment instruments
The legal framework governing investment instruments consists of the Prospectus Act of 2018 (the Prospectus Act).29 The Prospectus Act requires that a prospectus for a public offer of investment instruments be drafted. A list of such instruments can be found in Article 3(1) of the Prospectus Act. Its scope of application is very broad because investment instruments cover a catch-all category of 'all other instruments that enable carrying out a financial investment, regardless of the underlying assets'.30 Because virtual currencies are all traded on exchange platforms, and because their highly volatile nature leads to market speculation, it could be argued that bidirectional scheme virtual currencies would all fall under the scope of investment instrument within the meaning given to the term under the Prospectus Act.31 Hence, companies offering these virtual currencies to the public and certain intermediaries that act on their behalf would have to comply with the prospectus requirement under certain circumstances.32FSMA guidance and FSMA regulation on financial products
The FSMA has taken a rather neutral approach to virtual currencies, putting the onus on market participants to self-assess whether a given virtual currency would fall under the above-mentioned financial legislation. The FSMA mentions that this assessment should be based on the specific characteristics of the virtual currency, and states that the regulatory status of virtual currencies is to be assessed on a case-by-case basis.33
Apart from the neutral stance of the FSMA in relation to virtual currencies and the absence of any virtual currency-specific legislation in Belgium, the FSMA has adopted a regulation that applies to financial products (which are to be considered a subsection of the financial instruments as discussed earlier). This regulation prohibits the 'distribution, in Belgium, as a professional activity, to one or several retail customers of a financial product whose return depends directly or indirectly on a virtual money'.34 This ban on the distribution of financial products, which are defined as savings, investment or insurance products,35 applies to virtual money, which is, in its turn, defined as 'any form of unregulated digital currency that is not legal tender'. This ban would apply to derivatives if return depends directly or indirectly on a virtual currency. This would mean, for example, that exchange-traded funds (ETFs),36 which would invest the money of investors in virtual currencies, would be banned from offering their services in Belgium. This is highly topical considering the multiple requests for virtual currency ETFs that have consistently been rejected by the United States Securities and Exchange Commission (SEC).37
In the explanatory note accompanying the regulation, the FSMA describes various risks associated with virtual money, from hacking of trade platforms to lack of authority supervision and price volatility. The FSMA also describes several dishonest practices that have been identified in relation to derivative cryptocurrency products where the distribution of such derivative financial products to consumers has led to significant losses to the investors in question. This clearly indicates that the FSMA intends to use this regulation to protect small retail customers and investors against these very complicated financial products.
Banking and money transmissioni Electronic money directive
The Act of 11 March 2018 regarding, inter alia, the emission of electronic money (e-money) (the E-money Act),38 which is the Belgian law implementing the provisions of the E-money Directive,39 aims to facilitate the emergence of new, innovative and secure e-money services as well as to encourage effective competition between all market participants.
The E-money Act defines e-money as 'electronically, including magnetically, stored monetary value as represented by a claim on the issuer which is issued upon receipt of funds for the purpose of making payment transactions [. . .] and that is accepted by a natural or legal person other than the electronic money issuer'.40 Only bidirectional scheme virtual currencies41 might have some resemblances to this definition of e-money, that is, they are both stored electronically and some virtual currencies are accepted as a means of payment by other parties than the e-money issuer. However, virtual currencies should not be considered e-money under the E-money Act. The main argument supporting this is that virtual currencies are not issued upon receipt of funds because a virtual currency is created digitally.42 The requirement that e-money needs to be issued upon receipt of funds means that the e-money issuer cannot just create new e-money units, because only central banks have a monopoly over money creation.43 However, this is just what a virtual currency issuer does: digitally creating a certain amount of virtual currencies through software development. In addition, virtual currencies usually do not create a claim on the issuer, with the exception of certain bidirectional scheme virtual currencies that could be considered to be a means of investment.44 Consequently, virtual currencies fall outside the scope of the Belgian legal framework concerning e-money.45ii Payment service directive
Payment services are regulated at EU level by the Payment Services Directive II (PSD II),46 which has been transposed into Belgian law through the adoption of the Act of 11 March 201847 (the Payment Services Act). PSD II and the Payment Services Act aim to govern payment services and payment service providers, and to harmonise consumer protection and the rights and obligations for payment providers and users.
Although the Payment Services Act does not regulate the emission of virtual currencies per se, the question arises of whether certain virtual currency market players provide services that could be considered payment services, and whether these players can be seen as part of a certain limited number of payments service providers48 that have a monopoly over the provision of such services in Belgium.49 If so, a licence needs to be obtained from the NBB before any payment service provider can offer payment services in Belgium to consumers.50
The Payment Services Act defines payment services as any payment service set out in Annex I, which lists eight different payment services, including the execution of payment transactions, money remittance, payment initiation services and account information services.51 This definition seems very broad, but this broadness is mitigated by several exemptions in Article 3 of the Payment Services Act. For example, according to the limited network exemption, services based on a payment instrument 'allowing the holder to acquire goods or services only in the premises of the issuer [. . .]' or 'that can be used only to acquire a very limited range of goods or services' fall outside the scope of the Payment Services Act.52
Based on this latter exemption, closed scheme virtual currencies and (most) unidirectional scheme virtual currencies can be excluded directly based on their (absence of or limited) transferability. This exemption could even apply to certain bidirectional scheme virtual currencies if their use is limited according what is described above.53 Whether virtual currency service providers will fall within the scope of the Payment Services Act will have to be assessed on a case-by-case basis taking into account the factual circumstances of each case.