The brave new world of Bitcoin

Market trends

Given the convenience of established currency and payment systems, what is driving the ever-growing interest in Bitcoin and other virtual currencies?

In 2009, bitcoin emerged as a catalyst following the 2007-2008 global financial crisis and the subsequent loss of trust in the banking system, offering a peer-to-peer version of electronic cash which would allow payments to be sent directly from one party to another without going through a central financial institution.

While fiat currencies are given legitimacy as legal tender by national regulators, and established payment systems such as banks, electronic money institutions and payment institutions are thoroughly regulated since they form an integral part of the global economy, there are a number of pitfalls which become easily apparent to industry insiders.

First, banks and financial institutions are centralised and thus create a central repository that, if compromised – whether through malicious intent or system error – would render vulnerable all data or funds/assets within that system. While virtual currencies can be offered through a centralised system, the majority of these cryptocurrencies, including bitcoin, are decentralised since they are based on a distributed ledger technology platform. In practice, the bulk of cryptocurrency issuers are choosing to base their virtual currencies on the decentralised Ethereum blockchain owing to the ease of using the ERC-20 and ERC-223 protocols as the technical framework for their new cryptocurrency. Nonetheless, new dapp platforms such as Tron and EOS are gaining popularity as the distributed ledger of choice for a growing number of virtual currencies issuers.

The use of blockchain technology as the basis for these new cryptocurrencies also brings with it the added benefits of immutability and transparency since transactions are easily auditable, and changes cannot be made unless there is the consent of a majority of the network. The immutable audit trail of distributed ledgers would give auditors or future regulators the option of full visibility and supervision of such transactions.

Decentralisation of virtual currencies via blockchain and peer-to-peer transactions also means that the role of banks as intermediaries will be set aside, thus cutting out costs and delays for users.

The benefits underpinning virtual currencies as opposed to traditional fiat currencies are promising, and their potential has been recognised by several jurisdictions, including Malta, which have sought to enable virtual currencies to develop unencumbered within a sound regulatory framework which safeguards investors without stifling innovation.

While several crypto proponents maintain that traditional national currencies will eventually be phased out in favour of cryptocurrencies, a number of issues need to be addressed before this is possible. From an EU law perspective, member states which are part of the Economic Monetary Union may not freely take action in this respect since their economic and monetary policy falls within the jurisdiction of the European Central Bank (ECB).

In Annex 1: Legal qualification of crypto-assets – survey to NCAs the European Securities and Markets Authority (ESMA) noted that bitcoin, which was referred to as a “pure-payment type crypto-asset”, accounts for half of the total market value of crypto assets. However, the fact that distributed ledger technology and tokenisation work well for various functions has led to the emergence of virtual currencies which do not serve as a means of payment, but which fulfil the function of investment or security, or a mere utility function by giving access to application or services. It must also be considered whether cryptocurrencies will ever be an efficient form of payment given their volatile nature. While it is conceivable that a fiat currency may be available as a stable cryptocurrency, its value would need to remain centrally regulated.

At present, virtual currencies mostly serve as speculative instruments for investment with the ultimate aim of receiving profits in fiat currency by trading them through exchanges, as evidenced by the bull market throughout 2017 and early 2018, when an estimated $21 billion worth of initial coin offerings (ICOs) was launched worldwide. Even bitcoin, which was intended to serve as a means of payment or exchange by its issuer, was ultimately being used for speculation.


Has your jurisdiction taken steps to regulate virtual currencies? What is their current status?

Malta has been a trailblazer with respect to the regulation of virtual currencies and technology firms offering blockchain/distributed ledger technology (DLT)-based solutions. The Malta Financial Services Authority (MFSA) started issuing consultation papers with respect to the regulation of virtual currencies in the second half of 2017 and throughout 2018 to gather opinions of the financial services sector and interested stakeholders on the matter. These efforts culminated in the promulgation of three acts:

  • The Innovative Technology Arrangements and Services Act, which is a technology-neutral act which sets out the regime applicable for the registration of technology service providers and the certification of technology arrangements such as software and architectures which are used in designing and delivering DLT, smart contracts and related applications.
  • The Malta Digital Innovation Authority Act, which set up the Malta Digital Innovation Authority specifically to promote the development of the innovative technology sector in Malta.
  • The Virtual Financial Assets Act (the VFAA) and subsidiary regulations, which create a framework within which ICOs may be legally issued and service providers, including crypto-advisers, crypto portfolio managers and crypto-exchanges, may be set up. It collectively refers to assets which intrinsically depend on or which utilise DLT as DLT assets. The VFAA comes as a breath of fresh air in an industry where there is little clarity as to how assets are to be treated. Most countries agree that cryptocurrencies are not to be considered as currencies or legal tender, but are a digital form of investment or asset. In jurisdictions without specific legislation for cryptocurrencies, there is great uncertainty as to how DLT assets should be classified, particularly when there is the potential that digital assets may be qualified as financial instruments under the EU Markets in Financial Instruments Directive (MiFID) II. To mitigate this problem, by virtue of the VFAA, the Maltese legislature created the financial instruments test, which helps issuers and their legal advisers to classify DLT assets. Companies seeking to set up an ICO in or from within Malta, companies which issued DLT assets overseas but wish to carry out a related activity in or from Malta and all other entities which will be dealing with DLT assets must take this test in relation to any DLT asset issued. A DLT asset may be classified under four categories:
    • Virtual tokens, which are a form of digital medium recordation whose utility, value or application is restricted exclusively to the acquisition of goods or services, either solely within the DLT platform on or in relation to which it was issued or within a limited network of DLT platforms. Under the VFAA, virtual tokens (which often include fungible or utility tokens) cannot be traded on exchanges. In defining virtual tokens, the VFAA provides that a virtual token which is or which may be converted into another DLT asset type will be treated as the DLT asset type into which it can be converted. If the token standard used for a virtual token allows for such conversion, technical restrictions must be put in place to prevent conversion into other DLT asset types. Once a financial instruments test has duly classified a DLT asset as a virtual token, the asset and any activity carried out in relation to such asset requires no further regulation.
    • ‘Electronic money’, as defined in the EU Electronic Money Directive (2009/110/EC), refers to issues of tokens which electronically (including magnetically) store monetary value as represented by a claim on the issuer which is issued on receipt of funds for the purposes of making a payment transaction. If a DLT asset qualifies as electronic money, such an asset and any activity undertaken in relation to such an asset will be regulated under the Maltese Financial Institutions Act, which transposes the EU Electronic Money Directive.
    • Financial instruments, which are instruments regulated under Section C of MiFID II, generally include transferable securities, money market instruments, units in collective investment schemes and derivative instruments. The test assists issuers and their legal advisers in determining the kind of financial instrument being issued since this will also have a bearing on the applicability of other EU legislation such as the EU Prospectus Directive (2003/71/EC) and the EU Transparency Directive (2004/109/EC), as noted by the ESMA in its Advice on ICOs and Crypto-Assets issued on 9 January 2019. The aforementioned two directives will have significant application with respect to financial instruments which are set to be issued to the public, have been dematerialised onto the blockchain and which qualify as transferable securities.
    • ‘Virtual financial assets’ (VFAs) are, by elimination, defined as DLT assets that do not qualify as virtual tokens, electronic money or financial instruments. Generally, traditional virtual currencies such as bitcoin would fit this criterion. Issuers seeking to qualify their VFAs in terms of the VFAA must set up a company in Malta, draft a white paper which complies with the requisites set out within the VFAA and register that white paper with the MFSA. If a VFA has been admitted to trading on an VFA or DLT exchange without the consent of the issuer, there is no obligation on the issuer to register the white paper in terms of Article 3 of the VFAA. This provision exempts established cryptocurrencies such as bitcoin and Ethereum which qualify as VFAs from requiring a white paper to gain legitimacy under Maltese law. Nonetheless, it is still incumbent on VFA service providers (including VFA exchanges) to conduct the test to ascertain the classification of any DLT asset admitted to trading on their platform.

In order to ensure that issuers arrive at a proper classification, the VFAA creates the role of the VFA agent. All issuers must have a VFA agent in place at all times. The VFA agent is a person registered with the MFSA who can offer legal counsel and submit documents and information to the MFSA as requested. The VFA agent must confirm to the MFSA that the DLT asset qualifies as a VFA as set out in the test, and must note any reservations or assumptions which it has made when submitting the test. Moreover, the VFA agent acts on behalf of the MFSA in order to ensure that the issuer complies with the milestones set out in the white paper in a timely manner. An annual compliance report must be drawn up by the issuer, and will be reviewed by the VFA agent to ensure compliance with the VFAA, regulations and rules issued by the MFSA.

In addition to the VFA agent, issuers must have in place at all times a money laundering reporting officer, an auditor, a systems auditor and a custodian. The role of custodian may also be fulfilled through the implementation of a smart contract which has been certified by a systems auditor. The systems auditor shall be responsible for reviewing and auditing the issuer’s innovative technology arrangements and cyber security arrangements. Systems auditors must obtain a certification from the MDIA to fulfil this role.

Different EU member state authorities have thus far taken different approaches to the regulation of virtual currencies. Is this due to the different legal frameworks of the member states or (mainly) by institutional practices of the respective authorities?

There have been different approaches to the regulation of virtual currencies for a variety of reasons. As the industry is still in its infancy, the regulation of virtual currency is based on the institutional practice of the relevant authority, as shaped by its attitude towards disruptive innovation. Nonetheless, the transposition of certain directives will inevitably shape the definition of what constitutes ‘virtual currencies’, depending on the taxonomy applied in respect of different virtual currencies with different functions.

The general approach towards cryptocurrencies and innovative technologies will shape the policy and legislation (if any) of member states in this area. A report titled “Blockchain, Crypto and ICOs: A legal Review of Leading Jurisdictions”, published by Chetcuti Cauchi Advocates, noted that some jurisdictions maintain a favourable approach or advise investors or firms dealing with virtual currencies to use caution. Other jurisdictions are waiting until a clear approach has been outlined by the EU authorities.

Malta generally takes a proactive approach when it comes to disruptive innovations. As it did in 2004 within the remote gaming sphere, in 2018 the Maltese government enacted a bespoke legal framework for virtual currencies, as well as blockchain-based technology firms or service providers.

Since there is no harmonisation at EU level apart from high-level advice issued by EU authorities, member states may set their own rules as to which DLT assets qualify as ‘virtual currency’, or ‘crypto-assets’ as referred to by the ESMA and the European Banking Authority (EBA). In addition, since there is no international standard-setting body setting out a common taxonomy, member states that chose to regulate this area developed their own taxonomy through homegrown legislation. This has inevitably led to different approaches.

The taxonomy applied by jurisdictions which choose to regulate or which will regulate cryptocurrencies is also shaped by their existing legal frameworks with respect to financial instruments regulated under MiFID II, and instruments of payment regulated under the EU Electronic Money Directive. Maltese legislation has defined what constitutes a VFA by eliminating all assets based on DLT which qualify as:

  • financial instruments, as defined in Section C of MiFID II;
  • electronic money as defined in the Electronic Money Directive; and
  • virtual tokens, which are tokens whose functions are restricted to the platform or limited number of platforms on which they can be used.

Since transposition gives flexibility to local authorities as to the manner in which they legislate, the way in which institutions transpose legislation often becomes institutional practice for those authorities. The way in which MiFID II and the Electronic Money Directive have been transposed into local law affects whether crypto-assets with certain features will be regulated under these existing regulations. For example, EU member states that have defined ‘transferable securities’ through a restrictive list are encountering a problem in applying MiFID II to certain crypto-assets which have the same features as securities. Nonetheless, any crypto-asset which shows securities features or the features of an instrument of payment cannot escape legislation merely because of its ‘tokenised’ nature.

How likely is it that the regulation of virtual currencies will be harmonized at EU level? Could a consistent regulatory approach be reached through institutional guidelines for the competent authorities in the member states?

Initially, the European Union lagged behind crypto-friendly jurisdictions such as Japan and some of its own member states, which were more open to the idea of providing a legal framework than the bloc as a whole. Indeed, discussions on the topic mostly focused on warnings and concerns with respect to investor protection, the potential of an increase in financial crime such as fraud, money laundering, terrorism funding and tax evasion through the pseudo-anonymity which surrounds a number of cryptocurrencies. Indeed, the first definition of ‘virtual currencies’ at EU level was given within the context of anti-money laundering legislation through EU Directive 2018/843, which amended the EU Anti-money Laundering Directive (2015/849).

Another concern which prompted a change in approach is the attitude of certain issuers which sought to avoid the application of EU securities laws by misrepresenting financial instruments which have been dematerialised onto DLTs as cryptocurrencies. While contravening a number of pre-existing EU regulations, this could also have serious detrimental effects on consumer or investor protection, market stability and the fair promotion of competition. This led to greater political will among EU authorities to provide a legal framework for crypto-assets.

In its Advice on Initial Coin Offerings and Crypto-Assets the ESMA remarked that in cases where crypto-assets fall outside the scope of financial instruments or other EU rules applicable to non-financial instruments such as the EU Electronic Money Directive, consumers may be exposed to substantial risk. It urged EU policy makers to further consider how to address such risks in a proportionate manner. Moreover, the ESMA noted that while some EU member states have implemented, or are considering the implementation of, bespoke rules at the national level for crypto-assets which are not regulated under existing EU legal frameworks, there are concerns that lack of harmonisation in this field “does not provide for a level playing field across the EU”. The ESMA believes that an EU-wide approach is relevant, also considering the cross-border nature of crypto-assets.

A comparative analysis between Maltese legislation, which provides for a highly thorough classification of DLT assets, and the advice of EU authorities with respect to crypto-assets, also highlights the need for a harmonised body of rules and definitions, which becomes increasingly apparent as there is no common taxonomy of crypto-assets in use by international standard-setting bodies. This ultimately hinders the seamless regulation of these assets across all member states. By way of example, Malta has applied a more thorough classification process through the creation of the notion of VFAs, which would generally capture most of the traditional virtual currencies currently on the market. A VFA should be interpreted as any asset which is based on a DLT, and which does not qualify as:

  • electronic money in terms of the Electronic Money Directive;
  • a financial instrument in terms of MiFID; or
  • a virtual token, which refers to assets whose utility is limited to the platform or a limited number of platforms on which they operate.

Other jurisdictions classify cryptocurrency assets more generally as means of exchange, or mainly distinguish between payment, investment and access (utility) functions only.

In order for a consistent regulatory approach to be reached, the European Union must provide clarity with respect to two main issues.

First, clarity must be given with respect to crypto-assets which fall within the scope of pre-existing legal frameworks such as MiFID II and the EU Electronic Money Directive. As noted by the EBA in its Report on Crypto-Assets, issued on 9 January 2019:

At the EU level it is important to provide clarity about the applicability of current EU financial services law to crypto-assets/activities to ensure that there is a common understanding of the extent to which current legislation addresses the risks and supports the opportunities relating to crypto-assets and DLT.

Since these laws were not drafted with the possibility of having assets based on cryptography and DLT, a thorough evaluation of these laws must be undertaken in order to ascertain whether any amendments should be carried out for the seamless regulation of these assets and their issuance to the public. This may also require a number of member states to re-assess their transposed laws. As noted by the ESMA in its survey to national competent authorities, with the transposition of MiFID II some member states have defined the term ‘financial instrument’ differently by using a restrictive list of examples to define transferable securities, which may create challenges to the regulation and supervision of crypto-assets since they would be excluded from the scope of the legislation.

Second, the European Union must take a position on crypto-assets which are currently not regulated under any existing EU legal framework, particularly as consumers may still be exposed to substantial risks. This may require legislative intervention by the EU Parliament and Council since guidelines issued by EU authorities will not carry the force of law, but, as is the case of ESMA, often apply to national competent authorities on a ‘comply or explain’ basis.

Finally, while there may be different opinions with respect to how the European Union should go about providing for a more harmonised approach towards the regulation of crypto-assets, there seems to be consensus between the EU authorities and national competent authorities; Annex 1: Legal qualification of crypto-assets – Survey to NCAs issued by the ESMA noted that crypto-assets must fall under the scope of EU anti-money laundering regulation.


How are transactions using virtual currencies as the medium of exchange taxed in your jurisdiction?

In parallel with the launch of Malta’s regulatory regime for VFAs, widely referred to as cryptocurrencies, in November 2018 the Maltese commissioner for revenue (CfR) issued guidelines in relation to the taxation of DLT assets from an income tax and stamp duty perspective.

While the guidelines give definitions of coins and tokens (further divided into financial and utility tokens), they clearly state that such classification is of limited value for tax purposes since the tax treatment of any type of DLT asset will be determined on the basis of the purpose for and the context in which it is used.

By means of the guidelines, the CfR has confirmed that in general, applicable income tax principles will apply to DLT transactions with due regard being given to the nature of the transaction, status of parties and the specific facts and circumstances of the case.

The tax reference value of a DLT asset for income tax purposes is the market value of the asset in question determined by the rate established by the relevant Maltese authority or, where this is not available, by reference to the average quoted price on reputable exchanges, on the date of the relevant transaction or event, or such other methodology to the satisfaction of the CfR.

Values expressed in cryptocurrencies will need to be converted to the reporting (fiat) currency in which the taxpayer presents its financial statements.

Where a taxpayer agrees to be paid in cryptocurrency, this will be treated in the same manner as payment in any other currency, whereas payment by means of the transfer of a financial or utility token will be treated in the same manner as a payment in kind. The mode of payment will not result in a change as to when revenue is recognised or the manner in which taxable profits are calculated.

Any profits realised from the trading of coins are treated like the profits derived from the exchange of fiat currency and proceeds from the sale of coins held as trading stock in a business are taxed as ordinary income. Gains or profits from the mining of cryptocurrency also represent trading income. However, capital gains derived on the disposal of coins held as capital assets fall outside the scope of capital gains tax.

A return derived from the holding of a financial token such as interest, premiums or payments equivalent to dividends, whether in cryptocurrency or in kind, is treated as income for tax purposes. Taxation of proceeds derived from the transfer of tokens (whether financial or utility tokens) depends on whether the tokens are held for purposes of trade of whether they are held as capital assets.

Where the taxpayer trades in tokens, proceeds are taxed as trading income under Malta’s ordinary income tax rules and applying the ‘badges of trade’ test where necessary. Where the transfer is not a trading transaction, it is necessary to determine whether the transfer of a financial asset could be deemed to be the transfer of a security and therefore would fall within the scope of the provisions on capital gains. Transfers of utility tokens fall outside the scope of tax on capital gains. 

Where an initial coin offering involves raising capital, the proceeds of such issue are not treated as income of the issuer. Where an ICO of utility tokens entails an obligation of the issuer to perform a service or to supply goods or benefits to the token holder, the gains or profits realised from the provision of the services or the supply of the goods will represent income for the issuer.

In regard to stamp duty, where the DLT assets being transferred have the same characteristics as ‘marketable securities’, as defined in the Duty on Documents Act, they are subject to duty in accordance with the applicable provisions of the act.


If virtual currencies were to become a mainstream payment system, how might this affect the ability to control inflation in your jurisdiction?

Inflation occurs when prices increase as result of increased consumption and economic growth. Central banks control inflation mainly through interest rates or money supply, while governments can control consumption through fiscal policy. In Malta, monetary policy is determined by the Central Bank of Malta and follows that of the euro area, as administered by the European Central Bank. 

Inflation is based on the prices of goods and services and not on the payment method. If virtual currencies become a mainstream method of payment, they will simply represent another way of purchasing goods and services in addition to traditional fiat currencies or electronic payment gateways. Therefore, the process of adopting virtual currencies should not limit the ability of a central bank to control inflation provided that such transactions take place within a regulated monetary system.

However, since at present virtual currencies are decentralised and not pegged to any monetary system, no supervisory body has control of such currencies. Consequently, it will be difficult to regulate inflation should virtual currencies be adopted mainstream. The key challenge here is how to ensure the stability of the price of the virtual currency in an unregulated environment. The price of virtual currencies is solely determined by its own demand and supply, therefore its value and resulting purchasing power are highly volatile.

Until such time that virtual currencies are pegged to a unit which has intrinsic value (fiat currency or a tangible asset such as gold), it is unlikely that they will become a mainstream payment method, therefore posing a limited risk to inflation. Going forward, it is expected that some countries may introduce their own crypto version of fiat currencies based on blockchain technology. In this case the transition would be seamless in the sense that central banks will still retain the power to control inflation through monetary policy, albeit in a more complex environment.

Fraud and money-laundering

What are the potential risks of virtual currencies in terms of fraud? How would these be addressed in your jurisdiction? Have any specific instances emerged in which virtual currencies have been used for money-laundering or other fraudulent purposes?

Cryptocurrencies are unregulated and anonymous, creating a level of independence from regulation and allowing people to take control of their transactions. However, by making a few key changes to the way in which cryptocurrencies are issued and exchanged, it is possible to imagine a DLT platform in which users must be fully identified and regulators can have complete real-time access to audit every transaction and trace every outgoing transaction from one wallet, through merchants and exchanges to a final recipient.

The risks posed by cryptocurrencies have already been seen – a number of cryptocurrencies offering a high level of anonymity have been used to facilitate crime, or the proceeds thereof. Ponzi schemes, trading in illegal goods and services, and cyber risks are all issues that must be addressed in relation to virtual currencies. However, such risks are not impossible to manage as they are also present on the Internet, and financial fraud investigators have built up vast expertise and experience to mitigate against such risks.

The MFSA has implemented a rigorous set of measures to actively reduce the risk of illicit activity through cryptocurrencies issued or used in Malta. As a start, the role of VFA agent has been created, wherein licensed practitioners act as an extended arm of the regulator and bear liability for significant penalties if found to fall short of requirements. A heavy burden of investigation is placed on the VFA agent, who must analyse not only whether those behind the VFA offering are legitimate and competent, but also whether the business proposal itself is viable. The VFA agent acts as a filter between enterprises wishing to launch virtual currencies and the MFSA, which registers and legitimises such business. This places a substantial onus on the VFA agents, who must not only understand the legal requirements but also delve deeply into the business concept of the enterprise and ensure thorough good governance, risk management and compliance control. The risk assessment conducted by the VFA agent analyses whether the business is sustainable in the long term and flags any potential discrepancies and causes of concern, including scams or fraud, to the MFSA.

In order to register a VFA white paper with the MFSA, certain criteria and safeguards must be provided in order to mitigate the risks posed by such currencies. As a regulated sector, a VFA white paper must abide by the laws governing anti-money laundering and funding of terrorism. Enterprises wishing to register a white paper must put in place internal systems and controls that identify risks posed by users of the VFA. This is done through a customer acceptance policy, customer due diligence and risk management matters. From a technological standpoint, safeguards against the use of proxies, unverifiable IP addresses or geo locations and disposable email addresses should be used in order to reduce the risk of the VFA being used for criminal purposes.

A VFA issuer must conduct customer due diligence on the user including both an adequate identification of the user and verification of the user through documentation such as passports, utility bills and bank statements. This procedure is escalated to an enhanced level of due diligence if the issuer deems the risks posed by the user to be higher.