Fri, Mar 1, 2024

The official Financial Regulation Journal of SAIFM

The New Crypto-Asset Reporting Framework is a step towards International Coordination in Regulating the Crypto Industry

The New Crypto-Asset Reporting Framework is a step towards International Coordination in Regulating the Crypto Industry

Daniel Makina, University of South Africa

The emergence of cryptocurrencies in the early 21st century raised a debate on whether they can be regarded as money. Money is best defined by its five functions as a unit of account, medium of exchange, means of payment, standard for deferred payments and store of value. Generally, cryptocurrencies can somehow satisfy the first three functions. Largely, due to their volatility they can hardly satisfy the functions as a standard for deferred payments and store of value. Hence, in almost all jurisdictions save for El Salvador, cryptocurrencies are not regarded as money or legal tender. However, there is consensus that they can be regarded as an asset class. In South Africa a cryptocurrency is regarded as a private digital asset. While the South African Reserve Bank does not recognise it as legal tender, it acknowledges its legality and supports its development. In October 2022 the Financial Sector Conduct Authority (FSCA) classified cryptocurrency a financial product and brought it under its regulatory framework. The regulatory framework requires cryptocurrency service providers to register with the Financial Intelligence Centre (FIC) and comply with Anti-Money Laundering (AML) and Counter-Terrorist Financing (CTF) requirements in addition to the normal KYC requirements. By the end of 2023 over ninety (90) financial services providers had applied for licenses with FSCA to offer crypto-related services.

The Cockroach Theory of Crypto 

The crypto industry has over the years given regulators and central banks headaches because the high potential for cross-border reach and swift trading among different cryptocurrencies, makes them prone to being used for illicit transactions such as money laundering, terrorism financing, tax evasion, financial scams and other crimes, without being linked back to the illicit activity[1]. Cryptocurrency trading that happens through decentralized peer-to-peer transactions may not reveal any customer identity information, making it impossible to trace who controls the traded cryptocurrencies if illicit activity is involved. Even if the trading is done on centralized platforms, relevant crypto-service providers need not disclose their customers’ identity information, nor must they perform KYC in customers’ registrations. Moreover, the ability to trade rapidly among different cryptocurrencies enables multiple transactions of illicit funds in a short time to effectively hide the trail of funds. Furthermore, if illicit transactions are cross-border, which is often the case, supervision and enforcement will be impossible without coordinated international regulatory collaboration.  Because of these underlying risks there have been efforts to try to kill it. The Economist issue of 18 December 2023 aptly likened the crypto industry to cockroaches as follows: “Chopping of their heads does not work: cockroaches can live without one for as long as a week. Whacking them is no guarantee either: their flexible exoskeletons can bend to accommodate as much as 900 times their body weight. Nor is flushing them down the toilet a solution: some breeds can hold their breath for more than half an hour”.

In other words, crypto can be regarded by some as an unwelcome pest just as a cockroach because cryptocurrencies can be used for money laundering, financing terrorism and are generally created for speculative activities. More so, their values have no underlying assets, and cryptocurrencies are difficult to regulate. And just like cockroaches they are difficult to kill. They have endured against all odds because they underpinned by the innovative blockchain technology that has since found various important applications. It can be argued that a cockroach is even easier to kill than crypto because innovative technology like a chemical pesticide can instantly kill it.

Crypto Assets go Mainstream

Since bitcoin, the world’s largest cryptocurrency, achieved its highest price of almost $69,000 on 10 November 2021, it has been on downward trend reaching $16,600 by the beginning of 2023. The fall of crypto prices has been attributed to higher interest rates and a spate of scandals that beset the crypto industry. The founders and bosses of the two world biggest crypto exchanges – Binance and FTX – were convicted for breaking anti-money laundering laws and fraud in 2023. It is noteworthy that the financial crimes they committed are not unique to the crypto industry but are also common in the traditional financial sector.

The year 2023 saw crypto assets establishing themselves as a serious asset class. The dramatic change started when in the USA a court ordered the Securities and Exchange Commission (SEC) to reconsider the application by Grayscale, an investment firm, to convert a $17 billion bitcoin trust into an exchange-traded fund (ETF). BlackRock and Fidelity, the biggest fund managers in the USA, have also applied to launch their crypto asset ETFs. These developments brightened the prospect of crypto assets being approved as an asset class by the SEC in the course of 2024. Consequently, the last quarter of 2023 witnessed a significant increase of the price of bitcoin which touched a two-year high of nearly $45,000 on 11 December 2023, an almost 150% increase in a year.

As markets predicted, on 10 January 2024, the US regulator SEC approved trading of spot bitcoin ETFs. Notably, the approval was limited to ETFs holding one non-security commodity, bitcoin, and the Commission emphasized that it was not a signal of its willingness to approve listing standards of crypto asset securities. Emphasizing this point, the SEC Chair, Gary Gensler, stated: “While we approved the listing of certain bitcoin ETF shares today, we did not approve or endorse bitcoin.” Nevertheless,  bitcoin traded over $46,000 following the listing approval.

Towards International Coordination in Reporting Crypto Assets 

Countries have taken different regulatory approaches towards cryptocurrencies. For example, China banned the cryptocurrency trading and mining activities within the country in 2021[2], while Hong Kong, a special administrative region of China, has taken a more open regulatory stance, as seen in its policy statement, issued in October 2022[3], aiming to establish a consistent, predictable and clear regulatory framework and a facilitating environment for promoting sustainable and responsible development of the crypto sector in Hong Kong. US President Joe Biden issued an executive order in March 2022 outlining a policy approach for addressing the risks and harnessing the potential benefits of digital assets, including cryptocurrencies across six areas: consumer and investor protection, financial stability, illicit finance, international cooperation, financial inclusion and responsible innovation[4]. In September 2022, the US government released a framework composed of a series of reports for the responsible development of digital assets[5].

South Africa has taken a positive stance on cryptocurrencies. South Africa’s financial sector regulators have published a policy position paper on cryptocurrencies (named “crypto assets” in the paper) through the Intergovernmental Fintech Working Group (IFWG)[6]. The IFWG paper provides specific recommendations on developing a regulatory framework for cryptocurrencies, including confirmation of cryptocurrency legal status and tax application along with regulatory framework implementation for AML/counter-terrorist financing (CFT), monitoring and analysis programme, licensing and supervision, cross-border regulation, payment system providers, initial coin offerings, use in alternative investment and cryptocurrency market support services.

At the global level, in 2014 the OECD published the Common Reporting Standard (CRS) to promote tax transparency bringing its scope certain electronic money and Central Bank Digital Currencies (CBDCs). Since the CRS was adopted over 100 jurisdictions have implemented it. Cognisant of the emergence of crypto assets in the global tax space and realization that these assets can be transferred and held without interacting with traditional financial intermediaries or any central administrator and hence lack full visibility, in August 2022, the OECD, working with the G20 countries adopted the Crypto-Asset Reporting Framework (CARF), a dedicated global tax transparency framework. The CARF provides for the automatic exchange of tax information on transactions in crypto assets in a standardized manner. It consists of rules and commentary which can be incorporated into domestic law to collect information from Reporting Crypto-Asset Service Providers that are designed around four key building blocks.

The Scope of Crypto Assets to be covered

Crypto assets targeted by the CARF are those assets that can be held and transferred in a decentralised fashion using cryptographically secured distributed technology without the in the use of traditional financial intermediaries. These crypto assets also include: stablecoins, derivatives issued in the form of crypto assets and certain non-fungible tokens (NFTs). Notably, assets covered under the CARF also fall within the scope of Financial Action Task Force (FATF) Recommendations to ensure that due diligence requirements build on existing AML/KYC obligations.

Entities and Individuals subject to Data Collection and Reporting Requirements

Reporting crypto-asset service providers under the CARF include entities and individuals whose business is to provide effecting exchange transactions in relevant crypto assets for or on behalf clients. Such financial intermediaries and other service providers would also ordinarily fall within the scope of FATF and hence they are in a position to collect and review their clients’ documentation ensuring it complies with AML/KYC requirements.

Reporting Requirements

Three types of transactions regarded as relevant transactions reportable under the CARF include:

  • Exchanges between relevant crypto assets and fiat currencies;
  • Exchanges between one or more forms of relevant crypto assets; and
  • Transfers of relevant crypto assets.

The Due Diligence Procedures

Reporting crypto asset service providers are required follow due diligence procedures provided by the CARF. These due diligence procedures build on the self-certification process of the Common Reporting Standard (CRS) and existing FATF AML/KYC obligations. They are designed to allow service providers in crypto to efficiently determine the identity and tax residence of crypto asset users.

At the same time the CARF was adopted, the OECD, working with G20 countries, conducted a comprehensive review of the CRS in consultations with participating jurisdictions, financial institutions, and other stakeholders. The result was a set of amendments made to the CRS. Amendments were made in the light of CARF to ensure that indirect investments in crypto assets through derivatives and investment vehicles are covered by the CRS as well as to improve the operation of the Standard based on the experience gained by over 100 jurisdictions since the CRS was adopted. Since the CARF is a separate and complementary framework, there are going to be some entities reporting under both the CRS and the CARF. To lessen the burden of duplicate reporting, the CARF permits reporting crypto asset service providers also subject to the CRS to rely on the due diligence performed for CRS purposes.

South Africa is one of 48 jurisdictions so far that have pledged to adopt the new CARF. The list of countries that have pledged also include all 38 OECD countries and traditional financial offshore hubs such as the UK’s overseas territories – Cayman Islands, Gibraltar, among others. However, key markets such as China, Hong Kong, the UAE, Russia, and Turkey are excluded. The 48 countries adopting the standard have set a 2027 deadline for implementing it in their laws.

The South African Revenue Services (SARS) intends to work towards ensuring that the CARF is incorporated in the domestic law. It recognizes that lack of transparency makes it challenging for tax authorities to gain insight into crypto transactions or the location of crypto assets. Hence, the CARF new international standard will facilitate automatic exchange of information between tax authorities. Already crypto exchanges in South Africa were required to register for licences with the FSCA before the end of 2023. They are excited by the developments because they believe that regulatory oversight will increase public trust in crypto.

Going Forward

Perhaps the cockroach is a necessary evil in the natural ecosystem. By virtue of being an omnivore, it feeds on other pests and plants, some of which are harmful to humans. Similarly, crypto assets could turn out to be a useful diversification tool in the asset manager’s toolkit. Portfolio theory advises us to develop portfolios of assets that are either negatively correlated or not correlated at all. Crypto assets appear not to be correlated with other assets except among themselves. Although, going forward, crypto assets might constitute a worthy asset class for investment just like stocks, bonds, real estate, and other asset classes, countries should  prioritize targeted implementation of existing global regulatory standards and recommendations on cryptocurrency put forth by international organizations and standard-setting bodies based on the country-specific context, with coordinated mechanisms that allow for rapid review and adaptation to new developments of cryptocurrencies and their risks.  Such international standards[7]  can be seen in the FATF’s standards for mitigating the AML/CFT risks of cryptocurrency, the Bank for International Settlements (BIS) proposal for the prudential treatment of banks’ crypto exposures, the Financial Stability Board (FSB) recommendations on the regulation of global stablecoin arrangements and cryptocurrency activities and markets, and others.


[1] See IMF (2021). Global Financial Stability Report—COVID-19, Crypto, and Climate: Navigating Challenging Transitions. Washington, DC, October. https://www.imf.org/en/Publications/GFSR/Issues/2021/10/12/global-financial-stability-report-october-2021; and He, D., Habermeier, K.F., Leckow, R.B., et al. (2016). Virtual Currencies and Beyond: Initial Considerations. IMF Staff Discussion Notes No. 16/3. https://www.imf.org/en/Publications/ Staff-Discussion-Notes/Issues/2016/12/31/Virtual-Currencies-and-Beyond-Initial-Considerations-43618.

[2] See https://www.coindesk.com/learn/china-crypto-bans-a-complete-history/.

[3] See the Policy Statement on Development of Virtual Assets in Hong Kong by the Financial Services and the Treasury Bureau of Hong Kong: https:// www.info.gov.hk/gia/general/202210/31/P2022103000454.htm.

[4] See https://www.whitehouse.gov/briefing-room/presidential-actions/2022/03/09/executive-order-on-ensuring-responsible-development-of-digital-assets/.

[5] See https://www.whitehouse.gov/briefing-room/statements-releases/2022/09/16/fact-sheet-white-house-releases-first-ever-comprehensive-framework-for-responsible-development-of-digital-assets/.

[6] South African Intergovernmental Fintech Working Group (IFWG), Crypto Assets Regulatory Working Group (2020). Position Paper on Crypto Assets (updated in 2021). https://www.sars.gov.za/wp-content/uploads/IFWG-CAR-WG-Position-paper-on-crypto-assets.pdf.

[7] See more details in: FATF (2021). Updated Guidance for a Risk-Based Approach to Virtual Assets and Virtual Asset Service Providers. Paris: Financial Action Task Force (FATF): https://www.fatf-gafi.org/publications/fatfrecommendations/documents/guidance-rba-virtual-assets-2021.html; Basel Committee on Banking Supervision (2021). Prudential Treatment of Cryptoasset Exposures. Basel: Bank for International Settlements (BIS): https:// www.bis.org/bcbs/publ/d519.htm; FSB (2020). Regulation, Supervision and Oversight of ‘Global Stablecoin’ Arrangements. Basel: Financial Stability Board (FSB): https://www.fsb.org/2020/10/regulation-supervision-and-oversight-of-global-stablecoin-arrangements/; and FSB (2022). Regulation, Supervision and Oversight of Crypto-Asset Activities and Markets: Consultative Report. https://www.fsb.org/2022/10/regulation-supervision-and-oversight-of-crypto-asset-activities-and-markets-consultative-report/.

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