Consultation paper on policy proposals for crypto assets

1

Contents
1.

Introduction to the consultation paper

4

1.1

Background4

1.2

Problem statement5

1.3

Approach by the Crypto Assets Regulatory Working Group7

1.4

Purpose and scope of the consultation paper

72.

Classifying crypto assets

8

2.1

Defining crypto assets

8

3.

Use case analysis

9

3.1

Purchase and/or sale of crypto assets

9

3.2

Payments using crypto assets

10

4.

The risks and potential benefits of crypto assets

12

4.1

The generic risks posed by crypto assets

12

4.2

The specific risks posed by crypto assets in the use cases identified

15

4.2.1 Purchasing and selling crypto assets
4.2.2 Payments using crypto assets

15
17

4.3

The potential benefits of crypto assets in the two use cases identified

18

5.

Developing a regulatory response to crypto assets in South Africa

19

5.1

Challenges regarding regulating crypto assets

19

5.2

Approaches available to regulate crypto assets

19

5.3

Suggested regulatory approach to crypto assets in South Africa

23

6.

Objectives for regulating crypto assets

24

7.

Principles for regulating crypto assets

24

8.

Proposals for regulatory actions for crypto assets

26

9.

Conclusion and the way forward

30

10.

References

31

Consultation paper on policy proposals for crypto assets2Abbreviations

AML

anti-money launderingATMautomated teller machine

BCBS

Basel Committee on Banking Supervision

BIS

Bank for International Settlements

CDD

customer due diligence

CFT

combating the financing of terrorism

CPMI

Committee on Payments and Market Infrastructures

FATF

Financial Action Task Force

FIC

Financial Intelligence Centre

FIC Act

Financial Intelligence Centre Act 38 of 2001

fintechfinancial technology

FSB

Financial Stability Board

FSCA

Financial Sector Conduct Authority

FSR Act

Financial Sector Regulation Act

IADI

International Association of Deposit Insurers

IAIS

International Association of Insurance Supervisors

IFWG

Intergovernmental FinTech Working Group

IMF

International Monetary Fund

IOSCO

International Organization of Securities Commissions

NT

National Treasury

SARB

South African Reserve Bank

SSB

standard-setting body

SARS

South African Revenue Services

Consultation paper on policy proposals for crypto assets

3

1.

Introduction to the consultation paper

1.1

Background

1.1.1

The initial public statement on crypto assets1 was issued by National
Treasury (NT) in 2014 as a joint initiative with the South African Reserve
Bank (SARB), the Financial Services Board (now the Financial Sector
Conduct Authority (FSCA)),2 the South African Revenue Service (SARS) andthe Financial Intelligence Centre (FIC).3 The public statement warned
members of the public about the risks associated with the use of crypto
assets for the purpose of transacting or investing, and advised users to takeextreme caution in this regard. It further noted that no specific legislation or
regulation exists for the use of crypto assets. Therefore, no legal protection
or recourse is offered to users of, or investors in, crypto assets.

1.1.2 Following the user alert, the SARB, through the National Payment System
Department, issued a position paper on crypto assets in 2014 (South African
Reserve Bank, 2014).4 The position paper highlighted the risks surrounding
crypto assets, such as money laundering and the financing of terrorism. It
noted the lack of a regulatory and legal framework, the absence of consumer
protection laws, and the inability to enforce the principle of finality andirrevocability in the payment system as well as the circumvention of exchange
control regulations. The position paper stated that the SARB does notoversee, supervise or regulate the crypto assets landscape, systems orintermediaries. Therefore, all activities related to the acquisition, trading or useof crypto assets are done at the end users’ sole and independent risk, with no1

At the time this statement was issued, the term ‘virtual currencies’ was used to refer to crypto assets.
The Financial Services Board was wound down and a new Financial Sector Conduct Authority was created on
1 April 2018 as a result of the Twin Peaks reforms.
3
http://www.treasury.gov.za/comm_media/press/2014/2014091801%20%20User%20Alert%20Virtual%20currencies.pdf
4
https://www.resbank.co.za/RegulationAndSupervision/NationalPaymentSystem(NPS)/Legal/Documents/Positi
on%20Paper/Virtual%20Currencies%20Position%20Paper%20%20Final_02of2014.pdf
2Consultation paper on policy proposals for crypto assets

4recourse to the SARB. The SARB stated that it would continue monitoringthese activities and developments in this area.

1.1.3

In 2016 the Intergovernmental FinTech Working Group (IFWG) wasestablished, comprising members from NT, the SARB, FSCA and FIC. The
aim of the IFWG is to develop a common understanding among regulatorsand policymakers of financial technology (fintech) developments as well as
policy and regulatory implications for the financial sector and economy.

1.1.4

At the start of 2018, a joint working group was formed under the auspices of
the IFWG to specifically review the position on crypto assets. The working
group is represented by the members of the IFWG and SARS, and isreferred to as the Crypto Assets Regulatory Working Group.

1.2

Problem statement

1.2.1

The need to develop a policy and regulatory response to crypto asset
activities in South Africa is driven by the following:a. Crypto assets are a form of innovation that may impact the financial
sector of the country: Fintech is defined as technology applied tofinancial services, resulting in new business models, applications,processes, products or services with an associated disruptive effect onfinancial markets and institutions. This definition emphasises the focus ontechnology-driven

innovations

withinfinancialservices

that

could

potentially reshape financial services. Given the wide range of innovations
across financial services, the existing regulatory architecture should beassessed to determine its appropriateness and effectiveness. Crypto
assets are considered to be an innovation that could materially impact
financial services, as some view crypto assets as a new form of money thathas a direct impact on economic activities such as payments, investments
and capital raising, among other things.

Consultation paper on policy proposals for crypto assets

5

b. Crypto assets do not fit neatly within the current regulatory
framework: Globally regulators have not sufficiently addressed thephenomena of crypto assets. From conceptualisation to issues on
definition, it remains an area that requires further clarity for regulators.
Various approaches have been adopted, as some jurisdictions have
explicitly allowed its use and trade, others have banned and restricted it,
while most jurisdictions have followed the monitoring approach and issued
warnings, but have not declared it illegal.

c. Crypto assets may create conditions for regulatory arbitrage while
posing risks: The financial system and all participants operate in a highly
regulated area, which assists in ensuring a sound and safe financial
system. However, crypto assets perform similar financial sector activities
without the need for third-party intermediaries and without similar safetymechanisms. This leaves the crypto asset environment exposed topotential financial and consumer risks. Some of the perceived risks ofcrypto assets include an increase in undetected illicit financial flows,money laundering and terrorist financing risk, and consumer and investor
protection concerns, including market manipulation and tax evasion. Other
areas of risk include the circumvention of exchange controls, balance of
payments reporting requirements, and financial stability risks.

d. There is growing interest, investment and participation in crypto
assets: Financial institutions and individuals have shown growing interestin crypto asset activities. There are more than 2 000 different crypto coins
and tokens in circulation,5 and this is increasing as new schemes, throughinitial coin offerings, are continually launched. The available measures todetermine the exact size of the crypto assets market are limited. A tool
often

5

used by industry players is the

pricechecking website,

https://coinmarketcap.com/

Consultation paper on policy proposals for crypto assets

6Coinmarketcap, which indicates a perceived market capitalisation of about
US$200 billion6 for all crypto assets.

1.3

Approach by the Crypto Assets Regulatory Working Group

1.3.1

In order to develop policy and regulatory responses to the emergence of
crypto assets in South Africa, the Crypto Assets Regulatory Working Group
followed a functional approach. This means that the economic function of
crypto assets was assessed rather than the specific technology applied or
the entity involved. From this viewpoint, the following crypto asset specificuse cases were identified: (i) purchasing and/or selling; (ii) payments; (iii)
capital raising through initial coin offerings; (iv) crypto derivatives and funds;and (v) market provisioning. It is acknowledged that new use cases may
arise as the crypto asset market is a rapidly evolving market, and similarly
the underlying economic function will be assessed.

1.3.2

An in-depth analysis of the applicable use cases and implicit risks was
conducted. Guidance from international standard-setting bodies wasconsidered along with the approaches taken by various other countries.

1.4

Purpose and scope of the consultation paper

1.4.1

The purpose of this consultation paper is to:a.

provide an overview of the perceived risks and benefits associated withcrypto assets;

1.4.2

b.

discuss the available regulatory approaches; andc.

present policy proposals to industry participants and stakeholders.

This consultation paper focuses exclusively on non-government or noncentral-bank-issued crypto assets and not on central bank digital currencies,7
including central bank crypto currencies8.

6This amount was correct at the time of writing the consultation paper.

Consultation paper on policy proposals for crypto assets

71.4.3This consultation paper focuses on only two of the identified crypto asset use
cases, namely:

1.4.4

a.

the purchasing and selling of crypto assets; andb.

paying for goods and services using crypto assets (payments).

These two use cases form the basis of the crypto assets review, but all theuse cases are considered important, and equal attention will be given to theother use cases.

1.4.5

A similar approach will be taken in proposing policy and regulatory responses
to the remaining use cases in future policy documents.

2.

Classifying crypto assets

2.1

Defining crypto assets

2.1.1

From a regulatory perspective, having definitional clarity on the cryptophenomenon is crucial, as it directly influences its classification andconcomitant regulatory treatment. It may accordingly be noted that various
naming conventions have been adopted from ‘digital tokens or assets’ and,most recently, ‘crypto tokens’ and ‘crypto assets’, (CPMI, 2015; FSB, 2018;
BIS, 2018, Carney, 2018a) in the space of just a few years. Despite thevarious nomenclature used, the crypto-phenomenon is commonly based on
decentralised technology such as blockchain and distributed ledger
technology. The definitions used generally focus on its electronic nature, its
potential role as a medium of exchange, and its perceived role as arepresentation of value. Some jurisdictions have classified it as a unit of7

The term ‘central bank digital currency’ refers to a central bank liability, such as cash or central bank deposits,
issued in digital or electronic form, denominated in a sovereign currency and backed by the central bank’s assets(Panetta, 2018).
8
In contrast, a ‘central bank crypto currency’ specifically refers to the use of cryptography and distributed ledger
technology in the underlying application (BIS, 2018).

Consultation paper on policy proposals for crypto assets

8account, while others have rejected it as a financial instrument or financial
product. Central banks, in particular, have been reluctant to refer to thephenomenon as ‘currencies’ for concern of giving it unwarranted legitimacy
as a form of legal tender.

2.1.2 The South African regulatory authorities have taken a functional approach,focusing on the economic activities being performed, compared to a moregeneric 'all-encompassing' clinical classification. It is acknowledged thatcrypto assets may perform certain functions similar to those of currencies,
securities and commodities. The preferred term of ‘crypto assets’ thus
encapsulates and extends to all these functions and is used throughout thisdocument. The proposed definition is as follows:“Crypto assets are digital representations or tokens that are accessed,
verified, transacted, and traded electronically by a community of users.
Crypto assets are issued electronically by decentralised entities andhave no legal tender status, and consequently are not considered aselectronic money either. It therefore does not have statutorycompensation arrangements. Crypto assets have the ability to be used
for payments (exchange of such value) and for investment purposesby crypto asset users. Crypto assets have the ability to function as a
medium of exchange, and/or unit of account and/or store of value
within a community of crypto asset users.”

3.

Use case analysis

Developing a thorough understanding of the use cases of crypto assets isimportant to determine the applicable risk. Crypto assets differ in terms of
their value proposition and usage.

3.1

Purchase and/or sale of crypto assets

3.1.1

Crypto assets are purchased for different reasons such as speculative
investing (perceived increased future value), as a medium of exchange inConsultation paper on policy proposals for crypto assets

9facilitating transactions, or for access to specific services or utilities. Crypto
assets can also be purchased or acquired for the specific purpose of onselling or trading. Crypto assets can be purchased using three available
options. The buyer can purchase crypto assets from (i) a crypto trading
platform (domestically or internationally based)9; (ii) crypto asset vending
machines10; or (iii) bilateral transactions with other holders (peer-to-peertransactions). The buyer may require a digital wallet11 to acquire crypto
assets which can be obtained through software platforms or provided by adigital wallet service provider or crypto asset trading platform. An alternative
to obtaining or acquiring crypto assets is through the primary sourcing of
crypto assets by means of ‘mining’12 activities. Crypto asset mining is mostly
done by big companies or mining pools13 with expensive and specialised
computing equipment. Crypto asset mining is not included in this specific use
case, but will be addressed in use case five, which relates to market
provisioning, in consequent consultation papers.

3.2

Payments using crypto assets

3.2.1

This use case was envisioned as the original purpose of crypto assets,
namely providing users with an alternative to existing payment systems as
described in the white paper on Bitcoin written by Satoshi Nakamoto.14 The
whitepaper describes a purely peer-to-peer means of payment that allows
parties to transact without the need for intermediation by a financial institution
to execute online payments. Crypto assets are used to make payments,15

9

A variation of a crypto asset platform is a decentralised exchange. It uses an artificial intelligence (AI) systemthat is able to connect crypto asset traders electronically. These trades are done simultaneously through an
atomic swap using a smart contract and without any intermediation from a third party.
10
The crypto asset vending machine allows the user to make a physical deposit or electronic deposit using fiat
currency that is credited to a digital wallet. The operator of these machines acts as the counterparty to alltransactions.
11
A crypto asset digital wallet is defined as a software program with the ability to store private and public keys
that are used to interact with various blockchain protocols that enable the user to send and receive crypto assets
with the ability to monitor balances.
12
Crypto mining is the process of solving complex problems to verify digital transactions using computer
hardware. Miners can either create a crypto asset or get paid for the use of their processing power.
Source: www.luno.com
13

A network of computers to achieve the necessary computer powers.
https://nakamotoinstitute.org/static/docs/bitcoin.pdf
15
However, this value is not recognised as currency or legal tender in the majority of jurisdictions.
14

Consultation paper on policy proposals for crypto assets

10that is, exchange value between actors within the crypto assets user
community. Crypto assets are thus used to buy or sell goods and services
between transacting parties who accept such tokens as payment. They areused as a medium of exchange, with crypto assets as the store of value as
opposed to using fiat currencies. The associated value of crypto assets is stilllargely tied to fiat currency exchange rates, which attests to the fact thatcrypto assets have not yet been adopted as a unit of account.

3.2.2

Crypto assets challenge not only the process of how the movement of 'funds'
get processed or verified (through, for example, 'proof of work' or 'proof of
stake' protocols), but also how the underlying store of value is essentiallydisrupted. It is a decentralised-issued digital token, a perceived new
representative store of value, issued by a collective set of unknown
participants (i.e. not a single issuer). The token is not government decreed,
not currency, not central bank money, not commercial bank money, butrather an online network-created perceived store of value.

3.2.3

In the absence of a legal and regulatory framework for South Africa, theacceptance of crypto assets for the payment of goods and services iscurrently at the discretion of consumers and willing merchants. Crypto assets
are used for online purchases or purchases at physical stores. The majorityof crypto payment transactions in South Africa use the crypto asset Bitcoin
as the medium of exchange. Crypto assets are accepted at certain physicalstores across a variety of industries in South Africa.16 For both physical andonline transactions, the retailer usually displays a crypto asset logo, such as
the Bitcoin-accepted logo, in their physical store or on their website. Local
consumers can also make payments to international merchants using crypto
assets, and South African merchants can accept crypto assets frominternational consumers. Where this is done for services provided (e.g.
paying for website design services), everything can happen electronically. Insuch scenarios, no goods are exchanged and thus border customs control is

16

At the time of writing the consultation paper, specific data for physical and online acceptance were notavailable.

Consultation paper on policy proposals for crypto assets

11not applied. Retailers often prefer to outsource the processing of transactions
to accept crypto assets as payments. Some of these entities are referred toas ‘payment processors’ which are contracted to merchants to provide
acceptance, settlement and reconciliation services.

3.2.4

Besides the use of crypto assets for the payment of goods and services, they
could also be used for person-to-person credit transfers, such as
remittances. Crypto assets have specifically made advances in positioning asa ‘money remittance’ alternative.

4.

The risks and potential benefits of crypto assets

4.1

The generic risks posed by crypto assets

4.1.1

The risk with potentially the widest-ranging implications is the threat tocentral banks’ historical exclusive right to issue money and control the money
supply, which ability has the benefit of ensuring an efficient monetary policy
transmission mechanism. The risk posed by crypto assets to the monetary
policy transmission mechanism is: should demand for crypto assets increasesignificantly, demand for fiat currency would decrease. In essence, this would
lead to the creation of a parallel – and ultimately fragmented – monetarysystem.

a. By way of illustration, it may be noted that the largest crypto assets bymarket capitalisation, Bitcoin, currently has a reward rate of 12.5 and a
block time of 10 minutes. This means that 75 new bitcoins are mined
every hour, or 1 800 bitcoins per day. At the current market value ofaround US$6 500 per Bitcoin, this means that US$11.7 million worth ofnew ‘money’ is introduced into the global financial system every day, or
approximately US$350 million per month.17 While this amount is

17

It should be noted that this figure excludes the approximately 2 000 alternative crypto assets in existence. This
also excludes the incidence of hard forks, such as the split between Bitcoin and Bitcoin Cash, undermining the
fixed supply of the protocol.

Consultation paper on policy proposals for crypto assets

12significant, it is relatively much smaller in quantum from the global supplyof fiat money. Compared to existing fiat currencies, the overall value ofbanknotes and coin in circulation is over US$7.5 trillion, the global
narrow money supply (banknotes and coin, including cheque accountdeposits) is US$36.8 trillion, while the global broad money supply(banknotes and coin, cheque account deposits as well as money market
accounts, saving accounts and time deposits) is more than US$90
trillion, making crypto assets still relatively immaterial compared to fiat
currencies. The total trade of crypto assets in South Africa is estimated atless than 1% of the narrow money (M1) in South Africa.
Also, where only 180 fiat currencies are recognised by the United
Nations, already more than 2 000 crypto assets are listed on the crypto
asset tracking website, Coinmarketcap. However, by infringing uponcentral banks’ exclusive right to issue money, although not legal tender,
crypto assets can over time lead to the monetary policy transmission
mechanism becoming less effective if they become widely adopted.
Given that crypto assets will effectively be competing with fiat currencies,
the concomitant question is whether traditional monetary policy willremain effective in a world that is not dominated exclusively by central
bank money (He, 2018).

b. The second risk posed by crypto assets pertains to financial stability.
South Africa agrees with the FSB (Carney, 2018a), that the crypto assets
market (with a total market capitalisation, at the time of writing thisdocument, of around $200 billion) does not currently pose a threat tofinancial stability. Although a total crypto assets market capitalisation of
US$1 trillion will still not be considered as systemic by South Africa, it isacknowledged that this figure represents an important psychological level
which, once breached, may prompt greater regulatory scrutiny andsubsequent action by policymakers and regulators globally. Although thetotal global market capitalisation of crypto assets is currently relatively
small (or about 1.5% of the market capitalisation of the S&P 500 Index),
the fact that the crypto market experienced a market capitalisation
Consultation paper on policy proposals for crypto assets

13growth rate of 3 200% in 2017 has raised concerns about the unknown
impact of crypto assets, particularly if there is wide-scale use andadoption of such assets. A further significant factor is that low amounts ofselling and buying of crypto assets often result in large movements inprice. Volatility is an indispensable part of the price discovery process ofcrypto assets. Currently, the demand and supply of crypto assets can bemonitored, but no firm understanding of their intrinsic value exists (ifany), noting traditional valuation metrics such as a discounted cash flow
model, among other things, all of which should be investigated further toassess market and liquidity risks as well as leveraged positions.
c. The third pertinent risk is to the national payment system and, similar to
the threat posed to monetary policy implementation, relates to thecreation of a parallel – and ultimately fragmented – payment system. If
the adoption and use of crypto assets remain at the relatively low levels
currently observed, they are unlikely to pose a material threat to thenational payment system. However, should they gain widespread
adoption, crypto asset payments will essentially be competing directlywith the national payment system, but without the same level ofregulatory oversight. By way of an example, the estimated total value ofcrypto assets traded over a three-year period in South Africa is estimatedat less than 4% of the approximate amount settled every day via theSouth African Multiple Option Settlement (SAMOS) system. This is not
currently considered as a material value. On a global level, the share of
crypto assets in global payment transactions is also low. For example,
there are about 284 000 bitcoin transactions daily, compared to around
330 million retail payments in the euro area alone (ECB, 2018).18

4.1.2

While the three risks highlighted above seem unlikely to materialise at thecurrent juncture, the risks related to crypto assets that are of immediateconcern include the lack of consumer protection, possible misuse related to18

Virtual or virtueless? The evolution of money in the digital age. Lecture by Yves Mersch, Member of the
Executive Board of the ECB, Official Monetary and Financial Institutions Forum, London, 8 February 2018.
https://www.ecb.europa.eu/press/key/date/2018/html/ecb.sp180208.en.html

Consultation paper on policy proposals for crypto assets

14money laundering and terrorist financing, circumvention of exchange controls
and the increase of undetected illicit financial flows, inaccurate balance of
payments data, illicit purchases (stemming from the anonymity or
pseudonymity associated with crypto assets), tax evasion, and the lack ofmarket integrity. Unlike the risks related to monetary policy, the national
payment system and financial stability, these risks have already materialised,
and therefore require a regulatory response by South African authorities.
Further to this, as the price of crypto assets has increased, the number ofcustomers as well as the values traded in South Africa have grownsignificantly over the past three years. These risks and the proposed
regulatory actions to negate them are addressed under the policy proposals
on the way forward detailed in section eight. The proposed regulatory
actions, therefore, specifically aim to address the existing risks that havealready materialised, with the articulation of regulatory responses for therisks that are yet to materialise being deferred until such time that they are
more likely to materialise.

4.2

The specific risks posed by crypto assets in the use cases identified

4.2.1

Purchasing and selling crypto assets

4.2.1.1 In the case of purchasing crypto assets, there are currently no regulatory
requirements for customers to be identified. Hence, when purchasing crypto
assets, the risks of clients conducting money laundering or terrorist financing
activities, circumventing exchange controls and masking illicit financial flows
are potentially high. Although some crypto asset sellers, such as trading
platforms, have implemented client identification and verification (duediligence) processes, this is not a generic or standard process for all sellersof crypto assets. It is currently at the discretion of the crypto asset trading
platform to implement such measures. A further risk is the tracking of the flowof funds which is separate from the current monitoring activities of thefinancial system and regulators.

Consultation paper on policy proposals for crypto assets

15

4.2.1.2 Consumers are left vulnerable as sellers of crypto assets are not regulated.
Therefore, no specified rules exist to protect them or provide customer
resolution mechanisms (e.g. for disputes). Various incidents have beenreported of crypto asset trading platforms being hacked and consumers
losing their funds. Fraud could also be committed through accounting
practices on internal financial systems, as some transactions occur off theblockchain according to the trading platforms’ processes. Crypto asset
trading platforms and other crypto asset sellers may not have sufficientmechanisms to guard against fraud and hacking incidents. Consumers are
seldom sufficiently informed of the risk of crypto assets and the losses thatcan be incurred as a result of investing and trading in crypto assets. There is
no regulation or independent oversight to ensure that prices, and the fees
and charges involved in buying and selling crypto assets, are set fairly andtransparently. Users with large holdings of crypto assets have exploited themarket with market manipulation tactics whereby hype is created around
specific crypto assets. This artificially increases prices and subsequently thecrypto assets are sold in masses after significant profits have been made bythese users.

4.2.1.3 Crypto asset sellers may wish to buy crypto assets from international
providers for the purpose of market making (i.e. creating liquidity in the South
African market). For a company, the Currency and Exchanges Manual for
Authorised Dealers does not allow cross-border/foreign exchange transfers
for the explicit purpose of purchasing crypto assets, since crypto assets are
not officially recognised as legal tender in South Africa, nor have they
officially been allocated to a specific asset class. These crypto asset sellers
are left to find alternative measures to buy or obtain crypto assets. The
underlying risk is that companies are forced to come up with inventive means
to acquire crypto assets, which measures may not hold up to regulatorycompliance. The South African authorities are thus exposed to incomplete
information on the flow of funds or the movement of capital.

Consultation paper on policy proposals for crypto assets

164.2.2 Payments using crypto assets

4.2.2.1 The non-objection of crypto assets by regulators as a means of payment forthe purchase of goods and services (with or without a defined regulatory
regime), will imply the acceptance of multiple new decentralised stores ofvalue, different from ‘fiat’. Although the shifts to such crypto assets are still
negligible, larger shifts away from traditional deposits at banks to thesedecentralised stores of value may reduce a stable source of deposits forbanks, which banks generally use to augment their balance sheets in theintermediation process. The creation of competing stores of value may thus
have negative network effects. If these shifts occur to crypto asset trading
platforms that are not locally based, these impacts may be greater. These
crypto asset wallets and related stores of tokenised value would thus bedifferent from commercial or central bank money, yet perform the samefunction as deposits reserved for payment purposes. Participants wanting tooffer payment services could simply shift funds to crypto assets and thenoffer payment services, without the need to comply with any regulatory
requirements applied to fiat stores of value for payment purposes.
Consequently, the rules and requirements of current payment systems areunjustifiably circumvented due to the alternative payment system being used.

4.2.2.2 Alternate crypto asset payment systems will imply the creation of parallel
closed loop payment systems. These payment systems will conceptually
result in closed 'three-party payment systems'. Merchants will have to becontracted for multiple crypto asset wallets, potentially under various
schemes. Consumers will equally have to sign up for each of these schemes.
These competing schemes will likely not be interoperable. This could
potentially not be efficient for the system as a whole and may result in theinefficient allocation of resources at the system or national level. Allowing
these new competing crypto asset payment systems may result intransactions moving away from current national payment systems. If theseshifts happen on a large scale, this may reduce the efficiency of existing
national payment systems.

Consultation paper on policy proposals for crypto assets

174.2.2.3 Crypto assets are currently not widely accepted as a means of payment bymerchants or retailers. They have equally battled to be accepted as a meansof exchange among users. By allowing crypto assets within the regulatory
ambit, their perceived value will increase. Crypto-proponents potentiallyrequire this regulatory intervention in order for crypto assets to move beyond
being instruments of speculative investments to their initial intended purpose− a medium of exchange. Regulators thus need to reflect carefully on theappropriateness of regulatory intervention and review the unintended
consequences. Accommodative regulatory intervention will create thepotential market perception of regulatory acceptance or the endorsement ofsuch instruments.

4.2.2.4 No consumer protection exists for payments in crypto assets, and it isunclear whether payments can be reversed in cases of errors, overpayment
or even fraud. There is an increasing risk of payments being used to fundcriminal activities (e.g. increasing ransomware attacks where ransom
payment is made in crypto assets to avoid detection).

4.3

The potential benefits of crypto assets in the two use cases identified

4.3.1

Customers purchasing crypto assets could seek to diversify their investment
portfolio to an asset class that is not necessarily related to specific countryrisk. The anonymity with purchasing crypto assets is appealing to someusers who wish not to be identified. As more crypto asset sellers are able tooffer crypto assets locally, the premium paid might be reduced. Market
making may potentially increase the supply of (and the demand for) crypto
assets in South Africa, and thereby decrease the premium being paid on theinternational crypto assets price in South Africa.

4.3.2

The holders of crypto assets are able to participate in an alternative market
offering (e.g. specialised products/services where the provider only accepts
crypto assets), that is. accepting crypto assets as a medium of exchange.
Although the potential benefits of crypto assets that are related to lower

Consultation paper on policy proposals for crypto assets

18

transactional costs, greater speed and enhanced security of transactions areoften touted, actual use cases thus far are yet to demonstrate that crypto
assets payments are consistently faster, safer and cheaper than existing
options. While South Africa does not refute the potential to increase financial
inclusion both within the country and on the broader African continent,
current evidence suggests that such benefits are unlikely to be realised overthe short to medium term.

5.

Developing a regulatory response to crypto assets in South Africa

5.1

Challenges regarding regulating crypto assets

5.1.1

One of the most pertinent reasons why crypto assets are challenging toregulate is because they operate at a global level and could potentially beclassified under various economic functions. As a result, responsibility for
regulation often cuts across various different regulators and national
jurisdictions (He et al, 2016). The danger of a fragmented international
regulatory approach and national authorities reacting with varying degrees ofregulatory stringency is that crypto asset-related activities will naturally
migrate toward jurisdictions that are regulated less stringently in a ‘race tothe bottom’ – because crypto assets are borderless. A coordinated global
approach is, therefore, vital (Lagarde, 2018a). Similarly, if there is nocoherent regulatory approach at a national level, regulatory arbitrage could
challenge the effectiveness of regulatory actions. Crypto assets areborderless and their pseudonymous and anonymous nature increases thedifficulty of implementing the correct regulatory and monitoring tools.

5.2

Approaches available to regulate crypto assets

5.2.1

The most fundamental question in defining the most appropriate regulatory
approach is deciding whether crypto assets require completely new
regulation; if they should be regulated in line with existing regulations; or if

Consultation paper on policy proposals for crypto assets

19existing mechanisms should be refined to bring crypto assets into theregulatory ambit (EBA, 2014). There are accordingly two broad approaches
to regulating crypto assets (Enria, 2018):

a.

The first approach refers to regulating and restricting new products
according to existing regulations, and may in some instances evenentail outright banning. Under this approach, innovators are obliged toadapt to the prevailing regulatory environment.

b.

The second approach assumes a ‘let-things-happen’ approach,described by the Commodity Futures Trading Commission (CFTC) as
the ‘do-not-harm’ approach (Giancarlo, 2018), where the financial
sector is viewed as dynamic and the concomitant need to innovate isstrongly emphasised. The do-not-harm approach is highly cognisant of
not letting overregulation stifle innovation, and supports finding the
optimal balance between innovation, the concomitant risks and thewider safety of the financial system (He et al., 2016).

5.2.2

These two broad approaches are at opposite ends of the crypto assets
regulatory

continuum.

While

the

do-not-harmapproachencourages

innovation, it allows for the build-up of risk in the unregulated sector.
Similarly, the apparent inability of regulation to keep pace with innovation
impairs regulators’ ability to craft an appropriately agile regulatory framework(Enria, 2018). Regardless of the broad approach followed, reputational risk isa relevant risk regulators stand to incur should the selected regulatory
approach fail, followed by the risk that doing nothing may compromise theintegrity and viability of regulated financial institutions (EBA, 2014).

5.2.3

Building on these two broad regulatory approaches, Lansky (2018) provides
a useful scoring system to classify approaches to regulating crypto assets,
rating countries’ approaches on a scale of 0 to 5, with 0 denoting ‘ignoring’and 5 denoting either a full or partial ban, or integration. Table 1 below isbased on Lansky’s scoring system, with Carney (2018b) agreeing that

Consultation paper on policy proposals for crypto assets

20authorities essentially need to decide whether to isolate, regulate or integrate
crypto assets and their associated activities.

Table 1: Matrix for classifying approaches to regulating crypto assets
No. ofLevel

Description of levelcountries atthis level

Level 0: Ignoring

The government does not pay attention to 150 countries
the existence of crypto assets.

Level 1: Monitoring

An official body has released a statement

3 countries

recognising the existence of crypto
assets, but no approach to dealing withcrypto assets has been defined.
Level 2:An official body has released a statement

Recommendation

proposing an approach to deal with crypto

25 countries

assets.
Level 3: Guidance

An official body has issued guidance to

5 countries

govern the use of crypto assets.
Level 4: Regulation

Predefined conditions exist which, once

3 countries

complied with, could lead to formal
authorisation to provide crypto assetsrelated products and services.
Level 5: Ban or

A complete or partial prohibition or

integration (definitive

adoption of crypto assets. A ban may belegislation)

implemented via different forms, including

11 countries

banning banks from supporting activities

Consultation paper on policy proposals for crypto assets

21No. ofLevel

Description of levelcountries atthis level

related to crypto assets and a complete
ban on all institutions and individuals.
Adapted from Lansky, 2018

Consultation paper on policy proposals for crypto assets

22

5.3

Suggested regulatory approach to crypto assets in South Africa

5.3.1

Following the publication of the SARB’s 2014 position paper on crypto assets
and SARS’s statement on the treatment of crypto assets for tax purposes,19South Africa was classified as Level 2, as recommendations were made by
official bodies.

5.3.2

Given the related risk in crypto assets, it is proposed that South Africa moves
toahigher

level

in

2019.

In

order

to

achieveanti-money

laundering/combating the financing of terrorism (AML/CFT) requirements,
more specific requirements will be necessary in line with the recent
amendments

to

the

Financial

Action

Task

Force

(FATF)

Recommendations.20 This regulatory approach will not exactly fit into themodel created by Lansky, but a new level is proposed between levels 3 and4, namely ‘limited regulation’. At this proposed level, an official body places
specific requirements on providers of certain services in respect of crypto
assets, without setting predefined conditions for formal authorisation toprovide crypto assets-related products or services. Therefore, in terms of the
proposed level, the FIC will include crypto assets service providers as anaccountable institution and, as such, the accountable institutions will be
under legal obligation to comply with AML/CFT requirements in the FIC Act.
However, the FIC does not set predefined conditions or market entry
requirements for such business – therefore, South Africa will fall under a‘limited regulatory’ framework.

19

20

Available here.

http://www.fatf-gafi.org/publications/fatfrecommendations/documents/regulation-virtual-assets.html. It isnoted that during October 2018, the FATF adopted changes to the FATF Recommendations and Glossary thatclarify how the Recommendations apply in the case of financial activities involving virtual assets. These changes
add to the Glossary new definitions of ‘virtual assets’ and ‘virtual asset service providers’ – such as exchanges,
certain types of wallet providers, and providers of financial services for issuers’ offers and/or sale of crypto
assets. As a result of these changes, jurisdictions, including South Africa, have to ensure that crypto asset
service providers are subject to FATF requirements that are aimed at combatting money laundering andterrorist financing, for example, conducting customer due diligence, including ongoing monitoring, recordkeeping and reporting of suspicious transactions. Crypto asset providers that fall within the FATF’s definition of‘virtual asset service providers’ is proposed to be registered and subject to monitoring to ensure compliancewith these requirements.

Consultation paper on policy proposals for crypto assets

235.3.3The decision to further move to levels 4 and 5 will be considered pending
developments in the crypto asset environment and further clarity on theregulatory fit of specific crypto asset activities. South Africa thus proposes aphased and dynamic approach to progress between levels.

5.3.4

South Africa does not currently intend to ban the buying, selling or holding of
crypto assets, or to ban crypto assets for payments. However, because
crypto assets are not recognised as a currency, customers may be exposed
to harm in an unregulated environment. The decision not to ban the use of
crypto assets is, however, based on the existing landscape and current
levels of adoption, acceptance and use. South African authorities, therefore,
reserve the right to amend their policy stance should crypto assets pose amaterial risk to their respective regulatory mandates.

6.

Objectives for regulating crypto assets

6.1

The IFWG and Crypto Assets Regulatory Working Group agreed on thefollowing objectives for a crypto assets regulatory framework:

a. Ensure the safety and efficiency of the financial system and financial
institutions.
b. Ensure consumer and investor protection.
c. Minimise opportunities for regulatory arbitrage.
d. Combat the circumvention of exchange control rules and regulations.
e. Combat illicit financial flows, money laundering and the financing ofterrorism.
f.

Combat tax evasion and impermissible tax avoidance arrangements.

g. Support financial inclusion efforts and the advancement of technologicalinnovation in a responsible and balanced manner.

7.

Principles for regulating crypto assets

7.1

The regulatory response by South Africa to crypto assets will be undertaken
in line with the principles stipulated below.

Consultation paper on policy proposals for crypto assets

24

a. Risk-based approach: Regulatory actions will be undertaken in amanner and intensity that are commensurate with the level of risks posed
while balancing potential benefits, also taking into account developments
and requirements of relevant standard-setting bodies. The South African
authorities do, however, reiterate their responsibility to the safety,
stability and integrity of the wider financial system given the societal
benefits associated with ensuring such stability and integrity.

b. Technology neutral and primarily principles-based: In general terms,
principles-based regulation means moving away from reliance on
detailed, prescriptive rules and relying more on high-level, broadly statedprinciples. The term 'principles' can be used to refer to general
requirements and express the fundamental obligations that all users
should observe.21 Principles can be supported by more detailed
regulatory rules and standards, where appropriate. The regulatory
framework should also be based on the specific activity or function
performed, rather than the specific entity or the type of technology used.
The principle imperative is applied to the activity with the support ofregulatory rules and standards.

c. Unified regulatory approach: The regulatory approach adopted should
be a joint determination by all regulatory authorities impacted. This paper
aims to ensure clear and consistent regulatory treatment by relevantSouth African regulatory authorities, taking cognisance of international
approaches.

i.

Resilient and adaptive: All future amendments, guidance or new
legislation should be able to cope with rapid changes in thisenvironment.

21

J Black, M Hopper and C Band, ‘Making a success of principles-based regulation’, Law and Financial Markets
Review, 2007.

Consultation paper on policy proposals for crypto assets

25

ii.

Phased approach: A phased approach should be followed, where theregulatory treatment is timeously assessed before increased stringent
regulatory requirements are imposed.

8.

Proposals for regulatory actions for crypto assets

8.1

It is envisaged that the proposals will be implemented as appropriate by therelevant

andrespective

South

Africanregulatory

authorities,andoperationalised through the issuing of policy instruments. The proposals are
as follows:

8.2

It is recommended that crypto assets remain without legal tender status andare not recognised as electronic money either.

8.3

It is proposed that an appropriate regulatory framework is developed throughthree phases:

a. Phase 1: Registration process for crypto asset service providers.
b. Phase 2: Review of existing regulatory frameworks followed by new
regulatory requirements or amendments to existing regulations.
c. Phase 3: Assessment of regulatory actions implemented.

8.4

A useful starting point for regulatory intervention at this stage is throughregistration. The objective of the registration process is to specifically gain
further insights from the market participants. South African authorities
propose to implement the registration requirements for crypto asset service
providers, as defined below in paragraph 8.7. The phased approach, startingwith the registration requirement, could lead to formal authorisation anddesignation as a registered/licensed provider for crypto asset services
operating in South Africa at a later stage. The details of the registration
process will be set out in a policy paper to be published by the SARB in
2019. This first phase is expected to be implemented by first quarter of 2019
and the subsequent phases will follow thereafter.

Consultation paper on policy proposals for crypto assets

26

8.5

Following registration, in the second phase, authorities will assess whether
crypto asset activities could fit into existing regulatory frameworks. Where no
legal authority or mandate exists for certain crypto assets-related activities,
the regulatory framework will be assessed to determine what amendments
are required to bring the relevant activity into the supervisory ambit. Should it
be impractical to amend existing regulations appropriately, new regulations
can be drafted. The specific framework, the legislative amendments required,
the supervisory approach, the services covered and the level of protection
afforded will be addressed in this phase. Insights will be drawn from theapproach taken regarding AML/CFT requirements, ensuring consistency inregulatory consideration.

8.6

A final phase will assess the effectiveness of the regulatory actions that were
implemented and if the regulatory actions meet the intended objectives.

8.7

Registration is required for all entities performing the following crypto asset
activities:

a. Crypto asset trading platforms (or any other entity facilitating crypto asset
transactions)i.

Provide intermediary services for the buying and selling crypto
assets, including through the use of crypto asset vending machinefacilities.

ii.

Trading, conversion or exchange of fiat currency or other value into
crypto assets.

iii.

Trading, conversion or exchange of crypto assets into fiat currency
or other value.

iv.

Trading, conversion or exchange of crypto assets into other crypto
assets.

b. Crypto asset digital wallet providers (custodial wallets)

Consultation paper on policy proposals for crypto assets

27

i.

Entity offering a software program with the ability to store private 22
and public keys23 that are used to interact with various digital
protocols that enable the user to send and receive crypto assets
with the ability to monitor balances.

c. Crypto asset safe custody service providers (custodial services)i.

Safeguarding, storing, holding or maintaining custody of crypto
assets belonging to another party.

d. Crypto asset payment service providersi.

All payment services provided when using crypto assets as a
medium of exchange

8.8

It is recommended that the following entities are registered at a central point,
as stipulated by the Crypto Assets Regulatory Working Group of the IFWG:

a. Crypto asset trading platforms, and vending machine owners andproviders.
b. Crypto asset digital wallet providers.
c. Crypto asset safe custody service providers (custodians).
d. Crypto asset payment service providers.
e. Merchants and service providers accepting payments in crypto assets.

8.9

It is recommended that crypto asset service providers be required to comply
with AML/CFT provisions of the Financial Intelligence Centre Act 38 0f 2001
(FIC Act). These provisions would, among other things, require crypto asset
service providers to meet the following obligations:22

A private key is a secret number, usually a 256 bit encryption technique number, which the holder keeps
securely to allow spending (outbound).
23
A public key is a cryptographic code or number that allows a user to receive crypto assets into his account(inbound). This code is mathematically derived from the allocated private key.

Consultation paper on policy proposals for crypto assets

28

a. It is recommended that all crypto asset service providers register with the
FIC; conduct customer due diligence, including ongoing monitoring; keep
records; and file reports on suspicious and unusual transactions, cashtransactions of R25 000.00 and above and of control of property that is
linked to terrorist activity or terrorist organisations.

b. Institutions that are subject to the requirements of the FIC Act must apply
a risk-based approach in their implementation of measures to meet theserequirements. This includes the ability to distinguish between different
categories of risk and to apply enhanced customer due diligence wherebusiness with customers is deemed as higher risk and simplified
customer due diligence where business with customers is deemed aslower risk.

c. South Africa further proposes that compliance by crypto asset service
providers with obligations pursuant to the FIC Act be monitored and that
remedial actions be required of crypto asset service providers that fail tomeet these requirements. In egregious cases of non-compliance withthese requirements or in cases where remedial actions do not have thedesired effect of improving compliance with the relevant requirements,
administrative sanctions may be imposed.

8.10

South Africa proposes to continue monitoring crypto assets through the
Crypto Assets Regulatory Working Group and to define the specific focus of
crypto assets monitoring as follows:a. Monitoring the overall market capitalisation of crypto assets: As
mentioned earlier, a total global crypto assets market capitalisation of
US$1 trillion will not be considered as systemic by South Africa, but thiswill be the first level that could indicate potential significance. However,South Africa reiterates its intention to be proactive with regard to crypto
assets, and will not wait until this level is reached before it starts
preparing for the possible eventuality of crypto assets achieving systemic
significance in future.
Consultation paper on policy proposals for crypto assets

29

b. Monitoring crypto asset trading platforms domiciled in South Africa
through reporting: This will be done by monitoring issues including, but
not limited to, the flow of funds from fiat into crypto and vice versa,
functions performed, services offered, crypto

assets trading volume,

crypto assets traded, number of customers, insurance obtained,
governance mechanisms, and record-keeping of transactions. This will
include monitoring the volume and value of off-chain transactions
performed within the platform, and on-chain transactions where crypto
asset transactions involve counterparties not affiliated with the exchange.

c. Monitoring the crypto asset payment service providers and the number ofmerchants/retailers accepting crypto assets as payment both in South
Africa and internationally.

d. Monitoring the volume of crypto assets bought and sold via crypto asset
vending machines.
8.11

South African regulatory authorities propose not to impose market entry
conditions for registered entities at this stage.

9.

Conclusion and the way forward

9.1

This consultation paper sets out proposals for a policy and regulatory
response to crypto asset activities related to two identified use cases.
Subsequent to the first consultation initiative through an industry workshop,
the paper will be released for broader public comment. Upon conclusion of
the consultation phase, the regulatory authorities will specify the way forward
through a policy instrument such as a guidance note or position paper aimed
for first quarter of 2019. The remaining use cases will follow a similar
approach for review and through engagement with the industry.

9.2

The IFWG and Crypto Assets Regulatory Working Group is of the view that
regulatory action should not be delayed until the most appropriate regulatory

Consultation paper on policy proposals for crypto assets

30

approach has become clear, but to rather act and amend as innovation
evolves. The IFWG is further of the view that, for innovation to thrive, it does
not necessarily mean that lax or even no regulation should be implemented(Carney, 2018b, Werbach, 2017). “We must begin to consider the regulatory
framework of the future.” (Lagarde, 2018a, p 10).

10.

References

International Monetary Fund. 2018. What is money?
https://www.imf.org/external/pubs/ft/fandd/2012/09/basics.htm.
Oxford Dictionaries. 2018. Currency.
https://en.oxforddictionaries.com/definition/currency.

SARB. 2018. Currency management.
https://www.resbank.co.za/BanknotesandCoin/CurrencyManagement/Pages/Currenc
ymanagement-Home.aspx.

Zimmerman, M J. 2002. Intrinsic vs extrinsic value. Stanford Encyclopedia of
Philosophy. https://plato.stanford.edu/entries/value-intrinsic-extrinsic/.

Consultation paper on policy proposals for crypto assets

31Annexure A: What is money, and are crypto assets money?

In defining its policy stance on crypto assets, South Africa further considered thethree fundamental questions of (i) what is money; (ii) who issues it; and (iii) who has
the right to issue it? As a departure point for answering these questions, South Africa
first considered what crypto assets are not. To this end, South Africa considered theSouth African Reserve Bank’s (2018) definition of legal tender:

Legal tender refers to banknotes or coin that may be legally offeredin payment of an obligation and that a creditor is obliged to accept.

Of most significance in the above definition is the fact that creditors are obliged toaccept legal tender. Based on this definition, South Africa, like various othercountries,24 reiterates that crypto assets are not legal tender in South Africa.
However, it is highlighted that although crypto assets are not legal tender in South
Africa, there currently exists no prohibition preventing crypto assets from being
accepted as a means of payment.

Arguments accordingly abound as to why crypto assets do not satisfy the threecriteria for ‘money’25 as first identified by Jevons (1875), namely the need to serve asa (i) store of value;26 (ii) medium of exchange;27 and (iii) unit of account.28 South
Africa broadly agrees with this position, but qualifies its stance by noting that crypto
assets do not currently adequately satisfy the three definitional criteria of money:
crypto assets might not be a particularly good or stable store of value, but they are a
store of value nonetheless. Similarly, in selected circles, crypto assets are accepted
as a medium of exchange, while the largest crypto assets by market capitalisation,
Bitcoin, is widely used to price other crypto assets.

24

See, for example, Weidmann (2018), Poloz (2017; 2018), Wilkins (2017; 2018), Carney (2018a, 2018b),
Weidmann (2018).
25
See, for example, Bank of France (2018), Poloz (2017, 2018), Panetta (2018) and Wilkins (2018).
26
A store of value means that the instrument must hold its value over time so that people can save it and use it at
a later stage, thus allowing them to smooth their consumption over time (IMF, 2018).
27
A medium of exchange means the instrument must be accepted as payment for goods and services (IMF,2018).
28
A unit of account means that the instrument provides a common base for the setting of prices (IMF, 2018).

Consultation paper on policy proposals for crypto assets

32With regard to the extent to which crypto assets function as a medium of exchange,
the issue is more nuanced. Fundamentally, money is a social convention that is
accepted by people in the hope – or trust – that others will do so too (Carney, 2018b,
Carstens, 2018). South Africa extends this view of money as a social concept tocrypto assets, highlighting Nobel Prize laureate Professor Robert Shiller’s (2018)
observation that Bitcoin is a social phenomenon, and echoes sentiments that thecrypto assets phenomenon is as much a social one as a technological one. 29 Shoulda particular group of people – termed a society – be willing to offer and accept aparticular item as a medium of exchange, that item will essentially become acurrency or medium of exchange within that society. With crypto assets, however, thesociety within which a particular crypto asset could gain prevalence is likely to bedispersed across the globe. In this regard, South Africa maintains that the extent towhich crypto assets will become widely accepted as a medium of exchange within
the wider, global society still remains to be seen.

South Africa is therefore of the view that crypto assets do not constitute money as
per the traditional definition of the word, but may at times perform certain functions
akin to those of money, albeit imperfectly so at the current conjuncture. Crypto assets
may also function as securities, assets or commodities, and the regulatory
challenges associated with this cross-cutting nature are accordingly considered andclarified in this paper.

29

See Reijers and Coeckelbergh (2016) for a more detailed discussion on the social aspect of crypto assets.

Consultation paper on policy proposals for crypto assets

33