Wither the Regulatory Framework on Cryptocurrency?

Nancy Ezeonugo, a legal practitioner and investment banker, writes that there should be a framework where cryptocurrency is guided in Nigeria to be a unit of account, store of value and medium of exchange

Fintech and cryptocurrencies which is a digital asset/currency designed to work as a medium of exchange that uses cryptography to secure its transactions, to control the creation of additional units, and to verify the transfer of assets – most notably Bitcoin and Ether in particular present enormous and limitless opportunities. With a growing acknowledgment and acceptance of the technology in Nigeria - both as new and valuable technologies as well as potentially lucrative investment vehicles, it is now apparent that regulators such as the Central Bank of Nigeria (CBN) have taken notice. But what is the opinion of the Nigerian Securities and Exchange Commission (SEC)?

It would be injustice on my part if I fail to mention that the Bitcoin is the perfect symbol of cryptocurrencies as cryptocurrency is the insignia of block-chain technology. With a market capitalization of $284 billion and a current price above $19,000, Bitcoin remains the lion in the jungle of cryptocurrencies. Bitcoin at its core is based on a concept called the block-chain. And for many, it is this concept which is far more interesting than Bitcoin in itself. Further, a block-chain is by its very nature a safe record of things which is very hard to manipulate. The technology can be used across boards like smart contract, e-voting, identity management, healthcare amongst others.

Given the increasing demand for cryptocurrencies, it is no surprise that market participants are responding and racing to satisfy that demand by producing more of such currencies or so-called tokens representing the currencies. Additional digital currencies, or to be precise the tokens representing interests in such currencies, are produced and disseminated by a process colloquially known as an “Initial Coin Offering” or “ICO,” not coincidentally a term which is similar to the better-known term Initial Public Offering (IPO). The agreement to formally adopt the use in Nigeria by the CBN and the call by the Fintech Association of Nigeria confirms this and it is expected that a regulatory framework for same will be made available, but an exact time or date for its availability is not certain. Cryptocurrencies have a distributed and decentralized nature; granting transactions to be made without intermediaries and giving the players control over their money. Does it then imply that it cannot and should not be regulated?

Central to the availability of the regulatory framework and the threshold question of whether the SEC whose power is derived from the Investment and Securities Act (ISA) has jurisdiction to regulate these activities is the question of whether the token in question is a “security” as defined in the ISA and whether the offer, sale and distribution of such a token (such as via an ICO) would be deemed as an initial offering of a security. A look into the definition of securities in Section 315 of ISA of 2007 does not seem to capture any point on cryptocurrencies as provided below;

“Securities” mean-

(a) Debentures, stocks or bonds issued or proposed to be issued by a government;

(b) Debentures, stocks, shares, bonds or notes issued or proposed to be issued by a body corporate;

(c) Any right or option in respect of any such debentures, stocks, shares, bonds or notes; or

Commodities, futures, contracts, options and other derivatives, and the term securities in this Act includes those securities in the category of the securities listed in a (a) - (d) above which may be transferred by means of electronic mode approved by the Commission and which may be deposited, kept or stored with any licensed depository or custodian company as provided under this Act.

In a statement on Cryptocurrencies and Initial Coin Offering by the U.S Securities and Exchange Commission Chairman, Jay Clayton on the 11th of December 2017the U.S SEC has concluded that in many instances a cryptocurrency token in fact would meet the legal definition of a security and thus be subject to its jurisdiction. Therefore, the offer or sale of such a security also must comply with the federal securities laws, which appears to be independently adopting a similar approach as to Canada’s approach, which was released on the 24th of August 2017. Can this be the same position for Nigeria?

The statement also mentioned that the U.S SEC’s legal analysis relies on a traditional analysis of the definition of a security under the “investment contract” test and whether the tokens in question met that definition. They reaffirmed the fundamental principle under this test that the “hallmark of a security is an investment of money or value in a business or operation where the investor has a reasonable expectation of profits based on the efforts of others” and noted that anyone who solicits something of value in exchange for an interest in a digital or other novel form of storing value, such as a cryptocurrency, should carefully consider whether they are creating an investment arrangement that constitutes a security.

They further explained that not only must any offer and sale of such a security comply with the fundamental registration and disclosure requirements under the Securities Act of 1933, but market participants must also consider other aspects of the federal securities laws if they conclude that the assets in question meet the definition of a security.

According to the U.S SEC, additional potential obligations include the following:

If a platform facilitating transactions in such securities is operating as an “exchange,” the platform may require registration as an exchange or “alternative trading system” under the United States Securities Exchange Act of 1934.

If a person facilitates the purchase and sales of the token, in either the primary or secondary markets, the person may need to register as a broker-dealer under the United States Securities Exchange Act of 1934.

If the composition of assets of the entity offering and selling the security causes it to meet the definition of an “investment company,” even if inadvertently or temporarily, the entity may require registration under the United States Investment Company Act of 1940.

If a person provides advice about an investment in the security, that person may be deemed an “investment adviser” and may need to register as such under the United States Investment Advisers Act of 1940.

With the above reference points made by the U.S. SEC and Canada’s approach, the Nigerian regulators may want to take into consideration the above mentioned approach and additional potential obligations of the regulators in Nigeria. Can the laws governing the Capital Market operations in Nigeria provide for this development? Will this regulatory framework open the door for this investment to develop in a properly regulated manner?

With an unclear regulatory stance on cryptocurrencies in Nigeria and the constant delay being exhibited by the CBN in releasing regulations, it remains unseen how Nigeria expects to positively utilize the cryptocurrency. The ownership or possession of Bitcoin, Ethereum or related cryptocurrencies is therefore not illegal in Nigeria as at the date of this publication.

The regulatory framework is needed to protect consumers and the wider financial system. Therefore, Bitcoin and other cryptocurrencies should not remain in a legal vacuum without the appropriate supervision.

My Take

If the original concept as it is being said in some quarters is that “Bitcoin is to eventually replace Fiat currency” and with buyers and owners of Bitcoin holding it or even hoarding as against using it as a means of payment, then that might just be the reason why the price has skyrocketed.

When the primary motivation on a currency is to “hold” instead of deploying it as a “means of payment or exchange”, then equilibrium-value point would have a deflection. Over time, the value becomes speculative instead of being driven merely by the forces of demand and supply.

I would be open to a SEC framework where the Cryptocurrency is guided in Nigeria to be a unit of account, a store of value and a medium of exchange.