Regulation
Stabilizing the Cryptocurrency Frontier: UAE’s Groundbreaking Stablecoin Regulation
The United Arab Emirates has quickly positioned itself as a key player in the global virtual asset market, setting a benchmark with its forward-thinking regulatory frameworks.
In this article, Akshata Namjoshi, Kabir Kuma and Ahlam Faouzi Since KARM Legal Advisorsthe emerging technology-focused law firm provides an in-depth analysis of the UAE regulatory landscape for stablecoins.
The UAE has positioned itself at the forefront of the global virtual asset sector, becoming a pioneering jurisdiction in developing comprehensive regulations for virtual assets. This progressive approach has resulted in the creation of the world’s first virtual asset-specific regulator, the Dubai Virtual Assets Regulatory Authority (VARA).
Stablecoins are blockchain-based tokens pegged to fiat currencies or a basket of assets, designed to minimize volatility and serve as a reliable transfer of value within the virtual asset market. These tokens are designed to exhibit less volatility compared to other virtual assets, serving as a reliable transfer of value within the virtual asset market.
They provide a stable counterbalance to more volatile cryptocurrencies and are often used as a mechanism to liquidate investments in virtual assets. Additionally, stablecoins are increasingly being explored for use in payments due to their stability and efficiency.
The UAE’s regulatory framework is robust and comprehensive, with key regulatory bodies such as the Financial Services Regulatory Authority (Transportation Safety Regulatory Agency (TSRA)) In Abu Dhabi Global Market (ADGM), THE Dubai Financial Services Authority (DFSA) In Dubai International Financial Center (DIFC) and VARA, both of which implement specific regulations governing virtual assets and stablecoins.
The Central Bank of the United Arab Emirates (CBUAE) recently published the Regulation on Payment Token Services under Circular 2/2024 (Payment token Services Regulation), establishing a comprehensive regulatory framework for payment tokens.
ADGM
ADGM was one of the first jurisdictions to introduce comprehensive regulation for virtual assets, positioning itself as an industry leader. The FSRA, ADGM’s regulatory body, has established a detailed framework for the regulation of virtual asset service providers (VASP) within the financial free zone. The FSRA’s position on stablecoins is articulated in its Guide on the Regulation of Virtual Asset Activities in the ADGM.
The UAE FSRA recognizes three main stabilization mechanisms for stablecoins. First, there are fiat tokens where the issuer maintains reserves of fiat currency equivalent to the value of the tokens issued. Second, diversification or basket tokens peg their value to a diversified portfolio of assets including virtual assets, commodities, fiat currencies, and other financial instruments. Third, algorithmic tokens manage their token supply through algorithms designed to stabilize value, resembling central bank monetary policy.
Currently, the FSRA only permits fully collateralized 1:1 fiat tokens, which require each token to be backed by an equivalent amount of fiat currency. Compliance with regulatory requirements for financial services involving fiat tokens varies depending on the specific nature of the services or activities provided.
A unique feature of the FSRA regulatory framework is the regulation and licensing of the issuance of fiat tokens. The FSRA treats fiat tokens as digital representations of money and as a mechanism for storing value. Therefore, the issuance of fiat tokens, intended for use in the virtual asset ecosystem and/or as a means of payment, is subject to a Money Services (Issuance and Sale of Stored Value) Licence.
Fiat Token Related Activities
The conduct of specific activities related to fiat tokens is subject to separate licensing requirements. The FSRA has outlined several scenarios involving fiat tokens, providing specific regulatory approaches for each.
Custodians offering custody services for virtual assets and fiat tokens must obtain a specific license for custody, including virtual assets. For custodians that exclusively handle fiat currency and associated fiat tokens, a custody license is required with additional requirements for technology governance and reconciliation.
Agreed Multilateral Trading Facilities (MTF) using their own fiat tokens as payment mechanisms within their platforms do not require an additional license, provided that the tokens remain within the platform, subject to reconciliation requirements. MTFs using fiat tokens issued by third parties must conduct due diligence on the tokens, focusing on technology governance, reporting and reconciliation.
DIFC
DIFC VASPs are regulated by the DFSA, which introduced its crypto token regime on 1 November 2022. Unlike the FSRA, the DFSA does not expressly authorise the issuance of stablecoins but recognises fiat crypto tokens issued in other jurisdictions. Fiat crypto tokens have been defined as crypto tokens that stabilise their price or reduce the volatility of their price by pegging it to a single fiat currency.
Activities related to fiat crypto tokens
Since fiat crypto tokens are covered by the crypto token category, activities related to fiat crypto tokens are subject to the same licensing requirements as crypto tokens. The exact licensing category differs depending on the activity being carried out (e.g. asset management, trading in investments as an agent or principal, providing custody services, etc.).
With respect to the provision of money services, the DFSA has authorized the use of fiat crypto tokens for the purpose of transferring money or executing a payment transaction. However, the use of fiat crypto tokens is limited to facilitating the technology side of the business and supporting back-office operations. For example, a money services business may use fiat crypto tokens for internal settlements between branches.
The DFSA only authorizes financial services related to recognized crypto tokens. An application for recognition can be submitted by an existing licensee, an applicant, or the token issuer. For fiat crypto tokens, the DFSA has prescribed additional requirements for token recognition.
Recent changes
Recent amendments to the DFSA’s fiat crypto token recognition criteria, effective from 3 June 2024, have introduced greater flexibility by removing specific requirements relating to reserve asset proportions. Instead, the focus has been on ensuring that reserves are held in assets that are likely to retain their value (including in times of stress), are highly liquid, appropriately diversified and carry minimal credit risk.
In addition, the DFSA revised the definition of fiat crypto tokens, now requiring that they be pegged to a single fiat currency. This change was made to mitigate the increased risks associated with multi-currency pegs, based on market and regulatory experiences.
CBUAE – Regulation of Payment Token Services
THE Regulation on payment token services by the CBUAE is based on the Regulation on Retail Payment Services and Card Schemes (RPSCS Regulations), which initially set out the licensing framework for payment token services. The timing of this regulation is significant as it comes at a time when VASPs are looking for jurisdictions with clear regulatory frameworks that can accommodate their specific services and activities. The introduction of the regulation coincides with the EU’s MiCA regulation on stablecoins, which also recently came into force, requiring licensing and establishing a regulatory framework for stablecoin issuers within the EU. Thus, by issuing this regulation, the UAE is positioning itself as a leading jurisdiction in the cryptocurrency and virtual asset sector.
Under the new framework, a “payment token” is defined as a virtual asset (Virginia) which aims to maintain a stable value by referencing the same fiat currency in which it is denominated, or another payment token denominated in the same fiat currency.
There are two main categories of payment tokens:
“Dirham payment tokens”, which refer to the value of AED, and “foreign payment tokens”, such as USDT and USDC, which refer to USD. “Payment token services” are categorized into three main activities: the issuance of payment tokens (issuance), the conversion of payment tokens (conversion) and the custody and transfer of payment tokens (custody and transfer). Persons or entities wishing to provide or promote any of these services in the UAE must obtain a license from the CBUAE.
Foreign companies, including those registered in financial free zones, can apply for registration to issue foreign payment tokens. Onshore-licensed VASPs licensed by the Securities and Commodities Authority ((SCA) or VARA may request a no-objection registration (NEITHER) to provide payment token services. For example, a licensed VA exchange platform operator may request a NOR to perform a conversion, and a licensed VA custody service provider may request a NOR to perform a custody and transfer, although limited to foreign payment tokens.
Other considerations include that payment token issuers must not offer any interest or incentives related to the length of time a customer holds a payment token. The CBUAE may also impose restrictions on the volume or value of payment tokens that can be traded or the total number of customers that a licensee or registered entity can onboard.
In addition, the CBUAE may designate certain VAs as payment tokens subject to specific restrictions. In terms of merchant payments, UAE merchants may only accept dirham payment tokens from licensed issuers, while foreign payment tokens from registered issuers may only be accepted for the purchase of VAs and VA-derived products.
Conclusion
The UAE’s strong and progressive stance on stablecoin regulation underscores its global leadership in the virtual asset sector. Through detailed frameworks across the ADGM, DIFC, VARA and CBUAE, the nation aims to build market confidence, promote investment liquidity and foster digital payment innovation. It will be interesting to observe how the VARA and CBUAE’s mixed regulatory oversight models unfold in this dynamic landscape.