BY JOSH BHAGEERUTTY, PARALEGAL
A trust is a legally binding arrangement whereby a person (the settlor) transfers legal ownership of property to certain chosen persons (trustees) to be held for the benefit of persons named or defined by the settlor (the beneficiaries)[1]. In our rapidly evolving or transformative market, of paramount concern is whether virtual assets can be classified as property capable of being held in trust.
In AA v Persons Unknown [2019] EWHC 3556 (Comm), the High Court of England and Wales concluded that crypto assets such as Bitcoin are property. Similarly, in the leading New Zealand case, Ruscoe v Cryptopia Ltd (in Liquidation) [2020] NZHC 728, the New Zealand High Court held that cryptocurrencies were “property” within the definition in section 2 of the Companies Act 1993 and also probably more generally at common law. Therefore, the High Court concluded that cryptocurrencies, as property, could form the subject matter of a trust and may be held as investments. However, since virtual assets are not yet regulated in many jurisdictions, and there is little authoritative guidance in this sphere, this may lead to several problems.
What is a Virtual Asset?
The Financial Action Task Force (FATF) defines a virtual asset as a digital representation of value that can be digitally traded or transferred and used for payment and investment purposes. This definition excludes the digital representation of currencies, securities, and other financial assets already covered elsewhere by the relevant laws.[2] Notably, cryptocurrencies such as Bitcoin, Litecoin, Ethereum, etc., are virtual or digital currencies wherein transactions are secured using computerized databases or a well-defined and decentralized network or system. This pool of technology may include cryptography, public key, private key, blockchain, or mathematical function. A blockchain network serves as a public financial transaction database to track orders, payments, accounts, production, etc.[3]
What is a VASP?
FATF defines a Virtual Asset Service Provider (VASP) as any natural or legal person who, as a business, conducts one or more of the following activities or operations for or on behalf of its clients[4]:
• The exchange between virtual assets and fiat currencies.
• Exchange between one or more forms of virtual assets.
• Transfer of virtual assets.
• Safekeeping and/or administration of virtual assets or instruments enabling control over virtual assets.
• Participation in and provision of financial services related to an issuer’s offer and/or sale of a virtual asset.
Risks Involved and the Importance of Regulation
Similar to any new phenomenon, virtual assets have challenges that give rise to the need for legal regulation. The decentralized and anonymous nature of crypto assets can lead to various problems, and can be exploited for illegal purposes. The technological complexities and lack of authorized information may result in common issues such as market manipulation and price volatility. Therefore, it is imperative to place new regulations to safeguard investors.
Moreover, there exist several types of cryptocurrencies in this digital world. Traders should be safeguarded by regulating the market and requiring all crypto-related information to be disclosed regarding their performance. Likewise, these new technological inventions are not immune from online fraud and risk related to cyber security due to the complications involved.
The biggest challenges around the use of virtual assets in an unregulated economic system include preventing money laundering, terrorist funding and tax evasion schemes. Consequently, there is an emerging need to regulate so terrorists and criminals cannot exploit the regulatory gaps. This includes imposing new legislative requirements and building the foundations of a virtual asset compliance program.
Risk-based Approach to Regulation
In line with the FATF recommendations, countries need to assess and mitigate the risks associated with virtual asset financial activities and VASPs and subject them to supervision or monitoring by competent national authorities. It is recommended that VASPs should be licensed or registered to ensure that there is precise information on who are the beneficial owners of a VASP, the individuals having a significant or controlling interest, or holding a management function. As such, identifying the beneficial owners will prevent criminals or their associates from being involved in the structure of a VASP. Persons carrying out VASP activities without a proper license or registration should be subject to appropriate sanctions.
It has been suggested that VASPs should be subject to adequate supervision or monitoring by regulators. These regulators should also issue guidelines and provide feedback to help VASPs. Additionally, they should be empowered to impose proportionate and dissuasive sanctions.
It has also been proposed that, similar to other financial institutions, VASPs should be required to design and implement compliance programmes to identify and, accordingly, deal with the risks involved in virtual asset economic activities. Firstly, VASPs should complete a risk assessment of their client base. Once the risk assessment is complete, VASPs should implement appropriate onboarding policies and procedures that include KYC, AML, and CTF screening and monitoring.
In line with these suggestions, recommendations for VASPs include conducting customer due diligence on occasional transactions above USD/EUR 1000 before establishing a business relationship, to verify the customer’s identity and to identify the beneficial owner – focusing particularly on sanctions, enforcements, adverse media, state-owned entities, and politically exposed person status. In higher-risk situations, enhanced due diligence should be undertaken.
In addition, ongoing due diligence of the customer relationship should be performed on a continuous and regular basis or in related to specific transactions, when necessary, in order to scrutinize transactions, identify changes to customer profiles and mitigate risks. Proper record keeping should be maintained, transactions monitored, and suspicious transactions reported to the authorities, just as for standard financial institutions. VASPs should also have a framework to obtain, hold and securely transmit originator and beneficiary information when making transfers. Furthermore, they should be entitled to take freezing action and prohibit transactions with designated persons and entities.
Implementing recommendations such as these is an important step towards bringing VASPs into the financial mainstream and ensuring that they operate on a level playing field in compliance terms with more traditional financial service providers.
[1] The FindLaw Team, Thomson Reuters (2022).
[2] Glossary of the FATF Recommendations.
[3] Dr. Himani Sardar, Prof Chavi Sood “Cryptocurrency regulation: Need of the hour” vol 2 issue 1, Jan- Mar 2022.
[4] Glossary of the FATF Recommendations.
