Regulation
Stabilizing the Cryptocurrency Frontier: UAE’s Groundbreaking Stablecoin Regulations
The UAE has quickly positioned itself as a key player in the global virtual assets market, setting a benchmark with its forward-thinking regulatory frameworks.
In this article, Akshata Namjoshi, Kabir Kuma and Ahlam Faouzi from KARM Legal Advisorslaw firm specializing in emerging technologies, provides an in-depth analysis of the UAE’s regulatory landscape for stablecoins.
The UAE has positioned itself at the forefront of the global virtual asset industry, becoming a pioneering jurisdiction in developing comprehensive virtual asset regulations. This progressive approach has culminated in the establishment of the world’s first dedicated virtual asset regulator, the Dubai Virtual Asset 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 lower volatility than other virtual assets, serving as a reliable transfer of value within the virtual asset market.
They offer a stable counterweight to more volatile cryptocurrencies and are often used as a mechanism to liquidate investments in virtual assets. Stablecoins are also increasingly being explored for use in payments due to their stability and efficiency.
The UAE’s regulatory framework is robust and detailed, with key regulatory bodies such as the Financial Services Regulatory Authority (FSRA) In Abu Dhabi Global Market (ADGM), THE Dubai Financial Services Authority (DFSAF) In Dubai International Financial Centre (DIFC) and VARA, all three implement specific regulations governing virtual assets and stablecoins.
The Central Bank of the United Arab Emirates (CBUAE) has recently published the Regulation on Payment Token Services pursuant to Circular 2/2024 (Payment token Services Regulation), which establishes 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 a leader in the industry. The FSRA, the regulatory arm of ADGM, 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 Guidance on the Regulation of Virtual Asset Activities in ADGM.
The UAE FSRA recognizes three primary stabilization mechanisms for stablecoins. First, there are fiat tokens where the issuer maintains fiat currency reserves 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, similar to central bank monetary policy.
Currently, the FSRA only allows fully backed 1:1 fiat tokens, which requires 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, 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) license.
Fiat Token Related Activities
The conduct of specific activities in relation 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 both virtual assets and fiat tokens must obtain a specific custody license, including virtual assets. Custodians that handle exclusively fiat currency and related fiat tokens require a custodial license with additional requirements for governance and technology reconciliation.
Authorised multilateral trading facilities (MTF (Multilateral Trading Facility)) that use 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 that use third-party issued fiat tokens must perform token due diligence, focusing on technology governance, reporting and reconciliation.
DIFC
VASPs in the DIFC are regulated by the DFSA, which introduced its crypto token regime on 1 November 2022. Unlike the FSRA, the DFSA does not explicitly allow the issuance of stablecoins, but does recognise 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.
Fiat Crypto Token Activities
Since fiat crypto tokens fall under the scope of crypto tokens, conducting business in relation to fiat crypto tokens is subject to the same licensing requirements as crypto tokens. The exact licensing category differs based on the business being conducted (e.g., asset management, investment dealing as an agent or principal, providing custody, etc.).
In relation to the provision of money services, the DFSA has allowed the use of fiat cryptographic tokens for the purpose of transmitting money or executing a payment transaction. However, the use of fiat cryptographic tokens is limited to facilitating the technological side of the business and supporting back-office operations. For example, a money services business may use fiat cryptographic tokens for internal settlements between branches.
The DFSA only allows financial services related to recognized crypto tokens. An application for recognition can be made 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
The recent changes to the DFSA criteria for the recognition of fiat crypto tokens, effective from 3 June 2024, have introduced greater flexibility by removing specific requirements on the proportions of capital reserves. Instead, emphasis has been placed on ensuring that reserves are held in assets that are likely to retain their value (including during periods of stress), are highly liquid, appropriately diversified and carry minimal credit risk.
Additionally, the DFSA has revised the definition of fiat crypto tokens, now requiring them to 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 experience.
CBUAE – Payment Token Services Regulation
THE Payment Token Services Regulation of CBUAE is based on the Regulation on retail payment services and card schemes (RPSCS Regulation), which initially set the regulatory framework for licensing payment token services. The timing of this regulation is significant as it comes as VASPs look for jurisdictions with clear regulatory frameworks that can address their specific services and activities. The introduction of the regulation coincides with the EU’s MiCA regulations on stablecoins, which also came into force recently, which require licensing and set a regulatory framework for stablecoin issuers within the EU. Therefore, by issuing this regulation, the UAE is positioning itself as a leading jurisdiction in the cryptocurrency and virtual asset space.
In the new framework, a “payment token” is defined as a virtual asset (IT GOES) 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 classified into three main activities: Issuance of Payment Tokens (Issuance), Conversion of Payment Tokens (Conversion) and Custody and Transfer of Payment Tokens (Custody and Transfer). Individuals or entities wishing to provide or promote any of these services within the UAE must obtain a license from the CBUAE.
Foreign companies, including those registered in financial free zones, may apply for registration to issue Foreign Payment Tokens. Onshore licensed VASPs authorized by the Securities and Commodities Authority ((SCA) o VARA may require registration without objection (NEITHER) to provide payment token services. For example, a licensed VA exchange platform operator may apply for a NOR to perform conversion, and a licensed VA custody service provider may apply for a NOR to perform custody and transfer, although limited to foreign payment tokens.
Additional considerations include that Payment Token issuers must not offer interest or benefits related to the duration for which a customer holds a Payment Token. The CBUAE may also impose restrictions on the volume or value of Payment Tokens that may be exchanged or the total number of customers that a licensee or registered entity may onboard.
In addition, the CBUAE may designate certain VAs as payment tokens subject to specific restrictions. In terms of payments to merchants, 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 derivatives.
Conclusion
The UAE’s strong and progressive stance on stablecoin regulation underscores its global leadership in the virtual asset space. Through detailed frameworks in ADGM, DIFC, VARA and CBUAE, the nation aims to strengthen market confidence, promote investment liquidity and foster digital payment innovation. It will be interesting to watch how the mixed regulatory oversight models of VARA and CBUAE play out in this dynamic landscape.