Crypto

Definition

A digital asset that is designed to work as a medium of exchange that uses cryptography to secure financial transactions, control the creation of additional units, and verify the transfer of assets.

Treatment of Crypto within the CEG Ecosystem

The Operator shall not be allowed to make use of Crypto in the offering of B2C Services to End Users without explicit approval in writing by CEG. Failure to have obtained such approval shall qualify as a Material Breach.

Under the section “Crypto Compliance” with Annex 1 to the IP-agreement the operator can find status of approval at this time.

If unmarked, the use of Crypto has not been authorized

If marked “PSP”, CEG shall only follow the crypto compliance policies of the (accreditable tier I/II) payment service provider. No proprietary policies are allowed.

If marked “Proprietary”, CEG may allow proprietary crypto compliance policies, subject to explicit approval by CEG.

More on Crypto

Compared to conventional money, crypto assets have only been around for just a little while. Nevertheless, they have rapidly established themselves as a reliable method of payment within the gaming community and beyond. Nevertheless, from a regulatory perspective, the journey has barely started. In this chapter, we shall discuss the global trends in the development of regulatory frameworks pertaining to crypto assets. Will authorities ever agree on a global legal definition of crypto assets? Why would it be important to find consensus? Will crypto payments become the new standard and perhaps even replace conventional money? Do current regulations suffice? Is it essential for these purposes to introduce a new regulatory framework, specifically tailored to accommodate crypto compliance?

The search for a global legal definition

The global community has yet not been able to reach consensus on a legal definition for crypto. In the Netherlands, for example, the Bitcoin, a well-known crypto asset, often referred to as a cryptocurrency is from a legal viewpoint not necessarily qualified as a currency, but rather as a medium of exchange, with its own intrinsic value. Some even call it Digital Gold. Bitcoins are governed by a design decision by the developers of the core technology to limit its production to a fixed amount, namely 21 million tokens. An appeals court in the Netherlands indeed ruled that Bitcoin is indeed not a digital currency:

“Bitcoin is the peer-to-peer network that maintains a decentralized ledger - “the blockchain”. A “bitcoin” is the digital currency that is sent via the Bitcoin network. The addresses to which bitcoins are sent consist of a unique series of numbers and letters. An overview of all generated addresses and transactions is kept in the blockchain. The Bitcoin protocol is designed in such a way that miners (people who make computer power available to check the validity of transactions) can be rewarded with a number of bitcoins for their work on the validity of those transactions”.¹

Essential for this ruling is that the court deems it important that the Bitcoin cannot be made available without the allocation of resources (man hours, electricity).

In its ruling to date July 24th, 2020, the U.S. District Court reached just the opposite conclusion. This court ruled that the function that Bitcoin has in ordinary society should be compared to the function of money. The U.S. court, in short, looked up the definition of money in several dictionaries and compared if the functionality of money was comparable to the functionality of the Bitcoin:

“Any generally accepted medium of exchange which enables a society to trade goods without the need for barter; any objects or tokens regarded as a store of value and used as a medium of exchange.” [...] “Money is also often “regarded as a store of value.” [...] “Bitcoin is just that — a medium of exchange, method of payment, and store of value.” [...] “Bitcoin can be used to pay for goods or services.”

In other words: Bitcoin equals money in the view of this court as it can be used to “pay for things”.²

The latter does not sound very convincing to us, as it does not reconcile the essential difference between Bitcoin and money, namely the economic efforts locked up in the Bitcoin, necessary to mine it. Let alone the essential economic characteristic of scarcity. Bitcoin miners receive Bitcoins as a reward for completing "blocks" of verified transactions which are added to the blockchain. The mining of cash, however, does not exist. That is, if one does not include the act of counterfeiting, which would not meet the definition of mining anyway, as the act is aimed at producing a fake.

The highly volatile nature of traditional crypto assets that are not state-backed (which would potentially make it possible to label the asset as a currency) makes it very hard for those assets to become more widely adopted.³ Central banks therefore usually refrain from using the term cryptocurrencies to refer to these crypto assets all-together.⁴ We also rather speak of crypto assets, as a state-backed currency shall always qualify as an asset, but an asset does not always qualify as currency.

Could the end result of these tests differentiate between various types of crypto assets? Not really. The Venezuelan (state-backed) Petro⁵ , for example, has (allegedly) been 100% pre-mined by its government, meaning that new tokens could not be created after its launch, which would guarantee the presence of the economic principle of scarcity, hence an intrinsic value. Crypto assets, in principle, always have intrinsic value.

A globally agreed upon definition of crypto assets is essential for compliance purposes

Why is it at all important how crypto assets are qualified? There are several reasons, of which by far the most important would be, that without a global unified regulatory framework, it shall be impossible to come to a proper cross-border enforcement. Members of the Venezuelan government (allegedly) designed the Petro to circumvent U.S. sanctions, specifically tied to the control of the flow of money in and out of sanctioned countries.⁶

At the start of 2020, over 5,100 crypto-assets existed with a total market capitalization exceeding $250 billion.⁷ The ongoing COVID-19 pandemic has furthermore accelerated the development of digital assets as a currency by central banks in an attempt to motivate the world population to turn to cashless payments. These developments help chipping away the influence of institutions around the world. An inviting prospect to countries that seek immunity from the world powers that be. Having independence sounds appealing. However that perspective might change if that same strive for independence is pursued by rogue states seeking new means to finance terrorism. Such diversity would make a global attempt to effectively combat money laundering and the financing of terrorism impossible.

Another reason to aim for one global unified understanding of crypto would be the need for consistency on how to treat crypto assets within the conventional understanding of finance, taxation and privacy regulations. After all, institutions maintaining the stability of the international markets are built and are relying on rules and regulations that have been designed to regulate conventional payment methods. If payment via crypto assets would become mainstream, these rules and regulations may no longer match, as the differences between conventional currencies and crypto assets are simply too substantial. Nevertheless, legislators have been seeking ways to fit in crypto payment methods in existing legislation. We however feel that these efforts, in time, shall be certain to fail.

In its judgment to date October 22nd, 2015, the EU Court determined that non-traditional currencies, defined by the EU Court as: “currencies other than those that are legal tender in one or more countries, in so far as those currencies have been accepted by the parties to a transaction as an alternative to legal tender and have no purpose other than to be a means of payment, are financial transactions.”⁸

The compensation received is the actual equivalent for the service provided. As a result, the EU Court has ruled that Bitcoin should be treated equally as any conventional currency. Hence, Bitcoin transactions have been exempted from Value Added Tax (“VAT”), as it falls within the exemption of Article 135 paragraph 1 under e of the VAT Directive (2006/112/EU)|. Although not deemed by the EU Court equal to money, it is treated as such, thus creating a special status for this form of payment. As mining Bitcoins would not be the same as trading Bitcoins, the next legal question is already on the table whether or not miners should be allowed to deduct VAT paid on resources necessary to mine.⁹

Again - in essence this judgement has been a prequel to the ruling of the U.S. District Court that we touched on - this criterion does not seem viable, as it just compares more advanced forms of payment, to conventional, less advanced payments methods, such as payments in cash. The test wrongfully assumes that classic financial cash transactions would not be subject to evolution. Good old cash does not hold any intrinsic options. It needs banks and other institutions in order to be properly regulated. It cannot hold any information on its current, previous or future bearer. Hence, questions need to be answered whenever a transaction seems to be unusual and even then, the regulatory framework is not ideal and has many flaws.

Out with the old?

What if mainstream methods of payment, as a standard, would in itself be able to generate additional information that could be used for enhanced functionalities, related, however not essential to the payment itself? Would that not be preferable to the current system?

Lithuania’s Central Bank, for example, has been developing the “LBCOIN” as part of its trial of blockchain technology and digital currencies. Meant as an experiment, rather than an actual method of payment, each token features a portrait of one of the 20 signatories of Lithuania's declaration of independence signed in 1918, which have been divided into six categories: priests, presidents, diplomats, industrialists, academics, and municipal aides. Collectors are able to trade tokens then exchange a specific set for a physical silver coin worth € 19.18. The experiment is meant to engage more people, especially the youth, in coin collecting while gaining valuable experience and knowledge in the field of digital currencies.

The LBCOIN is an example of a crypto asset with an enhancement for cultural purposes attached to it.¹⁰ It is just one example. The possibilities are endless. What if payment methods could even be tailored to specific business branches?

Enhancing markets by payment methods tailored to specific business branches

KODAKCoin is designed as a photographer-oriented blockchain cryptocurrency, that is planned for payments for licensing photographs. It offers a so-called post-licensing solution for intellectual property. It directly ties users of copyright protected images to its legitimate owners, hence it is called post-licensing. It uses web crawlers to identify intellectual property licensed to the KodakOne platform, an ingenious method of enhancing copyright protection and at the same time stimulating trade in copyright protected imaging.

Crypto assets can also resemble regulated financial instruments

How to deal with crypto assets that would share characteristics with conventional financial instruments as defined in the Markets in Financial Instruments Directive (2004/39/EC, currently: MiFID II)? A stablecoin is designed to minimize the volatility of its price, relative to some "stable" asset or basket of assets. It can be tied to money or exchange-traded commodities (such as precious metals or industrial metals). As its value is derived from the performance of an underlying entity, it essentially qualifies as a derivative, a (regulated) financial instrument as defined in MiFID II.

Towards a sustainable regulatory future: the Crypto Directive

The point that could be made here, is that the courts cannot go on comparing enhanced future assets to conventional assets that they would be familiar with. The world has changed. Crypto assets require a new take, a fresh regulatory perspective.

The world might have to get used to the fact that conventional money trails will not be able to effectively safeguard against money laundering. As services become increasingly complex, methods of payment for such services should enhance as well. Crypto assets would be suitable, however their nature does not allow for centralized oversight by for example banks as the information on transactions will be processed, not on a centralized level but within the (decentralized) ledgers. Also, it cannot be regulated by rules and regulations that have been tailored to regulate money transactions, as crypto assets have their own, intrinsic value. They represent means of exchange.

With a Crypto Directive, EU Member states would be able to respond to the regulatory winds of change. The community would acknowledge that paying with means of exchange rather than with money will, in time, be much easier and safer, provided that proper quality standards for crypto currencies will be introduced. The LBCOIN, as mentioned, has a cultural upside but nothing prevents at this time the introduction of crypto assets that could be specifically tailored to facilitate the financing of terrorism.

When properly regulated, as said, the possibilities would be endless. Crypto assets could even be tailored to enterprise levels. If international corporations, for example, would be regulated to use a specific kind of crypto asset, one would be able to track, directly or indirectly, any payment, as a DNA-trail so to speak. This would allow the global community to, with each transaction de facto enhance the enforcement of sanctions in the battle against the financing of terrorism and money laundering. Pretty much equal to forensic analysis using DNA, it would also become possible to pursue the resolve of financial ‘cold’ cases, years after transactions have transpired, using data that has become available at a later time, to ‘connect the dots’.

Last but not least, regulations are required in order to start mitigating carbon footprints. After all, the carbon footprint connected to mining activities (electricity, cooling) of the Bitcoin alone is already matching the carbon emission of a small country.¹¹ Another reason why regulating crypto assets will never become effective if treated by the powers that be, as just another exotic currency.