Defining and Classifying Virtual Assets: Does it meow or roar?
by Senator Ihenyen
Cats and the feline family—numbering up to 37 cat specie—have always fascinated me. Whether a cheetah or jaguar, leopard or lion, panther or puma, they are all cats—at least colloquially. Even the graceful, low-slung bodied, white-furred Lidi—a pet in one of my aunts’ home while I was growing up in Lagos—is a cat. A domestic cat. And because Lidi is a cat for the house, she enjoys human company and habitation. A domestic cat, Lidi is expected to meow, not roar; drink milk and eat fish; not hunt down her prey with trimmed claws. Should Lidi ever roar, its classification as a felis catus—a domestic cat—would become questionable. Should Lidi roar, she may most likely lose her human home. Should Lidi roar, her unique specie might merit a redefinition in the feline family. And consequently, a reclassification. If redefined and reclassified, Lidi may end up in a game reserve, a zoo, or a woodland forest preying in the wild.
What a thing is defined as determines how that thing is classified, and consequently how the thing is treated. One of the major challenges of regulation today is the problem of how to treat virtual assets. This is often a consequence of the definitions and classifications adopted (or not adopted) by regulators around the world. And when you consider that with virtual assets it gets more complex because a particular virtual asset may have the capability to meow and roar depending on what it is used for, the need for a proper definition and classification of virtual assets is critical. In the world of virtual-assets regulation, a blanket, catch-them-all approach does more harm than good. Treatment of virtual assets calls for an adaptive, developmental, innovative, and risk-based regulatory approach. It starts with definitions.
The power of definitions—a matter of life and death
Definitions define the world. They also largely determine our relationships with it.
Whether you will label a person a tourist or terrorist depends on your definition of who a tourist or terrorist is. It is with that definition in mind you are able to identify what behaviours or characteristics the person has which merits an association with tourism or terrorism. Whatever it is, each comes with its own consequence—life or death. For example, following the Central Bank of Nigeria’s (CBN) recent circular banning cryptocurrencies in Nigeria’s banking and financial system, it defined ‘cryptography’ in the context of cryptocurrencies as “a method of encrypting and hiding codes that prevent oversight, accountability, and regulation”. With such a curious definition, the CBN definitely left no one in doubt that it was going for the kill. A classic giving a dog a bad name to hang it? Maybe.
Definitions rule the world. What makes the difference between manslaughter, murder, and mercy killing is definition, otherwise all three are simply deaths. So without objective and accurate definitions, disruptive innovations such as virtual assets, including cryptocurrencies, may die in the strangulating grip of rabid regulation. To have responsive and responsible regulation, we must get definitions right.
Why a blanket regulatory approach to virtual assets is a mess.
Virtual assets are dynamic. They have nuances that demand refinement, not blanket approaches. The recent CBN directive effectively banning cryptocurrencies in Nigeria’s banking and financial system, for example, is one of such blanket approaches. A ban—especially without a solution—is an immediate form of control but equally the remote form of losing control.
Speaking of control, what if I told you that CBN’s 5 February 2021 directive to Nigeria’s banking and financial industry only affects cryptocurrencies, not virtual currencies and other noncryptocurrency virtual assets? Yes, technically. What if I also told you that CBN’s ban of cryptocurrencies in Nigeria’s banking and financial system does not completely affect the SEC’s statement on the classification and treatment of digital assets in Nigeria? Yes, technically. How?
First, while all cryptocurrencies are virtual assets and virtual currencies, not all virtual assets and virtual currencies are cryptocurrencies. For example, while bitcoin is a virtual asset and virtual currency it is also a cryptocurrency because it uses blockchain technology which is a link of records that are linked using cryptography, XRP is a virtual asset and a virtual currency but not a cryptocurrency because XRP does not use blockchain technology. Second, regarding CBN directive and the SEC’s statement, while cryptocurrencies are affected, the SEC statement included other digital assets other than cryptocurrencies or ‘crypto assets’. These digital assets are utility tokens providing access to products or services, security tokens having features of investments or security, and derivatives and collective investment schemes of crypto assets, utility tokens, and security tokens. For example, bitcoin is a crypto asset, bnb is a utility token, and bitcoin futures and options are derivatives.
Now if we take the argument to another level, where bitcoin is used as a speculative asset or investment asset, this use case takes bitcoin off CBN’s jurisdiction, as far as that particular transaction is concerned. It becomes subject to the SEC‘s regulatory authority. And where bitcoin is used to perform the function of a currency, this use case takes bitcoin back under CBN’s jurisdiction.
The point is this: a proper regulation of virtual assets, virtual currencies, and cryptocurrencies require sound understanding. With sound understanding, it would become (more) obvious that CBN’s current blanket approach to virtual assets, virtual currencies, and cryptocurrencies badly needs help.
Understanding the distinction between virtual assets, virtual currencies, and cryptocurrencies and their regulatory implications
First, a ‘virtual asset’ or sometimes called ‘digital asset’ is a value represented in a digital form, making that value capable of being stored, traded, or transferred digitally. This “value”, as I pointed out in my inaugural column here, could be currency, identity, information, intellectual property, security, vote, etc. Also, storing, trading, or transferring this “value” does not require a central authority or third party. As defined by the Financial Action Task Force (FATF), a virtual asset “is a digital representation of value that can be digitally traded, or transferred, and can be used for payment or investment purposes.” Virtual assets include virtual currencies and other assets that have nothing to do with currencies or money such as Non Fungible Tokens (NFTs) for example.
Second, a “virtual currency”, on the other hand, has been defined as “a digital representation of value that can be digitally traded and functions as (1) a medium of exchange; and/or (2) a unit of account; and/or (3) a store of value, but does not have legal tender status (i.e., when tendered to a creditor, is a valid and legal offer of payment) in any jurisdiction.”
Third, cryptocurrencies are virtual currencies issued by largely anonymous and decentralized entities and secured by cryptography. Cryptocurrencies are convertible virtual currencies because they have equivalent value in fiat currency. They may be exchanged for fiat currencies based on offer and acceptance between the parties transacting in them.
So amongst other benefits, a proper understanding of the nuances of virtual assets will help to avoid unnecessary regulatory encroachments among regulators. For example, CBN encroached on the SEC’s turf when CBN maintained in a recent press release that cryptocurrencies have become more widely used as speculative assets rather than as means of payment. CBN even went as far as contrasting cryptocurrency investments with investments in stocks in the Nigerian Stock Exchange. However tenable that concern may be, this is not CBN’s call. It is SEC’s call. The SEC has decades of experience and knowledge regulating commodities, derivatives, securities, as well as various investment schemes. CBN may of course come in where virtual currencies or cryptocurrencies are used to enable savings & loans, payments, and cross-border transactions. CBN may also come in where it considers that cryptocurrency adoption in Nigeria directly affects—negatively, positively, or both—the country’s fiscal and monetary policy.
Both the absence of definitions or sometimes a lack of proper definitions have resulted in the seeming cluelessness, confusion, or conflicting policies in Nigeria’s regulatory response to virtual assets.
The current mess in Nigeria’s virtual-asset regulatory landscape suggest—rightly or wrongly—some level of cluelessness, confusion, or conflicting policies. This is unhealthy.
CBN has warned severally about ‘virtual currencies’ in Nigeria, but it failed to define it. When CBN issued its first-ever circular on virtual currencies to banks and other financial institutions in Nigeria on 12 January 2017, CBN neither defined nor explained what virtual currencies were. In that circular, CBN’s drew the attention of banks and other financial institutions to the risks associated with virtual currencies. These risks are as a result of the intersection of “convertible VC activities …. with the regulated fiat currency financial system”. According to the CBN, the risks involve the susceptibility of virtual currencies to “abuse by criminals, especially in money laundering and financing of terrorism.”
But without defining what it was trying to control, CBN’s first love letter on virtual currencies to banks and other financial institutions left many questions unanswered. Nigerians—as you would expect—found their own answers.
Similarly, the SEC advised against investment in cryptocurrencies, virtual currencies, or digital currencies, but also failed to define any of them. Curiously, the SEC’s first public notice on investments in cryptocurrencies and other virtual or digital currencies was delivered same day CBN’s love letter dropped. The SEC advised the members of the public against investing in “cryptocurrencies such as Swisscoin, OneCoin, Bitcoin and such other virtual or digital currencies”. This left more questions than answers on the lips of many Nigerians. Of course, much more was expected of Nigeria’s capital-market regulator. Again, Nigerians went in search of answers.
When the initial CBN circular did not stop the growing rate of cryptocurrency adoption in Nigeria, CBN dropped a public notice but again without any definition.
Exactly 14 days after what I imagine must have been a bad Valentine’s Day between the CBN and virtual currencies, CBN issued another circular on 28 February 2021. This time, CBN re-emphasized that virtual currencies are not legal tender in Nigeria and remain unregulated. Consequently, according to CBN, should exchangers or entities offering these virtual currencies “collapse or close business”, there would be no redress. The CBN, similar to its initial circular, did not define what cryptocurrencies, virtual currencies, or virtual assets were.
Curiously, 3 years later, virtual-currency exchanges in Nigeria—particularly the indigenous ones—currently face the risk of collapse or threat of closing business. Having warned the members of the public about the risks associated with virtual currencies—with little or no education from our regulators—one would have expected that the CBN would at this point use its regulatory authority to ensure that these risks are at least minimized. How? By adopting a risk-based approach to virtual-currency transactions in Nigeria’s banking and financial system. This was CBN’s approach in its January 2017 letter. That approach, instead of being improved upon, was suddenly abandoned 5 February 2021. And this was after 3 years. Is three years long enough for CBN to have conducted a comprehensive and publicly available research on virtual assets in Nigeria’s banking and financial system? Meow, Lidi would say. I also think so.
When CBN sneezes, others catch a cold.
By its 5 February 2021 circular, CBN effectively abandoned its initial risk-based approach, preferring an outright ban of cryptocurrencies in Nigeria’s banking and financial system. Before the cock crew twice, the SEC suspended its own regulatory position on virtual assets in Nigeria. All the SEC’s roadmap and whitepapers—as we love to call them in the crypto space—became just that: roadmap and whitepapers. Of course the SEC meant well. I know competent, knowledgeable, and well-meaning individuals who were part of the process that resulted in the SEC’s eventual roadmap for fintech innovation in Nigeria’s capital market.
So why has the SEC suddenly turned Peter overnight? Because CBN sneezed.
Whenever CBN sneezes, everyone seems to catch a cold in Nigeria. This may understandably be because of the immense responsibilities of CBN in ensuring a sound financial system in the country. Such responsibilities often overlap with certain regulatory concerns of other regulators. And this is why I think CBN needs to engage more, adopting a more collaborative and multi-stakeholder approach to dealing with challenges in the financial services industry. Apart from banks and other financial institutions, the CBN should also consider taking virtual assets service providers (VASPs) along as well. VASPs, including virtual assets exchanges, could very well be the vaccine that the financial system needs to immune itself against the risks often associated with virtual currencies. Banning cryptocurrencies in Nigeria’s banking and financial system is not a solution. It is only a sleeping pill for borrowed time. The fundamental issues will not disappear. Hopefully, CBN as well as other concerned regulators will wake up to smell the coffee soon. The time is ticking. To understand the urgency, think of it as a timebomb. We don’t have all the time we always seem to think we have.
To secure Nigeria’s future in the emerging virtual-assets industry, the SEC needs to step out of CBN’s encroaching and hovering shadow.
The SEC’s current place in the emerging virtual-asset space leaves much to be desired. Especially when you consider that more than any other regulator in the country the SEC arguably has a more significant role to play in the regulation of virtual assets, the big picture may become clearer. The SEC is the powerhouse of regulation of commodities, derivatives, and securities in the country. Think of Nigeria’s SEC as the US SEC and the US Commodities Future Trading Commission (CFTC) combined. Yes. So whether Nigeria will be left behind or not in the emerging global virtual-asset space will largely depend on the quality of leadership, innovation, and vision the SEC is capable of.
Presently, the SEC—though independently established under the Investments and Securities Act (ISA)—appears to be a capital-market department of the CBN. Appears, I said. In any case, while intergovernmental-agency collaboration should be encouraged, the SEC needs to be seen—and manifestly so—to be leading regulatory efforts in areas that fall within its regulatory purview. This, as I pointed out earlier, does not suggest that CBN or any other agency cannot also regulate virtual assets in Nigeria. Each regulatory body needs to properly define what virtual assets and their types are and then determine which of these assets fall under their regulatory purview. The SEC generally did so in September 2020 when it issued a statement on the classification and treatment of digital assets in Nigeria. Though not altogether the best of statements, the SEC’s position was historic and significant. To many Nigerians, it was a compass in the middle of nowhere, until now. After the CBN hammer of 5 February 2021, Nigeria is back in the middle of nowhere.
To move from nowhere to somewhere, let’s openly, meaningfully, and truly engage.
It is not enough for the CBN to deny an entire emerging industry access to banking and financial services over certain risks in a country that speaks of a sound financial system. A sound financial system must also be fair and inclusive. It is equally not enough to have the SEC simply say that it has suspended its fintech plans regarding VASPs in Nigeria because these VASPs will need bank accounts. It is a failure of regulation.
First, with the one-step-forward, 5-steps-backward movement Nigeria has in effect been making in the virtual-assets space over the years, I expect the SEC to play a more leading role in this space. This is the case all over the world, at least in countries where institutions and systems work. So it is not out of place if the SEC sent a(n) (open) letter to other concerned regulators as well as stakeholders on its regulatory efforts and in fact issue guidelines. This should address how the SEC will navigate the opportunities and risks towards ensuring innovation support, consumer protection, and investment safety in Nigeria. The SEC should be leading the way.
Second, regulators in the virtual-asset space, including CBN, NDIC, and the SEC, should embrace and incorporate the culture of releasing guidance and advisory on new issues that come within their regulatory purviews from time to time. While circulars and directives are no doubt vital in regulation, the need to constantly educate the public about disruptive innovations and their impact on the current regulatory regime should not be neglected. Consumer & investor education is a critical tool in regulation. It should not be relegated. Without adequate education, circulars and directives may achieve limited or minimal success. This is why research is key.
To leverage virtual assets for Nigeria’s competitiveness in the global economy, we must start having open, meaningful, and true engagements. No one has all the answers.
Senator Ihenyen is the Lead Partner at Infusion Lawyers where he heads the Blockchain Practice and the Intellectual Property & Technology Practice of the virtual law firm. He advises both local and global companies in various areas of law, including emerging technologies such as blockchain. A tech lawyer with interest in policy and regulations, Senator is the President of Stakeholders in Blockchain Technology Association of Nigeria (SiBAN). He is also the current General Secretary of the Blockchain Industry Coordinating Committee of Nigeria (BICCoN). He is the exclusive contributor (Nigeria chapter) to the International Guide to Blockchain as well as exclusive contributor to the Comparative Legal Guide to Data Protection 2019 (Nigeria Chapter). Senator is currently the 1st Vice Chairman, Intellectual Property Committee of the NBA Section on Business Law (SBL) and member of the Information Technology Committee. Contact: [email protected]
Credit:esq-law
