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Cryptocurrencies and exchange control: where to from here?

27 August 2021
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On 11 June, the Intergovernmental Fintech Working Group (IFWG) published its latest position paper, and a ‘Frequently Asked Questions’ (FAQ) document, on ‘crypto assets’, a blanket term that includes well-known cryptocurrencies such as Bitcoin.

These documents, prepared by the IFWG’s Crypto Assets Regulatory Working Group (CAR WG), are intended to reflect the latest views of South Africa’s financial sector regulators on how they will treat such crypto assets.

The IFWG’s position paper and FAQ document have generated much commentary and debate regarding the future of crypto assets in South Africa.

In particular, there has been much interest in how the SARB will apply its system of exchange controls to cryptocurrencies, which South Africans have been buying and selling on exchanges and through other channels for several years.

South Africa’s exchange controls: when has someone ‘exported capital’ from South Africa?

One of the primary purposes of South Africa’s exchange controls is to ensure that all flows of capital both in and out of South Africa are recorded through the South African Reserve Bank’s (SARB) reporting system designed to track South Africa’s balance of payments. 

To facilitate this, all cross-border flows of capital must be processed through an Authorised Dealer (AD).  An AD is a person that has been authorised to deal in foreign exchange by the SARB.  In this regard, different ADs have different degrees of authority to deal in foreign exchange.  Most banks operating in South Africa have some level of AD status. 

In the February 2020 Budget Speech, the Minister of Finance announced that the current exchange control regime would be modernised such that all foreign currency transactions would be allowed, except for a risk-based list of capital flow measures. When further detail was announced around these intended modernisations, the SARB made it very clear (in circular 2/2020) that cross-border foreign exchange activities will continue to be conducted through ADs.   

Regulation 10(1)(c), under the Exchange Control Regulations, 1961 (regulations), stipulates that no person may, without the permission of the SARB, enter into any transaction whereby ‘capital’ or any right to ‘capital’ is directly or indirectly exported from South Africa. 

The meaning of ‘capital’ in this context was considered in the case of Couve and another v Reddot International (Pty) Ltd 2004 (6) SA 425 (W), in which the court held that ‘capital’ means anything with monetary value. 

However, in the case of Oilwell (Pty) Limited v Protec International Ltd & others 2001 (4) SA 394 (SCA), which involved the transfer of intellectual property rights by a resident to a non-resident, the Supreme Court of Appeal held that the term ‘capital’ in this context must be interpreted restrictively, in a financial sense, to mean ‘cash for investment’ and ‘money that can be used to produce further wealth’. The court found that the term must not be interpreted to include goods on which capital has been spent, and intellectual property rights in particular.

In reaching the above conclusion, the Supreme Court of Appeal also made the following notable statements:

  • The court found that the meaning of ‘capital’ under the regulations was not the same as the meaning of ‘capital’ under the Income Tax Act, 1962 – the former was unrelated to the latter.
  • Importantly (though it was dealing with a different question), the court noted that the general object of the regulations is to, ‘regulate and control foreign currency’, and the object of regulation 10(1)(c) in particular is to, ‘control foreign exchange in the public interest and to prevent the loss of foreign currency resources through the transfer abroad of capital assets held in South Africa’.

After this case, the definition of the term ‘capital’ for the purpose of regulation 10(1)(c) was amended to include any intellectual property right, whether registered or unregistered.  In addition, the definition of the term ‘exported from [South Africa]’ for the purpose of regulation 10(1)(c) was also amended to include, ‘the cession of, the creation of a hypothetic or other form of security over, or the assignment or transfer of any intellectual property right, to or in favour of a person not resident in [South Africa]’. 

Therefore, by including this definition, the legislator arguably made it clear that the much wider Couve definition of capital is intended to apply under the law.

Applying our current exchange control rules and principles to crypto assets and cryptocurrencies

Having regard to the Oilwell case and the resulting amendments in relation to regulation 10(1)(c), the SARB, working with the IFWG and the CAR WG, has pondered how best to treat crypto assets under the regulations, and the more detailed South African exchange control rules.

If one considers the fundamental features and characteristics of crypto assets, including cryptocurrencies such as Bitcoin, it is not difficult to anticipate several difficult questions:

  • Is a crypto asset ‘capital’ under the regulations, and regulation 10(1)(c) in particular?
  • If a crypto asset is capital in that context, at what point in time is a crypto asset ‘exported from’ South Africa?
  • How should the SARB develop reporting requirements around crypto assets to ensure that the cross-border ‘balance of payments’ is accurate, bearing in mind that all cross-border flows of capital should be processed through an AD and recorded on the SARB system, and that this requirement will remain even once the exchange control systems have been modernised.    

In its latest position paper, the IFWG and the CAR WG have adopted the following definition of a ‘crypto asset’: ‘a digital representation of value that is not issued by a central bank, but is capable of being traded, transferred or stored electronically by natural and legal persons for the purpose of payment, investment and other forms of utility, applies cryptographic techniques and uses distributed ledger technology’. 

In the same paper, the IFWG and the CAR WG recommend, amongst other things, that:

  • the Financial Surveillance Department of the SARB (Finsurv) should ask the Minister of Finance to, inter alia, include crypto assets in the definition of ‘capital’ for the purposes of regulation 10(1)(c) (recommendation 12);
  • Finsurv should explicitly allow individuals to purchase crypto assets within their single discretionary allowance (‘SDA’) and the foreign capital allowance (‘FCA’) framework (recommendation 13);
  • Finsurv should amend the manual for ADs to enable ADs to facilitate the accurate reporting of cross-border crypto asset trades, including the transfer of fiat money to acquire crypto assets abroad (recommendation 14); 
  • a new dispensation should be created, under the exchange control framework, to allow appropriately licensed crypto asset trading platforms (CATPs) to source or buy crypto assets offshore for the purpose of selling these crypto assets in the local market (recommendation 16); and
  • an exemption should be provided for appropriately licensed market makers or arbitrageurs of crypto assets (recommendation 18).

Recommendation 14 is desperately needed as individuals and entities trading with crypto assets otherwise face much difficulty in practice.  By way of example, if an item is exported from South Africa and payment is received in the form of crypto assets, there is no way to record, for exchange control purposes, that the payment of crypto assets has been received. 

This leads to exchange control difficulties because payments for exported items must be settled within a prescribed period under the relevant exchange control rules.   

Recommendations 12 and 13 are puzzling, however. The question arises as to whether they are included for the sake of clarification or whether they are included as a suggestion that the law currently does not allow for such activities.  For example, why is recommendation 12 necessary, to expand the definition of ‘capital’ to expressly include crypto assets?  If such an expansion is needed, does this mean that until the proposed change is implemented, it is not possible to contravene exchange controls through the transfer of crypto assets offshore? 

Whether crypto assets constitute ‘capital’ under regulation 10(1)(c)

In the Oilwell case, the court found that ‘capital’ in this context should be interpreted restrictively, in a financial sense, to mean ‘cash for investment’ and ‘money that can be used to produce further wealth’. The court went further in clarifying this finding, noting that ‘capital’ in this sense could not be goods (i.e. the property or rights on which that capital was spent).

The 2021 IFWG position paper states that, ‘[p]olicymakers, regulators and central banks have been clear that crypto assets are not ‘money’ in the legal tender sense of the word, although they perform some of the functions of money.’

For example, although one can ‘invest’ with crypto assets, and although they ‘can be used to produce further wealth’, they are not regarded as ‘cash’ or ‘money’ in a legal sense. This is the case not only in South Africa, but in almost every other country, with the recent exception of El Salvador.

The term ‘capital’ under regulation 10(1)(c) has also, as we have noted above, been amended to include any ‘intellectual property right’, whether registered or unregistered. Given the apparent context of this amendment, as a direct response to the Oilwell decision, one could assume that ‘intellectual property right’ should be interpreted to mean ‘trademarks’, ‘patents’, ‘designs’ or ‘copyright’, which the Oilwell decision was concerned with.

It is submitted that the actual, doctrinal legal classification of crypto assets under South African law is a very complicated question. However, in the absence of further clarification, the IFWG’s adopted definition of a ‘crypto asset’ (i.e. ‘a digital representation of value’) does not appear to include an ‘intellectual property right’ in the context of a ‘trademark’, ‘patent’, ‘design’ or ‘copyright’.

In light of this, it appears arguable that crypto assets do not constitute ‘capital’ that can be ‘exported’ under regulation 10(1)(c), which would mean that recommendation 12 above is indeed necessary.

However, the Oilwell case also noted that the object of regulation 10(1)(c) is to, ‘control foreign exchange in the public interest and to prevent the loss of foreign currency resources through the transfer abroad of capital assets held in South Africa’ (our underlining). When interpreting any document or provision, our courts must consider, amongst other things, its ‘apparent purpose’ (Natal Joint Municipal Pension Fund v Endumeni Municipality (920/2010) [2012] ZASCA 13 (15 March 2012)).

It is a practical reality that, despite the difficulties inherent in regulating crypto assets, cryptocurrencies are already easily exchangeable for foreign currency. The IFWG acknowledges that crypto assets can be used to circumvent exchange controls and to facilitate the flow of capital out of South Africa, without reporting through the appropriate channels.

If the term ‘capital’ under regulation 10(1)(c) is interpreted with the above purpose in mind, an argument could be made that crypto assets must be regarded as ‘capital’, otherwise the purpose of regulation 10(1)(c) would be undermined.

If a crypto asset is regarded as ‘capital’, the question then remains: at what point does one ‘export’ the crypto asset (i.e. the capital)? 

If crypto assets constitute ‘capital’ under regulation 10(1)(c), when are they ‘exported’?

Because crypto assets perform some of the functions of money, we often talk about them in the same way that we talk about money. For example, we talk about storing cryptocurrencies in ‘wallets’, and we talk about ‘sending’ cryptocurrencies to other ‘wallets’ held by ourselves, or third parties.

However, the casual language we use when talking about crypto assets and cryptocurrencies should not distract from their fundamental differences with money.

If you ‘buy’ a crypto asset, such as Bitcoin, you do not actually ‘receive’ a coin or any other kind of asset. Your purchase is recorded on a ‘public ledger’, or ‘blockchain’, which is technically ‘visible’ to everyone. This ledger is not stored on any one computer or network.

In the case of Bitcoin and many other crypto assets, the ledger is stored on thousands of computers, called ‘nodes’ or ‘miners’. Because the ledger is public, all of these computers are able to track the transactions that are added to the ledger, and it is therefore almost impossible for someone to ‘cheat’ the system and claim that they have more Bitcoin than they actually do.

Balances of Bitcoin are kept using public and private ‘keys’. A public key can be compared to a bank account number – it is a number that you can share publicly, and it is the ‘address’ to which third parties may send Bitcoin. A private key can be compared to an ATM PIN – it allows people to access their own balances of Bitcoin, and it must therefore be kept secret in order to protect that balance of Bitcoin.

A Bitcoin ‘wallet’ is either ‘hot’ (i.e. it is essentially a piece of software linked to the internet) or ‘cold’ (i.e. it is software or hardware, like a USB stick or even a piece of paper) that is not linked to the internet.

It is not really accurate to say that Bitcoin is stored ‘in’ such a wallet: the Bitcoin in question will always be ‘stored’ at the abovementioned public key, on the public ledger or blockchain, as we have described above. The wallet effectively provides Bitcoin ‘holders’ with a mechanism by which they can store and use their private keys, in order to access the Bitcoin linked to their public keys.

In light of these fundamental features, the difficulties in talking about ‘exporting’ a crypto asset or cryptocurrency become apparent – despite the SARB’s intention that this word be interpreted generally.

If, for example, Jane, being a South African exchange control resident, buys Bitcoin in South Africa, she will then ‘hold’ the relevant amount of Bitcoin on a public key, on a public ledger or blockchain, which is ‘stored’ on thousands of computers around the world. Jane may ‘hold’ that Bitcoin in a ‘hot’ wallet, which is to say, she uses a software programme to store and use her private key, so that she can access her Bitcoin.

Say Jane ‘sends’ that Bitcoin to the ‘hot’ wallet ‘held’ by her friend, John, in Belgium. The Bitcoin is not transferred from South Africa to Belgium. Rather, the transfer is added to the public ledger or blockchain, again stored on thousands of computers globally, and John can now access that Bitcoin using his own private key. Has Jane ‘exported’ Bitcoin to John? Possibly, but arguably not in the ‘ordinary’ sense of the word ‘exported’.

But what if Jane does not transfer Bitcoin to John – she merely gives John her private key, so that John can now access her Bitcoin on the public ledger or blockchain. Has she ‘exported’ Bitcoin? Perhaps this scenario seems less clear-cut than the one above.

Or what if Jane had stored her Bitcoin on a ‘cold’ wallet, such as a USB drive, and then happened to carry the USB drive with her when she visited John in Belgium? The Bitcoin still sits on the public ledger or blockchain – it is only accessible to Jane in Belgium because she accidentally packed the USB drive in her luggage. Has she ‘exported’ Bitcoin? Depending on your perspective, you may view this scenario as being more or less clear-cut than the others.

There are no easy answers in the above examples. They simply highlight the complex challenges faced by the SARB in regulating crypto assets. However, in our view, these scenarios demonstrate that, in developing the exchange control regime to accommodate crypto assets, it is critical to keep in mind their unique features and their fundamental differences with traditional money.