In the swiftly evolving realm of virtual assets, cryptocurrency, and decentralised finance (DeFi), the UAE and Bahrain have emerged as influential players, actively shaping global standards while fostering innovation and safeguarding consumer interests.
This article explores recent regulatory developments, challenges, and the measures implemented by these Middle Eastern nations to lead the way in this transformative space.
Regulatory advances in the UAE, KSA, and Bahrain
UAE and Bahrain have adopted a proactive approach to virtual asset and DeFi regulation. The UAE features a versatile regulatory environment with emirate level and financial freezone- level regulators.
These include the Financial Services Regulatory Authority (in the Abu Dhabi Global Market) (FSRA), the Dubai Financial Services Authority (in the Dubai International Financial Centre) (DFSA), and Virtual Assets Regulatory Authority in the emirate of Dubai (VARA).
In parallel, the Central Bank of Bahrain (CBB) acts as the sole regulator of VA and DeFi activities in Bahrain. Here is a summary of the regulatory framework of VA and DeFi regulations in these jurisdictions:
ADGM
The ADGM emerged as a regulatory pioneer in 2018 and became the first jurisdiction in the UAE to issue a comprehensive regulatory framework for virtual asset service providers (VASPs). Shortly after in the same year, the FSRA amended regulations to cover various activities, including multilateral trading facilities (MTFs), brokers, custodians, and asset managers.
This was followed by the ADGM recognising stablecoin’s potential as a digital means of payment and store of value which led to their inclusion within ADGM’s regulatory ambit in 2019. In 2022, the FSRA released a discussion paper titled “Policy Considerations for Decentralized Finance” to elucidate its stance on DeFi.
The paper delineates key terms, outlines associated risks, and underlines high-level policy considerations that the FSRA could take into account when regulating this technology. In October the same year, the ADGM’s framework was amended to accommodate NFTs, allowing licensed MTFs to undertake specified NFT activities.
Furthermore, this year the ADGM became the first jurisdiction to issue a comprehensive framework for Decentralized Autonomous Organisations, enabling them to operate, issue tokens, and establish clear governance structures.
DIFC
The DFSA’s first VA framework termed as the ‘Investment Token Regime’ was enforced in 2021 and primarily governed the issuance and trade of security tokens within the DIFC. The next year the DFSA came out with an extensive framework to accommodate firms who wished to provide VA services, such as custodial services, broker-dealer services, fund management, exchange services etc.
Rules pertaining to fiat crypto tokens (fiat stablecoins) were included in the DFSA regime in the same year. Most recently, the DFSA issued Consultation Paper no.150 deliberating the regulation of “wrapped crypto tokens” under the DFSA’s regulatory framework.
VARA
The Emirate of Dubai enacted ‘Law No. (4) of 2022 Regulating Virtual Assets in the Emirate of Dubai’ (The Law) which became effective on March 11, 2022. This established the VARA, and authorised it to regulate VA activities pertaining issuance, trade, transfer and holding of VA, in Dubai.
Further, in February 2023, the VARA released VA activity-specific rulebooks to facilitate licensing. In the same year, VARA made two significant amendments to its regulatory regime which led to the inclusion of activities concerning custodial staking and stablecoins. The provisions on custodial staking enable licensed custodians to offer staking services from the same legal entity, eliminating the need for a separate license.
This reflects VARA’s ingenuity as a regulator to keep up pace with the rapidly evolving DeFi sector. Simultaneously, the fiat referenced virtual assets rules set out a well-rounded framework governing the issuance of stablecoins pegged to fiat currencies, specifying additional requirements for disclosures, reserve assets, capital etc. for consumer protection.
Bahrain
The CBB in 2019 issued the ‘Crypto Asset Module’ to govern and license crypto-asset services in Bahrain, aiming to minimise the risk of financial crime and illegal use of crypto-assets. The framework regulates the activities of reception and transmission of orders, investment advice, trading in crypto assets, portfolio management, custody services, exchange services.
Applicants must seek to be licensed to conduct such activities and must also meet the minimum capital requirements, appoint persons for ‘controlled functions’, and submit details as required by the regulation. The year 2023 saw significant additions to Bahrain’s crypto asset framework, with the inclusion of sections on ‘Digital Token Offerings’ and ‘Cyber Hygiene Practices’.
Interestingly, the ‘Cyber Hygiene Practices’ imposed obligations on crypto service providers to prevent unauthorised access, introducing mandatory multi-factor authentication, signalling a departure from the CBB’s technologically agnostic regulatory approach.
These initiatives position these states as pioneers, fostering a secure environment for virtual asset activities and granting them a first-mover advantage in the global conversation on DeFi regulation.
Tokenization and DeFi: Opportunities and challenges
Tokenization and DeFi are truly revolutionary technologies taking the finance world by storm. They offer unparalleled efficiency via instant transfers and unbreachable transaction records, while unlocking liquidity for illiquid assets and fuelling economic growth. However, their decentralised nature presents several challenges. Accountability gaps alongside cybersecurity threats loom large.
These issues were also addressed in the Financial Stability Board’s Global Regulatory Framework for Crypto-asset Activities, advocating for client asset protection by isolating them from VASPs, conflict-of-interest mitigation, and enhanced cross-border cooperation to pave the way for standardised global regulations. The explosive growth of DeFi, reaching $50 billion in total value locked, underscores its financial relevance, and merits proactive regulation.
As highlighted in ADGM’s consultation of DeFi, the regulatory challenges include anonymity, money laundering risks, and issues related to market conduct and investor protection. Additionally, the decentralized nature of DeFi convolutes the enforcement of anti-money laundering provisions.
Market trends and developments
Amid increased investment and market capitalisation, the DeFi sector is currently witnessing a revitalised wave of innovation being referred to as “DeFi 2.0”, which is marked by incremental, yet significant modifications made to traditional DeFi protocols to address their shortcomings. For example, Dash is a DeFi protocol that has been developed to offer faster transactions speeds than other cryptocurrencies, such as Bitcoin, Ethereum and Matic.
Recently, DeFi developers have turned to the real estate sector owing to the glaring issues of multiple intermediaries and long transaction times plaguing the sector, which can be solved with the help of decentralization. Propy is one of the leading service providers in this space and offers the service of converting the rights associated with real-world properties into NFTs and later trading these NFTs on its proprietary digital platform.
International collaboration
In addition to the milestone development of the Financial Stability Board releasing its Global Regulatory Framework for Crypto-asset Activities, in 2023, the Central Banks of UAE collaborated with the Hong Kong Monetary Authority on developing crypto-regulations.
Further, this month, the IOSCO issued a report that provides policy recommendations for addressing market integrity and investor protection issues in DeFi. The report aims to assist regulators in applying a “same activity, same risk, same regulation/regulatory outcome” approach to DeFi products, services, activities, and arrangements, and to promote greater consistency and cooperation among jurisdictions.
Closer to home, the UAE Executive Office of Anti-Money Laundering and Counter Terrorism Financing (EO AMLCTF), along with the International Monetary Fund held a “Fintech Roundtable” with regulators of 15 other jurisdictions to address money laundering and terror finance related challenges in relation to virtual assets, including gaps in existing AML/CFT regulations and insufficient state resources for supervisory authorities to effectively oversee virtual assets.
The discussions emphasised the need for a more global and interconnected approach to address cross-border concerns associated with VA. These recent developments indicate an expanding partnership between the Gulf countries and other advanced jurisdictions to effectively regulate virtual assets, laying the groundwork for standardised global virtual asset and DeFi regulations.
Leadership in shaping global regulations
From the recent regulatory developments, it can be deduced that the UAE and Bahrain have emerged as crucial players in shaping global crypto asset regulations, emphasising innovation and consumer protection.
The UAE, through bodies like VARA and financial zones like DIFC and ADGM, has implemented progressive regulations, including the DLT Foundations Regulation and Custodial Staking framework that foster a conducive atmosphere for virtual asset-based businesses.
Bahrain, with its “Crypto Assets Module ” and introduction of sections on ‘Digital Token Offerings’ and ‘Cyber Hygiene Practices’ increases it regulatory ambit to cover security tokens and acknowledges the unique technological and security needs of the VA and DeFi realm.
The UAE and Bahrain, continue to pave the way for a global regulatory landscape for virtual assets, cryptocurrencies, and DeFi, and their proactive measures, innovative frameworks, and collaborations with international counterparts position them as leaders in cultivating a secure and progressive environment for these technologies.
Conclusion
To conclude, the UAE, and Bahrain, continue to pave the way for a global regulatory landscape for virtual assets, cryptocurrencies, and DeFi, and their proactive measures, innovative frameworks, and collaborations with international counterparts position them as leaders in cultivating a secure and progressive environment for these technologies.
KARM works through multilateral fora such as the Arab Monetary Fund and UAE-level fintech associations such as the MENA FinTech Association to drive conversations on virtual assets. As we continue to navigate the complexities of this rapidly evolving field, our commitment to excellence, legal expertise, and collaboration with regulators stands as the cornerstone of our efforts to shape a future where virtual assets thrive within a secure and well-regulated environment.
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