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On January 3rd<\/sup> 2009 the Bitcoin network came into existence with the elusive Satoshi Nakamoto<\/a> mining the so called genesis block of bitcoin (block number 0) which had a reward of 50 bitcoins.<\/p>\n Initially brushed off as another iteration of E-Gold<\/a>, a rather popular digital currency from the internet\u2019s early years that was shut down by US authorities, Bitcoin was not seriously considered as a viable asset. Bitcoin however, and the multitude of other crypto assets launched since, followed a different trajectory.<\/p>\n Now, Investment Firms, Funds and other financial intermediaries allow their clients to invest in crypto assets. In this blog we will explore reporting obligations of such firms that emanate from trading cryptos.<\/p>\n <\/p>\n It is prudent to flesh out a few terms associated with the crypto-space which are relevant to the issue of transaction reporting obligations.<\/p>\n Distributed Ledger Technologies (DLT)<\/u><\/strong><\/span><\/p>\n A decentralised database which is managed\/distributed by various participants. There is no central authority to act as the administrator, with the ability to unilaterally make changes to the database without other participants accepting or condoning. As this database is distributed to all participants it may allow for greater transparency making the entire system more resilient to manipulation by bad actors.<\/p>\n Blockchain<\/u><\/strong><\/span><\/p>\n A specific type<\/a> of Distributed Ledger Technology that organises data into blocks, each block is closed and opened with a specific cryptographic signature called hash. This signature verifies that the data contained within the block have not been manipulated and seals them from further alterations. I.e. once data have been recorded into a blockchain they cannot be undone. Take home message, all blockchains are DLTs, but not all DLTs are blockchains.<\/p>\n Crypto-Coins\/Currencies<\/u><\/strong><\/span><\/p>\n A coin is created with the so-called mining process whereby a block is added on a blockchain (see above), the process of creating a block involves solving a cryptographic puzzle which increases in complexity as more blocks are added to the chain. This increase in complexity requires vast amounts of computing power. A lot of participants attempt to solve the puzzle, the first to get to the solution adds another block to the chain and is rewarded with a coin, which can then be traded with other participants. A key characteristic of this coin is that it can only exist on its native blockchain and cannot be used on other DLTs as is. I.e. Bitcoin\/DOGE can only be mined on their native blockchain and cannot be traded on e.g. Ethereum\u2019s blockchain as is.<\/p>\n Crypto Tokens<\/u><\/strong><\/span><\/p>\n Tokens are created on an existing DLT that allows such programmability, e.g. Ethereum blockchain allows for the creation of such tokens, but Bitcoin\u2019s blockchain does not facilitate this. Usually such tokens are pre-mined, i.e. the developer decides how many tokens they intend to create and distribute them to interested parties. In this case the mining process described for Crypto coins does not apply. Moreover, and more importantly, tokens may be coded with different functions (unlike coins) and can exist across different DLTs (e.g. a Token can exist on both Ethereum\u2019s and Solana\u2019s blockchains). Examples of tokens include Tether<\/a> and NFTs.<\/p>\n Tokenisation <\/u><\/strong><\/span><\/p>\n In layman’s terms, it’s the process of representing an asset in digital form. E.g. a title deed of a property, ownership of a car, or more relevant to the topic at hand, a financial instrument. The token is recorded on a programmable DLT which can then be traded across participants. Tokenisation promises to deliver reduced trading costs, reduction of counterparty risk and peer to peer trading. In a traditional exchange when trading e.g. shares, once execution is triggered, the order is processed by different functions within the exchange, such as e.g. the Central Clearing House that interposes between buyer and seller in order to verify that they have the monies and the assets to trade, the Central Securities Depositary that registers the change in ownership of the asset etc. Such functions may be rendered redundant if trading is done using a DLT.<\/p>\n In fact several exchanges have launched DLT trading platforms such as, Switzerland\u2019s SIX \u2013 Group with the SDX Exchange<\/a> and Japan\u2019s Osaka Stock Exchange Osaka Digital<\/a>. At the same time major financial organisations have introduced DLT solutions, such as JP Morgan\u2019s Kinexys<\/a> (formerly known as Onyx) as a platform for trading major currencies and tokenised securities.<\/p>\n <\/p>\n USA<\/u><\/span><\/strong><\/p>\n In the early days of crypto-assets\u2019 existence there was an incoherent framework on how securities regulators would be treating them, then in 2018, a landmark court ruling in the US<\/a> brought some much needed clarity on the issue. The Commodity Futures Trading Commission brought charges against an entity alleging that cryptocurrencies are commodities and as such any security referencing them is under CFTC purview. The courts adjudicated in favour of the CFTC and this created a legal precedent for crypto-coins, categorising them as commodities. The USA has yet to formulate a comprehensive legislation package at a federal level, although federal bodies such as the Securities and Exchanges Commission, the CFTC and FDIC have enacted policies towards better regulating the crypto space. E.g. the SEC is accepting feedback from interested parties as part of its own rulemaking for crypto assets under the umbrella of the Crypto Task Force<\/a> and the process is ongoing as of the date of publication of this blog.<\/p>\n EU<\/u><\/span><\/strong><\/p>\n In 2020, the European Commission communicated its intention to develop a framework for digital finance<\/a> across the EU which included crypto-assets.\u00a0 This spurred the European Supervisory Authorities -ESAs (ESMA, EIOPA, EBA) and the ECB to begin preparatory work on the said package. This eventually led to the adoption of the MICA package<\/a> in 2022. The said package came into effect in 2024. The ESAs have produced additional guidance such as ESMA\u2019s criteria for the qualification of crypto assets as financial instruments<\/a>.<\/p>\n UK<\/u><\/span><\/strong><\/p>\n In 2018 the UK government launched the crypto assets Taskforce<\/a> consisting of HM Treasury, the FCA and the Bank of England. The Taskforce in its final report identified trends in the ecosystem and set a path for prospective rules. Following this the FCA put in place a roadmap<\/a> detailing its intentions for rule making with respect to cryptos.<\/p>\n Australia <\/u><\/span><\/strong><\/p>\n The Australian Securities and Investments Commission, embarked on a Digital Transformation of the securities landscape and has provided a comprehensive and detailed breakdown<\/a> of Australian laws applicable to firms when trading with crypto assets.<\/p>\n Canada <\/u><\/span><\/strong><\/p>\n Similarly in Canada, the Canadian Securities Administrators, an umbrella body with the aim of harmonising rules of Canada\u2019s provincial and territorial securities regulators, has provided, similar to ASIC, guidance to Canadian entities when offering cryptocurrencies <\/a>and on the issue of Securities Law Implications for Offering Tokens<\/a>.<\/p>\n As we have seen, Securities Regulators from across the world are showing interest in better regulating the crypto space for the benefit of the investment public. While minute differences exist between jurisdictions, there is one common element, \u00a0the specific case of security tokens (as defined by each jurisdiction) may fall under the remit of existing rules.<\/p>\n <\/p>\n For this exercise we will consider the applicable rules under the EU\/UK\u2019s EMIR and EU\/UK\u2019s MiFIR transaction reporting, for illustration purposes. While the references here may imply that the EU\u2019s and the UK\u2019s MiFIR or, EMIR transaction regime is the same, we note that, since Brexit, the 2 regimes have started to deviate as we\u2019ve pointed out in a previous blog<\/a>.<\/p>\n Consider the following examples in relation to firms\/counterparties based in the EU or UK:<\/p>\n <\/p>\n Example 1:<\/u><\/strong><\/span> Appears to be an example of tokenisation and the said token appears to represent a financial instrument<\/a>, and in particular a transferable security, as defined in the EU and the UK MiFID package. In such a case, the Firm may require authorisation in the EU or the UK to operate as an Investment Firm in those jurisdictions, and the transaction with the said token may be captured under the UK\u2019s and the EU\u2019s MiFIR transaction reporting obligation.<\/p>\n As we have said in previous blog entries the UK and the EU are proposing changes to the MiFIR reporting obligation. One of the key changes they are proposing is the introduction of a specific identifier for identifying tokenised\/DLT securities. The code suggested by both bodies should comply with ISO 24165. The said code was adopted by ANNA DSB for the creation of UPIs for OTC derivatives where the underlying is a crypto-asset. Refer to our blog on the UK\u2019s proposed MiFIR changes<\/a>, the EU\u2019s proposed MiFIR changes<\/a>, as well our blog entry on DTIF codes (that comply with ISO 24165) for the creation of a UPI for derivatives on crypto assets<\/a>, for further details.<\/p>\n Example 2<\/u><\/strong><\/span>:<\/span> <\/strong>The contract appears to fall under the category of a swap, and particularly a total return swap. A swap is captured as a derivative under the applicable EU and UK EMIR rules and as such should be reported by the counterparties. Moreover, given that the derivative references the S&P500, it may be subject to MiFIR reporting also (if one, or both, of the counterparties is subject to the MiFID II\/MiFIR regime) by virtue of Article 26c) of EU\/UK MiFIR<\/a>.<\/p>\n Example 3<\/u>:<\/span> <\/strong>At face value the spot sale of a commodity (be that oil, gold, corn or crypto currencies) is exempted from any reporting obligation under EMIR or MiFIR reporting, however UK or EU rules on the function of crypto-asset providers and any associated reporting may be applicable in this case.<\/p>\nDefinitions<\/strong><\/span><\/h1>\n
Roundup of relevant Crypto asset rules<\/strong><\/span><\/h1>\n
Reporting obligations for trading crypto-coins and\/or tokens<\/span><\/strong><\/h1>\n
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