19 Oct 2017
The content of the article was first published in Lexology on October 16, 2017
Given the convenience of established currency and payment systems, what is driving the ever-growing interest in Bitcoin and other virtual currencies?
One of the main reasons why bitcoin and other virtual currencies have amassed such popularity, and continue to do so, is blockchain – the ingenious and innovative technology behind them. Thanks to its distributed ledger technology, blockchain has been touted as the future of banking. There are a number of reasons why blockchain is gaining preference over traditional banking methods:
Economic crises have also played their role in decreasing trust in the existing financial system.
Has your jurisdiction taken steps to regulate virtual currencies? What is their current status?
At present, virtual currencies are not regulated in Malta. However, the government is considering utilising blockchain technology and virtual currencies. On August 7 2017 it launched a public consultation document with the aim of restructuring the Malta Financial Services Authority (MFSA) to pave the way for the further digitalisation of and innovation in the financial sector.
The junior minister for financial services, digital economy and innovation has expressed his hope that once this process has been finalised, the MFSA will be better prepared to regulate cryptocurrencies (a type of virtual currency) and the innovative financial products which are increasingly entering the market, including financial products which are built using blockchain technology (eg, virtual currencies).
The government plans to make Malta a pioneer in embracing blockchain technology and attracting blockchain companies. In April 2017 the prime minister announced that Malta will become one of the first countries to embrace blockchain. He went on to say that:
“I understand that regulators are wary of this technology but the fact is that it’s coming. We must be on the frontline in embracing this crucial innovation, and we cannot just wait for others to take action and copy them. We must be the ones that others copy.”
The prime minister has also been quoted as saying that Europe should become the “bitcoin continent”.
Different EU member state authorities have thus far taken different approaches to the regulation of virtual currencies. Is this due to the different legal frameworks of the member states or (mainly) by institutional practices of the respective authorities?
The differing approaches of EU member states is due to the differences in both the legal framework of each state and the institutional practices of the respective authorities.
From a legal framework perspective, virtual currencies, unlike financial instruments, are not greatly harmonised in the European Union or highly regulated in the majority of EU member states. This is due to member states’ different interpretations of and approaches to virtual currencies. Spain and Italy are clear examples of this aforementioned difference. In Italy, virtual currencies are not considered legal tender. In January 2015 the Bank of Italy issued:
Conversely, Spain has recognised the potential of virtual currencies to expand its economy and has implemented a legal framework to accommodate virtual currencies.
Malta has yet to take a position, but updates on its position are expected by early 2018.
How likely is it that the regulation of virtual currencies will be harmonized at EU level? Could a consistent regulatory approach be reached through institutional guidelines for the competent authorities in the member states?
It is unlikely that this will happen in the near future. However, a few proposals may be put forward in the coming months, possibly by some members of the European Parliament. The timeframes for such proposals to become law could be years.
In the meantime, Malta will see harmonised areas of law embracing and providing for cryptocurrencies. Initially, this may happen in the context of anti-money laundering.
The European Parliament and the Council of the European Union have proposed amending the Fourth EU Anti-money Laundering Directive (2015/849/EU) to tackle terrorist financing risks linked to virtual currencies. To prevent the abuse of virtual currencies for money laundering and terrorist financing, virtual currency exchange platforms (VCPs) and custodian wallet providers (CWPs) will be brought within the scope of the proposed amendments – otherwise known as the Fifth EU Anti-money Laundering Directive (2016/0208/EU). Under the proposed amendments, VCPs and CWPs would have to apply customer due diligence controls. It has been proposed that the definition of ‘obliged entities’ under the Fifth Anti-money Laundering Directive be extended to:
The aforementioned proposed amendments to the Fourth EU Anti-money Laundering Directive are still being revised for any further counter-proposal or approval by the European Parliament and the European Council and it could take months for an agreement to be reached. However, the proposals regarding virtual currencies are not the sticking points between EU member states and, therefore, it is anticipated that they will shortly be transposed into national law by the different members states.
How are transactions using virtual currencies as the medium of exchange taxed in your jurisdiction?
There is no specific tax legislation regulating virtual currencies as a medium of exchange. However, Maltese tax legislation recognises payments in kind as a medium of exchange and treats the latter in the same manner as transactions via traditional currencies. Accordingly, in the absence of specific legislation, transactions using virtual currencies as a medium of exchange should – for tax purposes – be treated in the same manner as transactions made via traditional currencies or payments in kind.
In line with the above, the Value Added Tax Department follows the European Court of Justice judgment in Hedqvist (C-264/14), which provides that transactions to exchange traditional currencies for units of virtual currency and vice versa constitute an exempt supply of services under the provision concerning transactions relating to currency and bank notes used as legal tender.
If virtual currencies were to become a mainstream payment system, how might this affect the ability to control inflation in your jurisdiction?
Inflation for EU member states is controlled by the European Central Bank’s (ECB’s) monetary policy to a certain extent, which is one of the tools used to manipulate inflation. However, the ECB can apply monetary policies only to the legal tender of the Euro. Therefore, if virtual currencies became a mainstream payment system, without an EU Institution having the authority to supervise and control such virtual currencies properly, the ECB would become a lot less effective in being able to steer the European Union to meet its inflation targets.
Fraud and money-laundering
What are the potential risks of virtual currencies in terms of fraud? How would these be addressed in your jurisdiction? Have any specific instances emerged in which virtual currencies have been used for money-laundering or other fraudulent purposes?
Virtual Currency Schemes (VCS) present several drawbacks and disadvantages for users, such as:
In addition, users face payment system-like risks owing to their direct participation in a VCS and risks associated with certain intrinsic characteristics of a VCS, including:
At present, there are no safeguards in place to protect users against these risks.
These risks would be addressed by primarily transposing the Fifth EU Anti-money Laundering Directive into Maltese Law. As a result, VCPs and CWPs would be licensed, regulated and obliged to apply customer due diligence controls when exchanging virtual currencies for real currencies, ending the anonymity associated with such exchanges.
The government’s public consultation on reforming the MFSA and regulating innovative financial products is set to be complete by the end of 2017 and changes in the law to implement the results of this consultation process are expected in 2018. This will provide a clearer picture of how the potential risks of virtual currencies in terms of fraud will be addressed.
To date, no specific instances have emerged in Malta in which virtual currencies have been used for money-laundering or other fraudulent purposes.
Contributors - Joseph Borg, Ramona Azzopardi, Kelly Fenech and Erika Micallef