In Part 1 of this article, we defined cryptocurrency and stablecoins and considered the different types of stablecoins that can be created.
In Part 2, we examine the position of the regulators and also explore options that issuers of this virtual asset take up in order to operate in the Nigerian market.
CBN’S STANCE ON CRYPTOCURRENCIES
In a letter dated February 5 2021, the Central Bank of Nigeria directed all deposit money banks, non-bank financial institutions and other financial institutions to identify and close the accounts of persons and/or entities transacting in or operating cryptocurrency within their systems.
This letter was issued after previous CBN statements such as a Press Release dated February 28 2018 wherein CBN warned that virtual currencies are not legal tender in Nigeria; and a circular dated January 12 2017 where CBN directed banks and other financial institutions to ensure that they do not use, hold, trade and/or transact in any way in virtual currencies pending substantive regulation or decision by the CBN. Consequently, it is difficult to conceive a situation where an Issuer of Stablecoins can freely operate in Nigeria.
However, the Securities and Exchange Commission (SEC) on 11th May 2022 published the Rules on Issuance, Offering and Custody of Digital Assets (“the Rules”). It is expected that persons registered under the rules would be exempt from the imposition contained in the earlier referenced CBN’s Letter. Specifically, Issuers of Stablecoin may register as a Virtual Asset Service Provider (“VASP”) under Part D of the Rules to enjoy this potential exemption.
SECURITIES LAW CONSIDERATIONS
The Rules require every Issuer conducting initial digital assets offering within Nigeria or targeting Nigerians to file an Initial Assessment Filing containing, amongst others, a legal opinion on whether or not the tokens to be sold through the initial digital asset offering are security. Where SEC determines that the Stablecoin offering constitutes a Security, the Issuer will be required to register such Stablecoin unless it falls under one of the limited exceptions.
While SEC has not given any indication on the test it will use in determining if the digital assets to be offered are securities, SEC will likely adopt the Howey test which is applied by the United States Securities and Exchange Commission to make similar determinations.
Under the Howey test, an offering will constitute an investment contract and therefore security where the following conditions are met: an investment of money; in a common enterprise; and in which profits would be expected and derived from the entrepreneurial and managerial effort of others.
While the purchase of a Stablecoin will meet the first requirement, the existence of the other two requirements depends on the nature of the Stablecoin and the way and manner it strives to maintain its peg. For example, it is conceivable that purchasing DAI will not be regarded as a common enterprise because each User/Investor determines whether they have deposited sufficient collateral and their fortunes are not directly tied to the activity of other Users/Investors or the Issuer. Notwithstanding the above, most Stablecoins will meet the second requirement.
Most Stablecoins are purchased for their stability and not for any expectation of profit. Nevertheless, depending on the nature/structure of the Stablecoin, Stablecoins may be purchased with the expectation of profit. For instance, Users/Investors may purchase a rebasing algorithmic Stablecoin with the hopes of staking the tokens for the high APYs offered by most rebase tokens.
Similarly, Users/Investors in a seigniorage algorithmic Stablecoin may purchase the Stablecoin with the expectation of using it as a warrant to mint the Sharetokens or to trade between the multiple tokens. Collateral-backed Stablecoins may also be bought (a) at a discount; (b) with the hopes of selling at a premium; or (c) with the expectation of redeeming it when the collateral appreciates in value, particularly where the Stablecoin is redeemable at a Variable Redemption Value.
Investors/Users in any Stablecoin may also cause arbitrage based on the slight fluctuations of Stablecoins or purchase Stablecoins with the expectation of staking them for returns. Notwithstanding the above, even where profit is made, the issuance will not be treated as a security transaction when, generally speaking, purchasers are motivated by a desire to use or consume the Stablecoin rather than as an investment vehicle with an expectation of profit.
It must be emphasized that an investor merely purchasing a Stablecoin with the expectation of profit will not render the transaction a security transaction requiring registration unless the profits are expected from the activities of the Issuer or some other third party. For example, profits from the increased market cap of a rebasing algorithmic Stablecoin would likely be from the activities of the Issuer in making decisions about the supply/value of the various tokens in the Stablecoin ecosystem.
However, where profit made/expected is incidental to the use of the Stablecoin for functionality or not based on the managerial/entrepreneurial effort of the Issuer, it is highly unlikely that such issuance will be treated as a Securities Transaction.
Irrespective of the security status analysis, a fixed-redemption fiat-collateralized Stablecoin would very likely be regarded as receipt of deposit. This is because the Issuer receives value from the Investor/User and, in turn, gives the Investor/User of the Stablecoins the assurance that such Stablecoins can be redeemed for a specific amount of money.
This classification implies that the Issuer of such stable coins would likely be subject to the provision of BOFIA and must consequently be incorporated in Nigeria and obtain a banking license from the CBN. A non-bank Issuer looking to issue such Stablecoins would likely have to treat the investment from Users/Investors as credit and deal with the same as a Capital Market Agent such as a Broker, Fund Manager etc.
Similarly, irrespective of the security status analysis of the Stablecoin itself, the Sharecoin in a Seigniorage algorithmic Stablecoin may be treated as a participatory interest in a collective investment scheme. Such classification will trigger registration requirements with the SEC.
COMPANY TYPE CONSIDERATIONS
Private companies are prohibited from acting as Issuers of Stablecoins in Nigeria. This is because private companies are generally prohibited from inviting the public to subscribe to their securities and/or deposit money for fixed periods or payable at call.
Consequently, regardless of the classification as a Security, Digital Asset, Virtual Asset or not, private companies cannot issue Stablecoins. Stablecoins are typically issued by Public Companies while most State Bodies would rather issue Central Bank Digital Currency, as was done by the Central Bank of Nigeria when it issued the e-naira in 2021.
In addition to the regulatory requirements set out above, there are various practical requirements that a prospective Issuer of Stablecoins must comply with and some of these requirements are incidental to meeting regulatory obligations.
The Issuer must publish a whitepaper alongside its tokenomics and roadmap, the Issuer must also provide its Coin name, proposed ticket symbol, Github link tokenomics and roadmap, provide general information such as Coin name and proposed ticket symbol, Github Link and the team behind the token.
The Issuer must also meet prudential requirements such as risk management framework, business continuity plans, security arrangements as well as orderly failure and insolvency plans.
In essence, a prospective Issuer would have to meet the listing requirements of major cryptocurrency exchange platforms in order to receive acceptance and adoption. These requirements vary across exchange platforms and are regulated and updated.
All prospective Issuers of Stablecoins in Nigeria or targeting Nigeria are, on a preliminary note, required to register as a VASP in Nigeria and file an initial assessment filing and possibly required to register the proposed Stablecoins with the SEC.
Where the Stablecoin is backed mostly by Naira-denominated instruments and partly by other means, it is likely that the Issuer will be required to obtain a banking license and possibly register with the SEC where, for example, it is a fractional algorithmic Stablecoin.
It must be emphasized that final thoughts cannot be communicated in the absence of a draft/proposed whitepaper and even in the presence of same, there will likely be need to seek various clarifications from the Regulators.