How is Cryptocurrency regulated in Bahrain?

Nayel AlBorshaid – Associate ([email protected])

In an age where the virtual world is commonly affiliated with the physical, a degree of confusion surrounds the digital realm with its fast-paced nature. The rise of cryptocurrency has been an exponential one, influencing both the financial and legal industries. The legality of digital currencies are known to few and sought by many. Hence, it is necessary to understand the logic of virtual currency and seek protection through the legal aspect of the same.

Background 

Cryptocurrency is a digital currency that implements blockchain algorithms to facilitate its creation and trade. Digital currencies are decentralised forms of currency, meaning that they are free from any third party interference, whereby no government or central authority is able to distribute or dictate control of it. Coincidentally, blockchain is a set of ‘blocks’ that record information on transactions. A blockchain is a database formed by a sequence of entries called blocks. They feature a special characteristic by which any attempt to modify any of its entries will result in modification of the entire chain.

The Central Bank of Bahrain (‘CBB’) announced a legislative framework in 2019 to oversee and operate ‘Regulated crypto-asset services’ in Bahrain, in keeping with its ambition of becoming the region’s premier FinTech centre. Volume 6 of the CBB Rulebook, which controls Financial Markets, now includes the regulatory framework. Mr. Khalid Hamad, Executive Director – Banking Supervision, said: “We will continue to enhance our regulatory framework in order to keep pace with the innovations taking place in the major financial centres around the globe. The CBB’s introduction of the rules relating to crypto-assets is in line with its goal to develop a comprehensive rules for the FinTech eco-system supporting Bahrain’s position as a leading financial hub in the MENA region”.

The CBB Crypto-asset rules deal with the rules for licensing, governance, minimum capital, control environment, risk management, AML/CFT, standards of business conduct, avoidance of conflicts of interest, reporting, and cyber security for crypto-asset services. They also cover supervision and enforcement standards including those provided by a platform operator as a principal, agent, portfolio manager, adviser and as a custodian within or from the Kingdom of Bahrain.

The guidelines follow the CBB’s creation of a regulatory framework, which allows Fintech firms and other developers in the Kingdom to conduct real-time research in a controlled environment under the surveillance of a watchdog.

Since the establishment of the regulatory framework, a number of cryptographic protocol entities have taken advantage of the opportunity and joined the virtual world, collaborating closely with the CBB in screening and optimizing their technology-based innovative products, agencies, and systems in a monitored virtual space without being directly encumbered by the customary legal and financial prerequisites that would otherwise pertain to their own operations.

Prerequisites for Licensing

Entities who intend to participate in cryptocurrency financing must obtain a license to do so from the CBB, in order to participate and service a cryptocurrency division, such entities are required to apply to the CBB under one of the four categories listed below:

Category 1 – Reception and transmission of orders + Investment advice

Category 2 – Trading in Accepted crypto assets as an agent + Portfolio management & Crypto-asset custody service + Investment advice.

Category 3 – Trading in Accepted crypto assets as an agent + Trading in Accepted crypto assets as a principal + Portfolio management + Crypto-asset custody + Investment advice.

Category 4 – Operate a licensed crypto-asset exchange + Crypto-asset custody service.

Aside from the non-refundable registration fees of BHD 100, applicants will be required to pay an annual fee charge equal to 0.25% of their operational costs, which can span from BHD 2,000 to BHD 6,000 based on the applicant’s functioning capacity. The Regulations mandate a 60-day period for the CBB to decide on license applications.

An entity must be either, (i) registered as a Joint Stock Company or; (ii) a subsidiary of an international firm operating in Bahrain, legally established in line with the regulations of its native jurisdiction in order to be licensed as a cryptocurrency licensee.

The CBB’s regulatory framework on cryptocurrency servicing in the Kingdom also permits foreign entities, already operating in other countries to apply for a license within Bahrain and operate as an ‘Overseas crypto asset service licensee’. To be successful in such an application the CBB will investigate the applicant’s management structure, financial status, its scope of operations, as well as the cryptocurrency related legislation of its native jurisdiction, as part of the vetting process.

A key aspect of the licensing process is the option for applicants to appoint a representative (such as a law firm or professional consultancy) to prepare and submit applications on their behalf.

Prospective/Active licensees are required to maintain a minimum capital investment, according to the categories listed below:

Furthermore, the CBB may, at its discretion, require licensees to hold additional capital in the amount and form determined by the CBB, if this is required (in the CBB’s opinion) to safeguard the licensee’s financial integrity and continuous functioning.

The above applies equally to both ‘Bahraini Joint Stock Companies’ and ‘Overseas crypto asset service licensees’.

Accepted Crypto Assets 

The CBB has the authority to evaluate whether a crypto-asset is suitable for use in licensed crypto-asset services. After obtaining previous written clearance from the CBB, licensees must only provide regulated crypto-asset services for approved crypto-assets. Licensees who wish to use a crypto-asset(s) in addition to those already approved as part of their application process must notify the CBB of their intention to do so and provide all relevant information relating to the crypto-asset; the exchanges on which it is traded, and the additional systems and controls the licensee has or will establish to manage the risks specific to the crypto-asset.

The CBB will consider a number of factors when approving accepted crypto-assets, including but not limited to:

1. The technological experience, track record, and reputation of the issuers and its development team.
2. Issuer’s AML, cybersecurity systems & controls
3. Protocol for the underlying infrastructure (whether it is a unique blockchain with a new architecture system and network, or it’s a blockchain that takes advantage of existing blockchain synergies and distribution channels).

Eligible Investors

Licensees may undertake transactions with a person once they have been registered with the crypto-asset service as a client. Licensees must ensure that the client is:

1. A legal person incorporated either in the Kingdom of Bahrain or in an Overseas jurisdiction (under the law of its place of incorporation) or;
2. A natural person above 21 years of age

Licensed crypto-asset services can only be provided if the Crypto-asset license and its client (i.e. investors) enter into an agreement that includes (but not limited to):

1. The name and address of the licensee, and if it is a branch of an overseas crypto-asset exchanger, the name and address of the ultimate holding company;
2. The regulatory status of the licensee;
3. Details of fees, costs and other charges and the basis upon which the licensee will impose those fees, costs, and other charges;
4. Any soft dollar arrangements (i.e. Commission fees taken by the service);
5. The crypto-asset risk disclosure (as mandated by the CBB under these Regulations).

Conclusion

Many countries have outlawed cryptocurrency due to their uncertain nature. However, cryptocurrency is merely a fraction of the overall evolution that it is based upon; blockchain is arguably the future of commerce, and it is evolving right before our eyes. The internet allows us to communicate, the breakthrough technology of blockchain allows us to trust. The CBB putting in place measures to regulate cryptocurrency is merely the latter stages of a new beginning. The legal world will greatly benefit this early measure being put in place. Like the internet, cryptocurrencies are driven by advances in core technologies along with a new, open architecture – the blockchain. Many view blockchain technology and fintech as merely a new technology for delivery – maybe something akin to CD-ROMs. In fact, it is more likely to do with the financial system and legislative what the internet has done to media companies and advertising firms. The CBB’s introduction of the regulatory framework, in response to the fast-paced nature of the financial world is a testament to the dynamism of the financial markets and the progressiveness of the legal frameworks that regulate them, within the Kingdom of Bahrain.

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