Frequently asked questions on virtual currencies and their issuance (Initial Coin Offering)
What do the terms virtual currency, cryptocurrency, crypto asset, ICO and wallet service mean?
Virtual currency and cryptocurrency
A virtual currency is defined in the new Anti-Money Laundering Directive1). What virtual currencies have in common is that:
- they are not issued or guaranteed by a central bank or a public authority
- they are not necessarily attached to a legally established currency (legal tender)
- they do not possess the same legal status as currency or money
- they are accepted by natural or legal persons as a means of exchange
- they can be transferred, stored and traded electronically.
One of the best known virtual currencies is Bitcoin, which is a decentralised virtual currency that can be exchanged for legal tender, such as the euro. It was also the first cryptocurrency, i.e. a virtual currency based on encryption algorithms. A cryptocurrency is built on public and private keys by which value is transferred from one person to another and which are encrypted prior to every transfer.
Bitcoin and other virtual currencies can be considered as a form of asset, but only as long as they have a functioning market. Instead of virtual currencies and cryptocurrencies, the terms crypto or virtual asset are often used. For example, the Financial Action Task Force (FATF), an inter-governmental body working for the prevention of money laundering and terrorist financing which operates under the OECD, uses in its recommendations and guidance the terms virtual asset and virtual asset service provider (VASP). Bitcoin and other virtual currencies are, all things considered, a relatively small phenomenon and, at least for now, they have no impact on financial markets or financial stability.
ICO (Initial Coin Offering) and issuance of virtual currencies
Also associated with virtual currencies is the phenomenon ICO (Initial Coin Offering), which is one method of organising an issuance of a new virtual currency. An ICO is a way of raising risk funding for a business or product development project. It means the advance sale of a new virtual currency or token.
New virtual currencies issued via an ICO may vary greatly in nature, depending on how the ICO is organised. Virtual currencies can be roughly divided into three categories. In addition, hybrid models combining a number of different features have also been observed on the market.
- Payment instrument-like virtual currencies, originally planned as alternatives to traditional currencies and also intended to be used as payment instruments elsewhere than in their issuer’s services. The best known payment instrument-like virtual currency is Bitcoin.
- Virtual currencies used as payment for a certain commodity (utility coin), which can be used to pay for their issuer’s products or services. Generally, the products or services are only at an early stage of their development when the virtual currency usable to pay for them is issued.
- Financial instrument-like virtual currencies, where the virtual currency may have features in common with securities, such as voting and ownership rights or expected returns. These may, for example, be referred to as security tokens.
Stablecoins are cryptocurrencies with a value that is fixed to a predetermined underlying asset, such as a fiat currency, commodities, immovable property or financial instruments. This arrangement is commonly used to mitigate the sudden major fluctuations in value typical for many virtual currencies.
As with other virtual currencies, there are considerable differences between various stablecoins in terms of technological solutions, their features and the way they are used. The applicable regulation will be assessed on a case-by-case basis, depending on the features of the virtual currency to be issued.
Wallet service providers
A wallet service provider means a natural person or entity that provides services to hold, store and transfer virtual currencies on behalf of its customers. Attention should particularly be paid to the fact that activity in which virtual currency is held on behalf of another party is also classified as a wallet service. Outsourcing of storage solutions to technical service providers does not remove a company’s obligation to register as a wallet service provider, if actual control over clients’ virtual currencies is maintained by the company.
What are the risks associated with virtual currencies?
The security, integrity and balance of virtual currency systems are based on the mutual trust of their users. Value formation in virtual currency systems is not covered by the supervision of the Finnish Financial Supervisory Authority (FIN-FSA) nor any other authority.
Virtual currencies are primarily used as speculative investment objects, and their use for payment is secondary. No-one guarantees their value and as a result market prices fluctuate strongly. For these reasons, Bitcoin or other virtual currencies are not a real alternative to money, nor are they good payment instruments. There is also a money laundering and terrorist financing risk associated with virtual currencies, and they are widely used in criminal activity. The FIN-FSA has warned about the risks of virtual currencies.
What regulations must be taken into consideration when virtual currencies are used for trading, when they are accepted as payment instruments, when they are issued or when a wallet service is provided?
Parties involved with virtual currencies must take into consideration the regulation governing them and also stay aware of future regulatory projects.
Fifth Anti-Money Laundering Directive and Act on Virtual Currency Providers
A high risk of money laundering and terrorist financing is associated with virtual currencies. In addition, they have been widely used in other criminal activities. The amendment of the EU’s Anti-Money Laundering Directive, the so-called Fifth Anti-Money Laundering Directive, brought virtual currency exchange services and wallet service providers within the scope of regulation.
The regulatory framework entered into force nationally on 1 May 2019 with the Act on Virtual Currency Providers (572/2019, in Finnish). Under the new national regulations, an entity may provide virtual currency services only if it has been legally registered as a virtual currency provider. In the Act, a virtual currency service means the issuance of a virtual currency, a virtual currency exchange service, and provision of a wallet service. National regulation is more extensive than the Fifth Anti-Money Laundering Directive. The FIN-FSA maintains a register of virtual currency providers. Instructions for registration can be found in the Virtual currency providers section of the FIN-FSA website.
The Act on Virtual Currency Providers also includes provisions on virtual currency providers’ obligations in respect of retaining documents and data, holding of client money, and customer due diligence. The FIN-FSA has also issued Regulations and Guidelines 4/2019 (in Finnish) which further detail obligations over virtual currency providers’ protection and holding of client money as well as customer due diligence procedures.
Investors, miners or those accepting virtual currencies as payment instruments must take into consideration the detailed guidance of the Finnish Tax Administration
Investors who buy and sell virtual currencies must take into consideration the detailed guidance of the Finnish Tax Administration (in Finnish) on the taxation of income from virtual currencies. Similarly, parties who accept virtual currencies as payment instruments or parties who earn them from mining should be familiar with the Tax Administration guidance.
Regulation of virtual currency exchange services partly depends on what kind of virtual currencies are admitted to trading and how payment transactions are arranged
It is essential that parties establishing a virtual currency exchange service carefully review the virtual currencies admitted to trading. Virtual currency exchange services are responsible for determining the nature of each virtual currency admitted to trading and should assess, in particular, whether each virtual currency is a transferable security or other financial instrument referred to in chapter 1 section 14 of the Investment Services Act (747/2012). A security is defined in chapter 2 section 1 of the Securities Market Act (746/2012). Regulation of trading with financial instruments is applicable, technology neutrally, to exchange services in which virtual currencies classified as financial instruments are admitted to trading. Registration in accordance with the Act on Virtual Currency Providers does not therefore in itself cover trading with financial instruments.
Under the Act on Virtual Currency Providers, a virtual currency exchange service must be registered with the FIN-FSA but, in principle, no other authorisation or registration is required if trading takes place in the exchange service with payment instrument-like virtual currencies and/or with virtual currencies intended for payment for a certain commodity (utility coin). If an exchange service accepts from buyers fiat currency (such as euros) or transmits to sellers fiat currency, it must give due consideration to regulation concerning payment institutions which may apply to the organisation of operations, depending on the business model. Further information on payment institution authorisations is available in the authorisations section of the FIN-FSA website.
When arranging ICOs, it is essential to determine the features of the new virtual currency
The applicable regulation to ICOs should always be assessed on a case-by-case basis, because the virtual currencies issued in ICOs vary in terms of their features, and there are also large differences in the ways that ICOs are organised. The most important issue in arranging an ICO is the nature of the virtual currency to be issued and to what it entitles.
Securities market legislation is technology neutral. The virtual currency to be issued via an ICO may also fall within the scope of the definition of a security or financial instrument. A security is negotiable and issued or meant to be issued to the public together with several other securities with similar rights.
The FIN-FSA uses a list of questions in assessing whether virtual currencies are considered to be securities. If a virtual currency is considered to be a security, regulation applicable to issuing a security must be adhered to.
If a virtual currency is not considered to be a security or financial instrument, the general provisions of the the Consumer Protection Act, such as the provisions relating to distance selling, should nevertheless be taken into consideration.
What should I do if a virtual currency to be issued in an ICO is classified as a security?
If a virtual currency classified as a transferable security is issued via an ICO, securities legislation should be adhered to, in addition to the Act on Virtual Currency Providers. In this case, the issuer of the virtual currency may have, for example, an obligation to prepare and publish a prospectus. Further information on prospectus regulation can be found in the prospectuses section of the FIN-FSA website.
Even if a prospectus obligation does not arise, the general principles of the Securities Market Act, particularly chapter 1, must nevertheless be adhered to.
Prospectus regulation must be reviewed with care and enough time reserved for preparing a prospectus. The FIN-FSA reserves 20 banking days for approving a prospectus, from the date when the FIN-FSA has received a prospectus containing all the necessary information.
How does the FIN-FSA provide advice to organisers of ICOs and other parties planning services related to virtual currencies?
The FIN-FSA provides advice to new financial sector service providers centrally via the FIN-FSA Innovation Help Desk. Questions should be sent by email to the Innovation HelpDesk, and as detailed a description as possible of the planned activity appended. Parties planning to organise ICOs must also append answers to the questions which enable the assessment of whether a new virtual currency is considered to be a security. It is recommended that a draft for a white paper also be appended.
Registration granted in accordance with the Act on Virtual Currency Providers does not confer the right to engage in financial sector business activities regulated elsewhere in legislation. Similarly, registration or authorisation granted in accordance with other legislation does not confer the right to engage in business activities related to virtual currencies if the provision of the virtual currency service is other than incidental.
In all business activities related to virtual currencies, it is recommended that due consideration be given to regulatory development. In Europe, there is currently much discussion on the regulation of virtual currencies, and it is recommended that parties involved in virtual currency activities follow international regulatory development as closely as possible. Regulatory development may also affect how the FIN-FSA views the need for various registrations and authorisations of services in the future. The FIN-FSA may update its above-mentioned positions if regulatory development gives cause to do so.
1) According to the definition, a virtual currency means a digital representation that is not issued or guaranteed by a central bank or a public authority, is not necessarily attached to a legally established currency and does not possess a legal status of currency or money, but is accepted by natural or legal persons as a means of exchange and which can be transferred, stored and traded electronically.