Are Cryptocurrencies Treated As Financial Instruments?

In the Republic of Cyprus, the field of provision of investment and related services is, at a large extent, regulated. More specifically, the activities of and services provided by investment firms in the Republic of Cyprus are regulated by the Law on the provision of Investment Services and Activities and the operation of Regulated Markets (Law 144(I)/2007) (“the Law”). The main investment activities exercised and/or provided by such investment firms constitute the reception and transmission of orders in relation to one or more financial instruments, the execution of orders on behalf of clients, dealing on own account, portfolio management, investment advice and consultancy, underwriting of financial instruments, placing of financial instruments on a firm commitment basis, Placing of financial instruments without a firm commitment basis and operation of multilateral trading facility being a system that brings together or facilitates the bringing together of multiple third-party buying and selling interests in recognized financial instruments. In any case, however, it is worth to stressed that the aforesaid investment activities are exercised in connection to the financial instruments to which specific reference is made in and, thus, are duly recognized by the Law.

In particular, the activities relating to various financial instruments, specifically listed in Part III of the Third Appendix of the said Law fall within the scope of the Law and are subject to licensing by Cyprus Securities and Exchange Commission, in its capacity as the competent supervisory authority. That said, the scope of ‘financial instruments’ covers -among others- transferable securities, money-market instruments, units in collective investment undertakings, options, futures, swaps, forward rate agreements and any other derivative contracts relating to securities, currencies, interest rates or yields as well as other derivatives instruments, financial indices or financial measures which may be settled physically, in cash or otherwise (as provided in the Law) and any other derivative contract relating to commodities, assets, rights, obligations, indices and measures, which have the characteristics of other derivative financial instruments.

At first sight, it would appear that virtual currencies (a term which includes cryptocurrencies) are not considered as ‘Financial Instruments’ in the legislative meaning afforded to the term, thereby falling outside the scope of the Law. This general rule is subject to an exception in so far as and to the extent that Financial Contracts for Differences on Virtual Currencies are concerned. More explicitly, a Financial Contract for Differences constitute a financial instrument that allows traders to invest into assets without actually owning them (by agreeing to receive the difference between the current value of the asset and its value in the future). However, it must be underlined that it is up to the Central Bank of Cyprus in conjunction with Cyprus Securities and Exchange Commission to decide on the exact way a Financial Contract for Differences on Virtual Currencies shall be treated in each particular case (considering the background circumstances and particularities thereof).

Nevertheless, in so far as the legality and treatment of virtual currencies is concerned, there is a legislative gap that must be addressed especially in view of the expanding tendency of the incorporation and operation of businesses engaged in sectors relating to virtual currencies. Despite, however, the fact that virtual currencies as such are not regulated, due to their volatile nature, the said activities relating to virtual currencies are not currently regulated neither at national or European level, such activities are considered as especially high-risk activities. It is precisely for this reason that the problems that such a company may encounter are not, strictly speaking, restricted to the opening and maintenance of a bank account, but rather extent to the incorporation of the company itself.

Admittedly, considering the current legislative framework, today the differentiation of cryptocurrencies from the ‘recognized’ Financial Instruments constitute a matter of interpretation of the existing legislation regulating the provision of investment services. In light of the foregoing and given the fact that the governmental and other authorities face persons engaged in such activities with reluctance due to the particularity of virtual currencies, the introduction of a precise regulatory framework shall, admittedly, fill in the gap and provide guidance on the implementation and treatment of virtual currencies and related instruments.