Cryptocurrency – a financial asset?
Cryptocurrency – a financial asset?

As cryptocurrency evolves, unique regulatory, tax, accounting and exchange control challenges continue to emerge.

Over the past few years there has been no clear guidance on the regulation of crypto in South Africa. While South Africa is still assessing the best way to regulate crypto, other African countries like Nigeria and Mauritius have become frontrunners in crypto regulation.

The rapid and continuous rise of crypto has necessitated the regulation of crypto in South Africa. In recent headlines, the South African Reserve Bank (SARB) has signaled a serious intention towards regulating the crypto space, including regulating it as a “financial asset”.

How to classify cryptocurrencies is an important question requiring careful consideration as the classification will determine how the market is regulated and ultimately, how it matures and grows.

Understanding what cryptocurrency is

Put simply, cryptocurrency is an intangible, digital form of currency that uses a highly sophisticated type of encryption to regulate the generation of units of currency and verify the transfer of funds.

It is designed to work as a decentralized medium of exchange meaning it operates independently of a financial institution.

There are various types of cryptocurrencies that exist, with the most well-known being Bitcoin. Other major types of cryptocurrencies include Ethereum, Ripple, Tether and LiteCoin.

What are financial assets?

A financial asset is an asset whose value comes from a contractual claim and includes:

  • cash;
  • equity in an entity;
  • a contractual right to receive cash or another financial instrument;
  • a contractual right to exchange financial instruments with another entity on potentially favourable terms.

In order to better understand financial assets, some examples are highlighted below.

Cash and Cash Equivalents

Cash refers to notes and coins which are either on hand or in a bank account. Cash equivalents must be highly liquid investments which are short term and convertible to cash.

A contractual right to receive cash

An example of this would be money owed to you for the provision of goods or services.

Investment Securities

Securities that are issued by entities such as shares, bonds and other investment products that are purchased with the intention of obtaining economic benefit either from capital appreciation of the security product or from interest or dividends paid by the security issuer.

Cryptocurrency as a financial asset?

There are a number of articles stating that cryptocurrency cannot be considered a financial asset on the basis that it:

  • is not cash;
  • is not equity in an entity;
  • does not give rise to a contractual right to receive cash or another financial instrument; and,
  • does not give rise to a contractual right to exchange financial instruments with another entity on favourable terms.

However, if cryptocurrency is considered in a broader context, it could be possible to classify it as a financial asset.

Crypto as cash or cash equivalent

If regard is had to the abovementioned examples of financial assets, it appears that cryptocurrencies such as Bitcoin, is liquid in that it can be converted to cash via Bitcoin ATMs, rendering Bitcoin a cash equivalent capable of being converted to cash.

A contractual right to receive cash (i.e. crypto)

Some businesses accept crypto as payment for goods or services.

Crypto as Investment Securities

International companies such as Celsius Network and Binance allow their users to store their crypto in wallets and they pay users interest on their cryptocurrency which in turn attaches monetary value to their wallets.

In addition to this, international companies are moving towards a trend of issuing crypto as shares in a project and providing the crypto holders with voting rights to have a say in the development of the project.

Despite the foregoing taking place internationally, it is just a matter of time until South Africa follows suit.

In light of the above, if we digress from the traditional definition of financial assets, provision could be made for crypto as a financial asset but this could only be in respect of certain cryptocurrencies like Bitcoin. However, there will always be conflicting views on the classification of crypto.

How other countries are classifying cryptocurrencies

Conflicting classifications of cryptocurrency exist across the globe. Research shows that cryptocurrencies are being classified as follows:

Crypto as a legal tender

Legal tenders refer to forms of money the law says must be accepted in payment of debt such as a national currency. A good legal tender is reliable whereas cryptocurrencies are extremely volatile making its use as a true currency difficult. Despite this, countries such as the Central African Republic have adopted Bitcoin as legal currency.

Crypto as a commodity

In America, the Commodities Future Trading Commission has classified Bitcoin as a commodity as it is said to behave like oil and gold because it can be bought and sold in cash markets. Like crude oil, there are costs associated with generating and using crypto.

Crypto as security

Some cryptocurrencies are issued like shares in “initial coin offerings” and used to represent shares in online projects. For example, a Switzerland based company raised funds in 2017 by issuing crypto tokens that gave voting rights on how the system is developed.

SARBS Approach

SARB made it clear that it views crypto as a financial asset and not a currency given the perceived inability for everyday retail use and the associated volatility.

In addition to declaring crypto a financial asset, SARB intends including it in the definition of a “financial product”. Financial products include, shares, debentures and money-market instruments, amongst others.

As the term financial assets cover investment securities and financial product also covers investment securities, it appears SARB is viewing crypto as a financial asset on the basis that it acts as investment security.

The Takeaway

The classification of crypto is important as it will determine how the industry is regulated. The classification of crypto will also affect the accounting, tax and exchange control, applicable to crypto.

Proper regulation will usher in stability in a notoriously volatile crypto market. The regulatory framework should allow the crypto space to continue flourishing while protecting investors and minimizing the risk to the broader financial system.

Industry players have valuable knowledge to contribute to the regulation of crypto. It is therefore imperative for the regulators and industry players to have continuous consultations to ensure that crypto is not over regulated but instead regulated in a manner that allows the industry to flourish.

Written by: Accelerate Legal Solutions
July 21, 2022