Stabilizing Crypto Frontier: UAE’s Groundbreaking Stablecoin Regulations

The UAE has quickly established itself as a key player in the global virtual asset market, setting standards with its innovative regulatory framework.

In this article, Akshata Namjoshi, Kabir Kuma and Ahlam Faouzi With KARM Legal Advisorsa law firm specializing in new technologies presents an in-depth analysis of the regulations governing the stablecoin market in the United Arab Emirates.

The UAE is positioning itself at the forefront of the global virtual asset sector, becoming a pioneering jurisdiction in developing comprehensive virtual asset regulations. This progressive approach has led to the establishment of the world’s first dedicated virtual asset regulator, Dubai Virtual Asset Regulatory Authority (WARA).

Stablecoins are blockchain-based tokens pegged to fiat currencies or a basket of assets, designed to minimize volatility and serve as a reliable transfer of value in the virtual asset market. These tokens are designed to exhibit lower volatility compared to other virtual assets, serving as a reliable transfer of value in the virtual asset market.

They offer a stable counterweight to more volatile cryptocurrencies and are often used as a mechanism to liquidate investments in virtual assets. Additionally, stablecoins are increasingly being explored for use in payments due to their stability and efficiency.

The UAE’s regulatory framework is robust and detailed, with key regulatory bodies such as Financial Services Regulatory Authority (FSRA) IN Abu Dhabi Global Market (ADGM), Dubai Financial Services Authority (DFSA) IN Dubai International Financial Centre (DIFFC) and VARA, which implement detailed regulations governing virtual assets and stablecoins.

Central Bank of the United Arab Emirates (CBUAE) recently issued a regulation on payment token services by Circular 2/2024 (Payment token Services Ordinance), establishing a comprehensive regulatory framework for payment tokens.

ADGM

ADGM was one of the first jurisdictions to introduce comprehensive regulation of virtual assets, positioning itself as a leader in the sector. FSRA, the regulator of ADGM, has established a detailed regulatory framework for virtual asset service providers (Financial Service Providers (VASP)) within the Financial Free Trade Area. The FSRA’s position on stablecoins is set out in their guidelines for regulating virtual asset activities in the ADGM.

The UAE FSRA recognizes three primary mechanisms for stabilizing stablecoins. First, there are fiat tokens, where the issuer maintains reserves in fiat currency equivalent to the value of the issued tokens. Second, diversification or basket tokens peg their value to a diverse portfolio of assets, including virtual assets, commodities, fiat currencies, and other financial instruments. Third, algorithmic tokens manage the token supply using algorithms designed to stabilize value, resembling the monetary policy of a central bank.

Currently, the FSRA only allows for fully collateralized 1:1 fiat tokens, which requires that each token be backed by an equivalent amount of fiat currency. Regulatory compliance for financial services involving fiat tokens varies depending on the specific services or activities provided.

A unique feature of the FSRA regulatory framework is the regulation and licensing of the issuance of fiat tokens. The FSRA treats fiat tokens similarly to digital representations of money and as a store of value mechanism. Therefore, the issuance of fiat tokens for use in the virtual asset ecosystem and/or as a means of payment is subject to a money services license (issuance and sale of stored value).

Activities related to fiat tokens

Conducting certain activities in relation to fiat tokens is subject to separate licensing requirements. The FSRA has outlined several scenarios involving fiat tokens, providing specific regulatory approaches for each.

Custodians offering custody services for virtual assets and fiat tokens must obtain a license specifically for custody, including virtual assets. Custodians handling only fiat currency and related fiat tokens must have a custodial license with additional requirements for technology governance and reconciliation.

Licensed Multilateral Trading Facilities (MTFs) using their own fiat tokens as payment mechanisms on their platforms do not need an additional license, provided the tokens remain on the platform, subject to reconciliation requirements. MTFs using fiat tokens issued by third parties must conduct due diligence on the tokens, focusing on technology governance, reporting, and reconciliation.

DIFFC

VASPs in the DIFC are regulated by the DFSA, which introduced its crypto token regime on November 1, 2022. Unlike the FSRA, the DFSA does not explicitly allow the issuance of stablecoins, but recognizes fiat crypto tokens issued in other jurisdictions. Fiat crypto tokens have been defined as crypto tokens that stabilize their price or reduce the volatility of their price by pegging it to a single fiat currency.

Activities related to fiat crypto tokens

Since fiat crypto tokens fall under the umbrella of crypto tokens, conducting activities related to fiat crypto tokens is subject to the same licensing requirements as crypto tokens. The exact license category varies depending on the activity being conducted (for example, asset management, trading investments as an agent or principal, providing custodial services, etc.).

In relation to the provision of money services, the DFSA has permitted the use of fiat crypto tokens for the purposes of transferring money or making payment transactions. However, the use of fiat crypto tokens is limited to facilitating the technological side of the business and supporting back-office operations. For example, a money services company may use fiat crypto tokens for internal settlements between branches.

The DFSA only allows financial services related to recognized crypto tokens. An application for recognition can be made by an existing licensee, applicant or token issuer. For fiat crypto tokens, the DFSA has set out additional requirements for token recognition.

Last changes

Recent changes to the DFSA criteria for the recognition of fiat crypto tokens, effective from 3 June 2024, introduced greater flexibility by eliminating specific requirements regarding the proportion of reserve assets. Instead, the emphasis was on ensuring that reserves are held in assets that are likely to maintain their value (including during periods of stress), are highly liquid, appropriately diversified, and carry minimal credit risk.

In addition, the DFSA has revised the definition of fiat crypto tokens, now requiring them to be pegged to a single fiat currency only. This change was made to mitigate the increased risks associated with multi-currency pegging, based on market and regulatory experience.

CBUAE – Payment Token Services Regulation

The CBUAE Regulation on Payment Token Services is based on the Regulation on Retail Payment Services and Payment Card Systems (RPSCS Regulation), which originally established a licensing framework for payment token services. The timing of this regulation is significant as it comes at a time when payment service providers are looking for jurisdictions with a clear regulatory framework that can apply to their specific services and activities. The introduction of the regulation coincides with the EU MiCA stablecoin regulations, which also recently came into force, requiring licensing and establishing a regulatory framework for stablecoin issuers in the EU. In this way, by issuing this regulation, the UAE is positioning itself as a leading jurisdiction in the cryptocurrency and virtual asset sector.

In the new framework, “Payment Token” is defined as a virtual asset (Virginia) the purpose of which is to maintain a stable value by referencing the same fiat currency in which it is denominated or another payment token denominated in the same fiat currency.

There are two main categories of payment tokens:

“Dirham Payment Tokens” which refer to the value of AED, and “Foreign Payment Tokens” such as USDT and USDC which refer to USD. “Payment Token Services” are divided into three main types of activities: Payment Token Issuance (Issuing), Payment Token Conversion (Conversion), and Payment Token Custody and Transfer (Custody and Transfer). Individuals or entities wishing to provide or promote any of these services in the UAE must obtain a license from the CBUAE.

Foreign companies, including those registered in financial fee free zones, may apply for registration to issue Foreign Payment Tokens. Licensed VASPs in the domestic market, licensed by the Securities and Commodities Authority (SCA) or VARA may file an application for registration without objection (OR) to provide Payment Token Services. For example, a VA licensed exchange platform operator may apply for a NOR to perform conversions, and a VA licensed escrow service provider may apply for a NOR to perform deposits and transfers, albeit limited to foreign payment tokens.

Additional considerations include that Payment Token issuers may not offer interest or benefits related to the time a customer holds a Payment Token. The CBUAE may also impose limits on the volume or value of Payment Tokens that may be traded or the total number of customers a licensee or registered entity may accept.

In addition, the CBUAE may designate certain VAs as Payment Tokens subject to certain restrictions. In terms of merchant payments, UAE merchants may only accept Dirham Payment Tokens from licensed issuers, while Foreign Payment Tokens from registered issuers may only be accepted for the purchase of VAs and VA derivatives.

Application

The UAE’s strong and progressive stance on stablecoin regulation underscores its global leadership in the virtual asset industry. Through detailed frameworks in ADGM, DIFC, VARA and CBUAE, the country aims to strengthen market confidence, promote liquidity in investments and support innovation in digital payments. It will be interesting to see how the mixed regulatory oversight models of both VARA and CBUAE evolve in this dynamic landscape.