Cryptocurrencies, or digital currencies secured using encryption techniques, have seized the imagination of a motley crew of anti-capitalists, financial experts and computer scientists. At the same time, cryptocurrencies operate outside the purview of central banks and have created a regulatory conundrum for governments. Regulation of this digital currency in Africa has been varied, with some countries offering full-throated endorsements while others look to ban or discourage its use. The Central Bank of Nigeria (“CBN”) had adopted an interesting middle ground approach, not looking to either ban or adopt cryptocurrency but offer stern warnings to banks, financial institutions and customers not to transact in it. In January 2017, the CBN issued a statement to all banks and financial institutions prohibiting transactions in digital currencies on account of its volatility. This shaped the tenor of the subsequent regulatory approach by the CBN, the Nigerian Securities and Exchange Commission (“SEC”) as well as consumer protection authorities. However, Nigeria is reported to have the world’s third largest number of users of digital currencies with no adverse impact reported as a result of these actions. We take a closer look at Nigeria’s approach to regulating cryptocurrencies through the lens of regulatory models adopted by other African countries and recent legal developments in the field.
Cryptocurrency Regulation in Africa
African countries have adopted a disaggregated approach to regulating digital currencies in general. Several countries have either decided to ban or prohibit the use of digital currencies. A significant number of countries have not adopted a coherent approach towards regulation at all, deciding instead to let the market grow for now. A relatively smaller number of countries have taken an explicitly progressive approach towards the growth of digital currencies, deciding to either formally adopt the use of such currencies or legalise it to allow for regulation. For instance, Senegal and Tunisia have announced their own forms of digital currencies, signalling a welcome approach. We take a closer look at some African countries that previously had a hard-line stance against cryptocurrencies but are beginning to adopt a more reconciliatory approach.
The Bank of Ghana had previously announced that digital currencies were not licensed or legal within the country, therefore rendering the public that uses it especially at risk. However, this hands-off approach might change, with calls in Parliament to regulate to mitigate the risks of fraud. Moreover, the Governor of the Bank of Ghana recently announced that the country may issue its own digital currency in the future. This ‘sandbox’ approach to digital currencies is also reflected in the country’s Payment Systems and Services Bill, through which cryptocurrencies are believed to be regulated as ‘electronic money issuers’. Similarly, Kenya is also on the cusp of a regulatory overhaul towards cryptocurrencies. Previously, its Central Bank had made announcements declaring digital currencies to be outside the purview of its regulation and therefore prohibited its use. However, the Kenyan government has changed its attitude towards blockchain technology in general, seeing its potential in resolving conflicts over title to land, ramping public health infrastructure and enhancing the transparency of records through smart contracts. On February 28, 2018, an 11 member government task force to study the use of distributed ledger technology was announced. Moreover, the Kenyan Central Bank has also indicated that it is re-thinking its position by announcing a whitepaper on its use. Kenya also offers a window into the potential outcome of lawsuits surrounding the use of cryptocurrencies in jurisdictions that have not specifically outlawed its use but simply declared it to be ‘unregulated’. In 2015, the Kenyan High Court ruled in the case of Lipisha Consortium Ltd and Bitpesa Ltd v Safaricom Petition that bitcoin represented monetary value and that suspension of services for use of bitcoin was justified since the approval of the Central Bank was not received. This category of states – with no explicit prohibition but robust warnings against use – is proximate to Nigeria’s model, and warrants closer analysis.
Concerns Surrounding Cryptocurrency in Nigeria
Similar to several other African countries, Nigeria voiced early concerns surrounding the popularity and appeal of cryptocurrencies. On January 12, 2017, the CBN issued a circular to banks and financial institutions in Nigeria (“2017 Circular”) warning of the risks associated with virtual currency operations. That virtual currencies were unregulated made transactions “largely untraceable and anonymous making them susceptible to abuse by criminals, especially in money laundering and financing of terrorism”, it said. Therefore, “pending substantive regulation” in Nigeria, banks and financial institutions were directed to do the following:
- Not hold, trade or transact in any way in virtual currencies;
- Virtual currency exchanges who are currently customers have effective anti-money laundering and combating the financing of terrorism (“AML/CFT”) controls in place;
- Such AML/CFT controls should facilitate customer identification, verification and monitoring of transactions; and
- Suspicious transactions to be reported to the Nigerian Financial Intelligence Unit.
This was a strongly worded circular that indicated a strict directive to completely ring-fence the financial services sector from the vagaries of virtual currencies. However, the second directive in the circular – that of implementing AML/CFT controls for current customers – also belied a more positive outlook. The 2017 Circular was followed up with a more mildly-worded press release on February 28, 2018 (“2018 Press Release”). The 2018 Press Release states that cryptocurrencies are unlicensed, unregulated and accordingly do not constitute legal tender in Nigeria. Therefore, investors are warned of the lack of any legal redress in relation to virtual currency transactions. A January, 2017 public notice from the SEC also reiterated this hands-off albeit highly cautious approach towards cryptocurrencies, leaving investors in the lurch and the market highly susceptible to fraud.
The combination of a teeming market of cryptocurrency users and exchanges in a largely unregulated market in Nigeria has provided the ideal conditions for fraudulent schemes. For instance, two Nigerian nationals were indicted in April, 2019 by the US Attorney’s Office in the District of Oregon on charges of defrauding investors of approximately USD 60,000 by causing them to transfer bitcoin to virtual wallets with the promise of financial gain. Similarly, users of a Nigerian crypto wallet called Satowallet reported losses of over USD 1 million caused by a scam allegedly perpetrated by third parties. Unfortunately, the CBN played a passive role through this. As early as March, 2017, the Deputy Director of CBN’s Banking and Payment System stated that the “Central bank cannot control or regulate bitcoin. Central bank cannot control or regulate blockchain. Just the same way no one is going to control or regulate the Internet. We don’t own it.” As a consequence, CBN would not be a forum for consumer protection since “We can’t stop bitcoin.” This position was backed by the Nigerian Deposit Insurance Corporation (“NDIC”), which stated that crypto users would not be afforded either consumer protection or insurance. This absence of regulation coupled with the reluctance of regulators to mitigate the risks of fraud in the crypto market may have exacerbated these risks and led to reduced trust in the overall fintech ecosystem.
This approach is beginning to change. The Speaker of the Nigerian House of Representatives called for a legal framework to regulate cryptocurrencies. Moreover, on August 22, 2019, the FinTech Roadmap Committee of the Nigerian Capital Market constituted by the SEC submitted its report to the SEC (“FinTech Report”). The FinTech Report contains the following findings and recommendations in relation to cryptocurrencies:
- Currently, the absence of a classification of cryptocurrencies as commodity, security or currency is causing regulatory uncertainty. The recommended classification is either as a commodity or a security but not a currency;
- SEC should be primarily responsible for the regulation of virtual financial assets exchanges;
- SEC should develop a stringent KYC and due diligence framework for initial coin offerings of digital currencies; and
- All of these should be in place in the first quarter of 2020, as per the timeline laid down by the report.
The direction of the FinTech Report towards regulation of cryptocurrencies is in consonance with developments in the rest of the world. Similar to action by the CBN, the Reserve Bank of India (“RBI”) had also at first taken a hands-off approach by issuing advisories by way of press releases. In 2018, the RBI flipped to the other extreme, prohibiting banks and financial institutions not only from dealing in cryptocurrencies, like the CBN had, but also prohibiting them from transacting with businesses dealing with cryptocurrencies. This meant than banks could no longer open accounts for or service crypto-businesses such as exchanges in any way. A legal challenge against this action by the RBI before the Supreme Court of India recently succeeded. The petitioners had contended that ring-fencing the financial services sector from cryptocurrencies amounts to a shadow ban. The court held that regulation should be proportionate to the risk posed by cryptocurrencies, and in the absence of empirical evidence of damage caused by cryptocurrencies, a ban cannot be considered proportionate. Similarly, the United States, the United Kingdom and the European Union all either already regulate certain aspects of or intend to regulate cryptocurrencies as a whole.
As Nigeria moves away from a hands-off or shadow banning approach towards a pro-regulatory approach, two considerations may be foremost in the minds of policy makers. At the outset, as the FinTech Report indicates, the possibility of regulatory overlap is high. The SEC would have an incentive to classify cryptocurrencies as a security, the NDIC as a commodity and the CBN as a currency – in order to ensure that it is the primary regulator. This would only further exacerbate the regulatory uncertainty that already exists in the market. Therefore, in order to avoid regulatory overlap it is critical that any framework be developed in consonance with all three regulators. This would ensure that not just cryptocurrencies but also other elements of the crypto infrastructure – exchanges, assets, coin offerings – are all adequately regulated by the appropriate regulator. The need for widespread consultation is critical, as was highlighted by policy makers to be lacking in the RBI’s actions towards cryptocurrencies in India. Bringing stakeholders into confidence makes for more effective policy. Lastly, given numerous fraudulent schemes that have shaken the trust of ordinary Nigerians in the crypto market, it is imperative to have robust consumer protection measures in any regulatory framework being envisaged. The Nigerian Government may decide to empower existing consumer protection bodies to investigate and prosecute instances of fraud, wilful misrepresentation and other modes of market manipulation. In the alternative, a specialised consumer protection body may be set up that can work in tandem with the CBN, SEC and NDIC to support the integrity of the cryptocurrency market.
This post is authored by Varun Baliga, a consultant working with Ikigai Law, with inputs from Anirudh Rastogi, founder and managing partner at Ikigai Law. Reach out to us at [email protected].
Disclosure – Ikigai Law represented the crypto-exchanges in their challenge against the shadow ban on cryptocurrencies before the Supreme Court of India.