Assessing the UAE Payment Token Services Regulation

October 2024 | SPOTLIGHT | BANKING & FINANCE

Financier Worldwide Magazine

October 2024 Issue

This article outlines some of the key developments in relation to the new Payment Token Services Regulations (PTSR) in the United Arab Emirates (UAE), what it could mean for the future of cryptocurrency tokens and its potential impact on accepting cryptocurrency for goods and services within the UAE.

The PTSR was issued on 7 June 2024 by the Central Bank of the UAE (CBUAE), the UAE’s regulatory authority for the banking and insurance sector. Following its one-month publication in the Official Gazette, the PTSR came into effect on 6 July 2024. The PTSR establishes a comprehensive framework for the use of digital payment services in the UAE, particularly those made with cryptocurrency ‘payment tokens’ or ‘stablecoins’.

There are significant implications around the introduction of the PTSR, particularly when it comes to the current acceptance of cryptocurrency by merchants for their goods and services in the UAE and what this could mean for new payment tokens denominated in UAE dirhams.

Background

In recent years, the UAE has emerged as a hotspot for cryptocurrency adoption. Driven by a commercially focused regulatory environment and fast-growing financial industries, the regulators of the UAE (including those of the financial free zones) have taken a proactive approach to regulating the cryptocurrency and digital asset sector. For instance, the Abu Dhabi Global Market (ADGM), Abu Dhabi’s financial free zone, was among the first to introduce guidelines on cryptocurrencies and digital assets in 2018. Subsequently, the Dubai International Financial Centre (DIFC) created the world’s first independent regulator for digital assets, the Virtual Asset Regulatory Authority. Further regulations have since been established to clarify and accommodate entities dealing with virtual assets. More recently, the Dubai Courts have, in a landmark case, accepted the issuance of cryptocurrency as a form of compensation of salary payable by the employer to an employee. As a result, the UAE is one of the leading countries in terms of crypto ownership as a percentage of the population according to global digital currencies ownership data by Triple A.

The PTSR broadly regulates services related to payment tokens. What the CBUAE calls payment tokens are known in the cryptocurrency industry as ‘stablecoins’. They act as digital representations of fiat currency such as the US dollar, where the value of the stablecoin is pegged to the value of that fiat currency. They are generally backed by a treasury reserve of the same fiat currency on a fixed ratio to maintain the peg. There are also what are known as ‘algorithmic stablecoins’, a type of stablecoin whose value is maintained by computer code rather than by being pegged to fiat currency. As a side note, the new PTSR prohibits the usage of algorithmic stablecoins and ‘privacy tokens’ – a virtual asset that anonymises the sender and receiver.

The two largest stablecoins by market capitalisation are Tether and USDC, both of which are US dollar stablecoins. Stablecoins serve a significant role in bridging the gap between highly stable real-world assets and often volatile virtual assets. They offer a greater degree of price stability, while allowing the user to continue operating on the blockchain. Additionally, traders often use stablecoins to reduce trading fees since most exchanges do not impose a fee for conversions between stablecoins and other virtual assets.

Prohibition of payment token services and promotions

The PTSR imposes a stablecoin licensing and registration framework that prohibits a person or entity from providing or offering ‘payment token services’ and other related activities within the UAE (or directed to persons within the UAE) without the appropriate licence or registration to perform such services or activities.

The PTSR defines ‘payment token services’ as payment token issuing, payment token custody and transfer, and payment token conversion. Such services may include the launch of a new stablecoin denominated in dirhams or a foreign currency within the UAE, holding and transferring stablecoins on behalf of UAE customers akin to a bank or financial institution, and providing exchange services akin to a foreign exchange house within the UAE. The PTSR also prohibits related activities such as the promotion and marketing of payment tokens without an appropriate licence or registration.

Only entities which are incorporated in the UAE may apply for a licence under the PTSR. For clarity, this includes the free zones but excludes financial free zones, the DIFC and the ADGM. Entities incorporated in foreign jurisdictions (including the DIFC and the ADGM) may apply to become a registered foreign payment token issuer, registered foreign payment token custodian and transferor, or a registered payment token conversion provider. For both licensing and registration, the entity must specify in its application one or more categories of payment token services it intends to provide, which would serve to limit the entity’s activities under that licence. To be granted a licence, an entity must, among other things, meet the initial capital requirements and ongoing requirements relating to corporate governance and risk management, technology and security, business conduct and consumer protection, and anti-money laundering and countering terrorism finance.

A key provision in the PTSR, which has garnered some attention, prohibits merchants within the UAE from accepting virtual assets for the sale of goods and services during the course of business, unless that virtual asset is a licensed payment token or a foreign payment token (provided that the foreign payment token is being used only as a means of payment for the purchase of a virtual asset or virtual asset derivative). On its face, this would mean that established virtual assets such as Bitcoin and Ethereum can no longer be accepted, according to the PTSR, since they are not stablecoins. Further, this provision of the PTSR seems to suggest that foreign stablecoin can only be used to purchase virtual assets, such as non-fungible tokens (NFTs), and for all other goods and services, only dirham stablecoins may be used. This provision is interesting as it extends beyond the regulation of stablecoins, which is the main subject of the PTSR.

Several services are explicitly excluded from the purview of the PTSR. These include services that do not constitute payment token services, such as any activity that requires a licence under the Retail Payment Services and Card Schemes Regulation or the Stored Value Facilities Regulation, providing or maintaining communication networks or distributed ledger technology, providing or maintaining any terminal or device used for any payment token services, activities carried out between licensed payment token service providers and central banks, clearing houses, settlement agents and other similar participants, and payment token transfers and services between group companies, subject to some requirements.

The PTSR contains several exemptions for certain types of payment tokens that pose a low risk to customers and tokens that can only be used for non-financial goods or services provided by the issuer, such as reward or loyalty schemes. The CBUAE also has the authority to exempt a payment token issuer from licensing and other requirements where the required reserve of assets does not exceed 500,000 UAE dirhams and there are no more than a hundred token holders.

Implications for businesses dealing in cryptocurrency and the future of cryptocurrency tokens in the UAE?

The prohibition on payment token services and promotion comes into effect following a transition period of one year from 6 July 2025 and is extendable at the discretion of the CBUAE. During this transition period, the prohibition (as contained in the PTSR) will not apply. Such a transition period will allow businesses and individuals to be regulated under the PTSR. Following the transition period, the prohibition introduced by the PTSR will come into effect and will especially impact businesses that accept cryptocurrency as payment for their goods and services.

What does this mean for the future of crypto payments in the UAE?

Merchants will have until July 2025 to obtain licences and stop accepting non-dirham stablecoins and other cryptocurrencies. However, it could be argued that until such time, businesses can continue accepting a wide array of cryptocurrencies as recognised forms of payment.

Another key observation arising from the PTSR is that currently there are no licensed dirham stablecoins tokens or foreign stablecoins. It stands to reason that over the next year (or until the transition period lapses), several dirham and foreign currency stablecoins will be licensed and registered in order to give effect to the PTSR. The UAE’s ambition to pioneer a central bank digital currency (CBDC) is not new. The CBUAE has launched several successful CBDC initiatives over recent years, starting in 2020 with ‘Project Aber’, a collaboration with the Saudi Central Bank to confirm the possibility for two banks to use CBDCs to settle cross-border payments. In 2022, the ‘mBridge’ Project, in collaboration with the Hong Kong Monetary Authority, Bank of Thailand, Digital Currency Institute of the People’s Bank of China and the Bank for International Settlements, was launched and signified the first phase of a real-value cross-border CBDC pilot. More recently, the CBUAE has published its CBDC strategy for the ‘Digital Dirham’ to address the friction of domestic and cross-border payments, enhance financial inclusion and move toward a cashless society.

Additionally, a wide interpretation of the PTSR suggests the prohibition on the usage of cryptocurrencies (other than stablecoins). In this respect, there seems to be an open question whether businesses could still accept BTC (which is recognised as the legal tender of El Salvador), or if it will be caught under the PTSR’s prohibition. This presents a peculiar interaction where accepting BTC (as a virtual asset) for goods and services is prohibited under the PTSR, but equally, the PTSR does not have purview to prohibit accepting a foreign jurisdiction’s legal tender for goods and services. Applying the current draft of the PTSR, BTC is classified as a virtual asset and potentially also a fiat currency. This potential ‘double classification’ means that payments in BTC might be accepted depending on which classification the CBUAE favours.

Conclusion

The PTSR brings clarity and regulatory oversight for businesses in the UAE currently accepting cryptocurrency for their goods and services, and equally provides consumer protections for those receiving such goods and services. It represents another step in the continued development of the UAE’s regulatory framework with respect to cryptocurrency and virtual assets. While the impact of the PTSR on businesses and consumers may be protracted due to the one-year transition period, it is expected that savvy businesses will aim to obtain the required licences to continue accepting stablecoins. The PTSR also alludes to the imminent release of a CBUAE-backed ‘Digital Dirham’, which may be the first dirham stablecoin and ultimately the virtual currency of choice for businesses in the UAE once the application of the PTSR comes into effect.

Shiladitya Majumdar is a senior associate and Bryce Siu is an associate at Trowers & Hamlins LLP. Mr Majumdar can be contacted on +971 4 302 5101 or by email: smajumdar@trowers.com. Mr Siu can be contacted on +971 2 410 7641 or by email: bsiu@trowers.com.

Shiladitya Majumdar and Bryce Siu

Trowers & Hamlins LLP