The European Commission adopted the new standard contractual clauses (SCCs) regarding transfers of personal data on 4.6.2021, and according to the transition period, they must be fully implemented by 27.12.2022 at the latest.

The SCCs refer to standard agreements drawn up by the EU authorities, the aim of which is to provide different actors with an easy-to-use means of protecting personal data in international data transfers. In practice, SCCs are used in the same way as standard contracts in situations involving transfers of personal data from the EEA to third countries; the SCCs are therefore an agreement on the ways in which personal data must be protected in international data transfers.

Why are standard contractual clauses needed?

When personal data is transferred between different actors from the EEA to third countries, according to the EU’s General Data Protection Regulation (GDPR), the transfer of personal data must be adequately protected. According to the GDPR, SCCs can be used as one way to protect personal data in data transfers.

While SCCs are a means of protecting personal data offered and approved by the EU authorities, in practise, they are most commonly used as a means of protecting personal data in international data transfers. This manifests e.g. in that practically all internationally operating digital service providers utilize the SCCs as a part of their standard contracts. 

The advantage of SCCs is their pre-approved standard form. This saves both time and money and is particularly advantageous for SMEs that do not have the resources to negotiate individual contracts with each contract partner.

Why have the standard contractual clauses been changed?

During the old Data Protection Directive, the Commission approved three sets of standard contractual clauses that remained in force after the GDPR entered into force on 25.5.2018. In addition, at that time the Privacy Shield arrangement between the EU and the United States was in force, which was intended to guarantee an adequate level of data protection when data was transferred from one region to another.

The reason for changing the standard clauses was the desire to update them to meet the requirements of the new legal framework, namely the GDPR. The goal was also to take into account the new case law, especially the so-called Schrems II judgement (C311/18), in which the European Court i.a. invalidated the Privacy Shield arrangement because the US legislation did not ensure a level of data protection that was equivalent to the EU level. Moreover, the case was simply that the old standard clauses could no longer keep in pace with the modern digital economy: as the number of parties to contracts increased and the need for complex chains of contracts arose, it was appropriate to update the structure of the standard clauses to be more approachable and flexible.

How have standard contractual clauses been changed?

The core content of the SCCs has remained the same. As before, the current SCCs include commitments to essential data protection principles, data security obligations, third party beneficiary rights and submission to the jurisdiction of EEA data protection authorities and courts.

In terms of changes, first of all, the structure of the SCCs has been changed to enable a wider range of data transfer scenarios. This has been done by creating a module structure from which users can choose the module corresponding to each transfer situation. With this, it has been possible to replace three SCCs with one module-structured SCC. In addition, the standard clauses now permit new parties to join the SCCs throughout the lifecycle of the contract and include a list of attachments for providing information about each data transfer.

Second, the update has also introduced substantive changes: now the SCCs meet GDPR requirements and include enhanced transparency obligations as well as more detailed clauses on data subject rights, data breach notification and rules for onward transfers. In addition, with the update, the Schrems II judgement has been implemented, so the parties to the contract must henceforth carry out a case-by-case assessment of whether a level of data protection corresponding to the EU requirements for the transfer of personal data is guaranteed and assess the need for the use of additional protective measures (so-called "transfer impact assessment"). Disclosure obligations and the obligation to resist unlawful requests have also been added to the SCCs.

Data protection agreements concluded after 27.9.2021 must be based on the new SCCs. A transition period of 18 months has been granted for those entities that have entered into a data protection agreement using the old standard clauses. This transition period ends on 27.12.2022. At that time entities must replace the previous SCCs with the new SCCs, including the annexes. However, if the contracts are modified before the end of the transition period, the parties must switch to using the new standard clauses immediately.

Our Associate Trainee Savva Kuparinen took part in writing this article.

New Standard Contractual Clauses (SCC) and Data Transfers

Based on current information, there will be significant changes in Finland’s taxation in upcoming years, which every current or future entrepreneur should take into account in their own activities. These changes will involve both the development of entirely new types of taxes and the tightening of existing ones.

This fall, we will be looking at these upcoming changes in our articles. This article focuses on one of the taxes referred to above, the so-called exit tax.

The exit tax is a new tax that, subject to certain limitations, aims to tax the increase in value of individuals’ assets when they move out of Finland. The Ministry of Finance published a draft proposal for the upcoming amendment on 12 August 2022, with the aim of introducing the exit tax as early as the beginning of 2023.

According to the draft, the exit tax would apply to the calculatory increase in value of an individual’s assets (e.g. the deferred capital gains would be in the focus). The calculatory increase in value of an individual’s assets would be determined by deducting the assets’ acquisition cost from the probable transfer price (as per the day prior to moving out of Finland). This calculatory increase in value would be regarded as capital income in the taxation of the year when moving out or, if the taxpayer so requests, in the year in which the assets are actually transferred, up to the following eight years, after which the tax liability would cease.

The aim of the exit tax is to apply to all domestic and foreign assets, excluding real estate and housing shares as well as the companies that typically own them. The draft specifically notes that the exit tax will also cover crypto-based assets. The tax is intended to be comprehensive; therefore, it is irrelevant what legal form the business has. 

Under what condition is the exit tax applied?

The draft lays down certain conditions for the exit tax, which, if met, would apply. The conditions consist of 1) the euro-denominated threshold values; and 2) the tax residence requirement of individuals in Finland. These are presented in more detail below. 

The exit tax will not apply if the total value of the assets subject to the calculatory increase in value is less than EUR 500,000 or if the calculatory increase is less than EUR 100,000. If both above-mentioned euro-denominated threshold values ​are exceeded, the exit tax would be paid on the excess of the calculatory capital gain of EUR 100,000, and that gain would be taxed according to the capital gains tax rates (30 – 34%) under Finland’s Income Tax Act (1535/1992). 

The exit tax would apply to natural persons who move out of Finland, who have had unlimited tax liability in Finland and have lived in Finland in accordance with the possibly applicable tax treaty for at least four of the ten years preceding the move. Therefore, tax liability also arises for non-Finnish citizens.

In particular, the exit tax would affect entrepreneurs who have created and grown their businesses from scratch. If such an entrepreneur moved to another EU member state or outside the EU altogether, he would have to pay the exit tax, even if he has not actually sold any of his assets. Moreover, the calculatory increase in value of the assets of such an entrepreneur is likely to be high, given that the acquisition cost can be regarded as close to non-existent and that the assets typically consist of other resources than real estate or housing shares.

On the other hand, the exit tax will most probably affect the attractiveness of Finland and, consequently, the attractiveness of Finnish companies. Attracting labor from abroad can be challenging when the exit tax also applies to non-Finnish individuals. Internationally competitive employees have the choice to work in whichever country they want. They may not find settling in Finland for a longer period of time and thus subjecting themselves to the exit tax particularly attractive.

What consequences may the exit tax cause?

In the worst case, the exit tax may force entrepreneurs, even before starting a business, to decide whether it would be wiser to set up a business in a country with no exit tax if the aim of the business is international growth and a possible subsequent move from Finland. This may lead to Finnish startups being set up outside Finland and thus withering away the entire startup infrastructure.

The threat for entrepreneurs is that if the company was founded in Finland and the move abroad happens at a stage where the valuation of the company's ownership exceeds the set euro-denominated threshold, the entrepreneur must pay the exit tax, even though the company may not have generated any cash for the entrepreneur yet. As a result, the entrepreneur may have to liquidate his or her assets or find another way to organize his or her personal finances to be able to pay the exit tax.

The exit tax, if implemented, would constitute a significant change to Finnish taxation. However, it should be noted that its final content is not yet finalized and may be subject to changes after the hearing rounds. 

In addition, when it comes to the exit tax, it is important to follow the upcoming Finnish parliamentary elections, which will be held in April 2023. The National Coalition (Fin. “Kansallinen Kokoomus”), currently leading in the polls, has announced that it does not accept the exit tax and will abolish it if it gets into government. Thus, even if implemented, the exit tax may be very short-lived or even not be enacted at all.

At Nordic Law, we assist our clients in a wide range of tax law issues, and we are happy to discuss future changes and their impact on your business planning. Do not hesitate to contact us. 

Our Associate Trainee Mikael Huhtala took part in writing this article.

New and old taxation – the proposed exit tax and its implications

Who's Who Legal: Jon Hautamäki is one of the leading Fintech & Blockchain lawyers

Who's Who Legal has named our Managing Partner Jon Hautamäki as one of Finland's leading Fintech and Blockchain lawyers in 2022. Jon received the same designation from Who's Who Legal in 2021.

Who's Who Legal recognises the leading lawyers in their respective fields by country. The leading Fintech and Blockchain lawyers recognised by Who's Who Legal are known for their first-class expertise and experience in advising financial institutions, investors and regulators on matters concerning, for example, Fintech, payment institutions and e-money.

Our firm congratulates Jon on his honourable designation!

It is time for the fourth installment of our 8-part series covering different crypto phenomena, and this time we dive into one of the most revolutionary topics in the financial world – decentralized finance, DeFi.

In this article, we will guide you through the basics of DeFi as a phenomenon, what possibilities it offers and what drawbacks DeFi systems have. This is a long one, so strap in for a thrilling journey into decentralized finance.

The DeFi system can be characterized as a collection of finance applications that use blockchain technology and seek to democratize finance in a way that replaces traditional financial institutions and intermediaries with (automated) smart contracts on a blockchain.

In the traditional financial system, all transactions require an intermediary. To buy and sell stocks or to send money to another person, the services of an intermediary is required to complete the transaction (e.g. a stock exchange, bank or a payment service provider). DeFi aims to cut out the oh-so traditional (e.g. centralized) middleman and replace it with blockchain-based smart contracts that allow peer-to-peer transactions without having to trust and utilize intermediaries and pay them transaction fees. Simply put, DeFi participants are part of a peer-to-peer network where assets can be transferred automatically via smart contracts without the need for a centralized entity that controls access to their users’ funds or financial services.

DeFi has already been adopted as the bedrock in a plethora of different crypto projects’ financial systems. At least six different categories for DeFi usage can be recognized in the current market:

Stablecoins are crypto assets that have their value attached or “pegged” to another asset (usually the United States Dollar), and they retain their value by having the stablecoins backed by, for example, 1:1 ratio with the US Dollar. The most prominent stablecoin in the crypto market is the USD-pegged Tether, or USDT, which provides investors a way to invest in cryptocurrencies and not having to switch between fiat currency or other crypto assets in order to maintain their portfolio value; owners of crypto assets can trade their assets to a stablecoin in order to lessen their exposure to risks induced by high volatility crypto assets or unstable markets.

How are stablecoins relevant in DeFi systems? Stablecoins usually act as enablers for these systems to work. Firstly, they serve as a stable medium of exchange to enable investors to enter and exit DeFi ecosystems without having to carry the risks associated with volatile crypto assets or unstable market conditions. Secondly, they provide an agile way to users to deposit their more volatile crypto assets as collateral in exchange for a stablecoin loan, which can the be utilized in different transactions inside a DeFi ecosystem (see “Lending” below).

As opposed to using any crypto assets as means of payment, DeFi projects enable users to spend their crypto in stores and online merchants with no costs to the users, using decentralized instant payment networks. Some of the networks can utilize their own issued crypto tokens that can be used as collateral, which settle the transactions made on the the payment network’s blockchain. The merchants pay these networks a processing fee that the network then pays to the collateral provider(s).

Traditional centralized exchanges (or ‘CEXes’) require an intermediary to facilitate trading between interested parties. In CEXes, the “centralized” means any of the big crypto exchanges you see today – Coinbase, Binance, Crypto.com and so on. These CEXes provide a custodial (CEX-specific) crypto wallet that contains a user’s crypto funds. The CEXes safeguard the cryptos on the users’ behalf, and the users do not have the private keys of the wallet to directly control their own crypto. Instead, users can only access their crypto using the login information they have created in tandem with creating a user account in a CEX and trade their crypto via the CEX.

Decentralised exchanges (or ‘DEXes’), on the other hand, are used for facilitating crypto asset trading by executing trades through smart contracts without the aforementioned centralized intermediaries. DEXes do not require account creation, and the users themselves are in full control of their own crypto assets, along with the wallet’s private keys.

As opposed to traditional trading platforms, some DEXes do not have market makers and allow only for transactions to happen between two individuals sharing exact opposite interests – in other words, peer-to-peer exchanges. In addition to peer-to-peer exchanges, other variations of DEXes are decentralized order book exchanges and automated market makers.

The former variations often have something called reserve aggregation implemented in the smart contracts, which enable users and liquidity providers to bid and ask prices for a certain trading pair in the smart contract which automatically accepts the best offer and executes the trade on the users’ behalf.

The latter variation is a liquidity pool that holds at least two types of crypto assets in a smart contract and allows anyone to deposit one type in exchange for the other. As opposed to reserve aggregation, the prices for a trade are set automatically by the smart contract, which regulates the availability and price of the crypto tokens traded through the liquidity pool.

Collaterized lending is the most widely used lending function in DeFi – the function allows borrowers an access to new trading funds while depositing their own existing funds as collateral without having to sell them. Lenders can deposit their crypto assets into liquidity pools, and borrowers can borrow these assets from the pools by depositing their other crypto assets as collateral. For example, a user of a certain (DeFi) lending protocol can borrow the DAI stablecoin by depositing a certain amount of ether as collateral which is liquidated in case of a payment default by the borrower. Lending protocols often involve some form of collateral, and in case of liquidation, the smart contract offers the collateral up for auction to market makers at a discount in exchange for the stablecoin used in order to help the stablecoin to maintain its peg to the asset it is pegged to (see “Stablecoins” above). Other iterations of collateralised debt are, for example, peer-to-peer liquidity provision and credit pools.

In addition to collateralised lending, some DeFi protocols offer uncollateralised lending whereby depositors of collateral can delegate their credit lines to third parties. A potentially dangerous sub-category of uncollateralised lending is so-called flash loans, in which the loan is granted on the condition that the loan capital is received, used and repaid during the same set of blockchain transactions. These flash loans can be used for refinancing and arbitrage, but they have also been used in some attacks on DeFi systems, including market manipulation.

Insurances in the DeFi ecosystems focus on the inherent risks of the blockchain environment. Such risks include smart contract failures or bugs, hacks or governance risks. Users deposit crypto assets as collateral in exchange for insurance tokens that grant their holders rights to insurance premiums collected. If a smart contract failure or other “insurance event” takes place, the collateral is used to reimburse the insured.

In traditional finance, if an investor wants to profit from price fluctuations in capital markets, they can use derivatives. Derivatives are financial instruments that represent a certain stock that the trader does not own but wants to buy or sell. Such derivatives can be, for example, futures, credit default swaps, forwards or options.

In the DeFi ecosystem, synthetic assets (or ‘synths’) are derivatives that are tokenized (ie. the derivative is added on the blockchain and it becomes its own cryptocurrency token). Synthetic DeFi tokens can be divided to at least two categories: asset-based and event-based tokens.

Asset-based tokens are somewhat closely related to lending protocols. Users can deposit crypto tokens as collateral, and in return they are issued debt which they can use to trade other synthetic tokens that track the value of other assets. Some asset-based synthetic DeFi tokens represent a basket of crypto tokens, much like a traditional investment fund with multiple different assets in their portfolio.

Event-based tokens gain value from any observable event. With event-based tokens, users deposit collateral and receive a set of tokens that they can use to predict the outcome of said event, with each token of a token set representing a certain potential outcome of the event. The tokens can be traded between traders to reach a desired prediction “portfolio”. Profits can be made if a certain set of potential outcomes comes to pass, which is when the collateral deposited is paid out to the token holders that predicted the outcome of the event right. Such an event could be anything, for example, whether bitcoin (BTC) reaches a certain price before a certain date.

As DeFi systems are based on smart contracts – lines of code – they are always subject to the risk of being hacked or having bugs, which can lead to the loss of millions of dollars. If the coding in said smart contracts is flawed, malicious users can exploit weaknesses in the code and steal user funds. A case can be made, for example, of the DeFi stablecoin system Terra Luna, which was subject to one of the largest crashes in the history of crypto due to an unprecedented flaw in the system that ultimately lead to the depegging of their stablecoin pair, which set in motion a “bank run” where all investors cash out and the price of the asset crashes to virtually zero.

The Luna smart contract was coded so that it if you sold the stablecoin Terra, the smart contract guaranteed you one dollar’s worth of the native token Luna. After the depegging of the stablecoin Terra (ie. the price of Terra was not tied to the dollar), users could exploit this feature in the smart contract and print Luna tokens indefinitely.

Given that DeFi systems are unregulated, the risk of scams and fraud are ultimately carried by the investors (institutional or retail). The current DeFi sphere makes it possible for tax fraud, money laundering and pump-and-dump schemes to happen. While not specifically a DeFi-issue, the crypto sphere in general has witnessed multiple rug pulls, where project developers abandon a project after an ICO or token launch, cash out and disappear with investor funds.

Multiple DeFi applications work in a way that keeps their users anonymous so that they do not have to verify their identities. This can be seen as a double-edged sword as while anonymity is seen as a cornerstone for the decentralized aspect of DeFi, this also makes it hard to hold accountable malicious actors that could benefit from fraudulent behaviour as described afore.

While DeFi offers possibilities the traditional financial markets have not seen before, there are still some unaddressed regulatory issues that could be seen as beneficial for the greater good and security of investors in the DeFi world. DeFi offers solutions that enable anyone with an internet connection to trade, lend, borrow, invest and pay without banking credentials or necessarily having to disclose their identity to anyone. This can democratize finance in a way that allows people from relatively poor or disadvantaged financial or social backgrounds to accumulate wealth in ways that the centralized system can not provide. Nevertheless, due to the regulatory vacuum they are in, DeFi applications inevitably expose investors to risks without the possibility of claiming damages caused by an inherent weakness in the smart contract used or the fraudulent activity committed by malicious actors.

Entrepreneurs planning to implement DeFi in their projects should always account for the risks adhered to using DeFi applications in their business models and prepare for the unexpected legal issues that might present themselves. If you are planning a DeFi project and have questions about what these issues may be, we are happy to assist you in your project.

Our Associate Trainee Patrik Anthoni took part in writing this article.

Decentralized Finance (DeFi)

July went by fast, and it’s time to take a look at our next Crypto Phenomenon!

As a part of our 8-part series covering different crypto phenomena, we wanted to discuss one of the most brand new trends in cryptocurrencies – the metaverse. In this article we will go through the basics of the metaverse phenomenon, what possibilities it offers and what legal hurdles it presents.

Simply put, the metaverse is a 3D virtual world in which people can interact with each other via the internet. The contents and functionalities of metaverse can vary depending on the (metaverse) provider – some can offer virtual real estate, a sandbox-style building world or a social metaverse. As the metaverse is a somewhat new concept, it raises several legal questions that this article shall assess.

This article will not discuss non-fungible tokens (NFTs) per se. If you would like to know more about NFTs, check out our previous article here.

Transactions in the metaverse are usually done with cryptocurrencies or NFTs (for clarity, an NFT can be classified as a virtual currency if it meets the requirements set for virtual currencies; inversely, if the requirements are not met, the NFT is not a virtual currency).

Metaverse is a web where users can interact through avatars and utilize NFTs or cryptocurrencies to purchase e.g. virtual real estate, new apparel, avatar properties or other possible visual goods.

From a copyright perspective, it is important to let the buyer know what rights they actually receive when they buy an NFT in the metaverse and what restrictions apply. Metaverse projects can limit these rights contractually, whereby it can be agreed upon that the buyer of virtual real estate can receive only a license to the real estate located in the metaverse, and the actual IPRs (intellectual property right) inside the metaverse still belong to the issuer/project owners.

Data protection can create its own hurdles to metaverse projects and their regulatory compliance. The general data protection principles, such as data minimisation and purpose limitation set out in  Article 5 of the General Data Protection Regulation (GDPR) could be difficult to comply with in the virtual metaverse environment. The metaverse can bear new categories of personal data, such as the facial expressions of avatars’ faces, body movements and other reactions. The surroundings or behaviour of a user inside the metaverse could, in theory, reveal some sensitive personal data (e.g. political standing, religious beliefs, sexual behaviour or orientation) about them as per GDPR article 9, which would make compliance even more complicated.

Another problem could be the transfer of data outside the European Union. How are the borders between countries defined, who are controllers, processors or data subjects and who are responsible for data breaches?

One of the central legal challenges is the regulation of user interaction and related rights of users, especially from the perspective of criminal law and damages. How could legislation be utilized to interfere with assault, sexual harassment, theft or fraud between users? From these examples, only fraud might be punishable under current regulation, even if fraud is committed in a virtual world through avatars. The first two titles are bound by their wording, which require physical violence or unsolicited sexual touching.  It is noteworthy to mention that a legislative renewal project concerning, among other things, sexual harassment, is currently in motion and the new law is set to come into force in January 1st 2023, after which also other than physical acts could be seen as sexual harassment. The renewal project would clarify the interpretation of such acts in the metaverse as well.

The legality principle in criminal law forces courts to interpret the wording of the law narrowly and forbids them to extend criminal liability using analogue interpretation. In order to extend criminal liability for the aforementioned acts committed in the metaverse, the law would need to be updated to cover the metaverse, or avatars would need to be granted some form of personhood.

As to theft, stealing another person’s virtual property could not be prosecuted since the subject matter of the offense concerns, by its wording, the theft of movable property, not intangible property. From all the current criminal acts, fraud might be the most easy to prosecute since the subject matter of the offence does not require a connection to movable/physical property, and a person could get significant financial gains from virtual assets by committing fraud.

Metaverse can be understood as a 3D virtual world that has similarities with the so-called real world, where people can interact with each other and exchange virtual assets and utilize the metaverse for business, for example holding meetings in a virtual reality environment.

The metaverse in itself is currently a non-regulated phenomenon, and the legal questions surrounding it are still open. Questions regarding the metaverse, cryptocurrencies and NFT tokens are subject to interpretation, and current legislation does not provide a clear framework to answer these questions. Due to non-regulation, all metaverse projects must be vigilant about the possible obligations that might apply to them. Does the project have to register as a virtual currency provider? What data protection obligations apply? What should the project consider when drafting contracts?

If you need a sparring partner in your crypto, NFT or metaverse project, do not hesitate to contact us.

Metaverse

The summer is here, and so far this year has been a bumpy ride for the crypto sphere.

As a part of our 8-part series covering different crypto phenomena, we wanted to bring light to one of the most popular trends in cryptocurrencies – non-fungible tokens, or NFTs. In this article we go through the basics of NFTs and take a peek on their current and future market view.

The legal nature of NFTs is not intrinsically complex, but there are certain aspects in NFTs that are good to understand before diving into the details in order to get a grasp of what NFTs are and how they differ from traditional cryptos.

Simply put, NFTs are a completely unique virtual asset – like a picture or a video depicting digital art – that is stored on a blockchain and built on a certain blockchain standard, usually on Ethereum using the ERC-721 or ERC-1155 standard. At the turn of the year, the transaction costs of Ethereum were rather high, and more and more NFT collections were launched on the Solana blockchain.

NFTs can present practically anything, which means that using NFT technology it is possible to tokenize a car or a building and then saving them on-chain to prove ownership, after which the tokenized item can be transferred from one blockchain wallet to another.

Being a unique digital asset, NFTs cannot be traded in the same manner as regular cryptos; NFTs are unique whereas regular cryptos are identical, making regular cryptos easy to be used as a method of payment. With that in mind, the price fluctuation of NFTs can be strong and unpredictable, since their value is solely based on the subjective estimation of the community. Take tokenized art for example: an orange drawn by a known artist is more valuable as an NFT than a nearly identical piece drawn by the average Joe. A reference can also be made to physical collectible cards and their price estimation mechanism – they gain their value simply through the fact that enough people deem owning the card a great thing. After this the final price of the card is defined with supply and demand, using the same principles to both physical or digital rarity items.

Now that we have scratched the surface on NFTs, we can move on to certain crucial legal aspects currently surrounding NFTs.

The issuance of NFTs starts by creating the NFTs where, for example, a piece of art is tokenized and morphed into an NFT over a certain token standard to be saved on a blockchain. Here is where the NFT issuer usually turns to a third party service provider who has the technological capability to create – or ‘mint’ – the NFTs. In these situations the creator and the minter agree on a minting agreement containing all the responsibilities of the provider and the rights of the parties to the NFTs after minting and other ordinary details from IPRs to non-disclosure.

Anyone can issue NFTs and thousands of people are doing so every day. It should be kept in mind, however, that if the issued NFTs would be considered cryptocurrency according to applicable legislation, it could result in a registration/license obligation (e.g. in Finland an issuer of cryptocurrency has an obligation to register itself to the Finnish Financial Supervisory Authority).

When NFTs are minted, sold or purchased, it is important to agree on the arrangements in a contract, whereby contract law becomes an integral part of an NFT’s life cycle.

From a lawyer’s perspective, contract law in NFTs is nothing out of the ordinary, though it is paramount that the legal expert drafting contracts understands what the object of the contract is – otherwise it is impossible to draft a suitable contract for the situation.

In regard to tokenized art, it is crucial to agree about the restrictions of intellectual property rights and whether the minter gains the right to sell the NFTs on the secondary market in exchange for a royalty paid to the issuer.

It is also important for the NFT buyer to understand what they are really buying. NFTs may contain certain built-in smart contract properties, for example reselling royalties – therefore a thorough research of the NFT planned to be purchased is vital. Without a sufficient understanding of the rights attached to owning an NFT makes it impossible to understand its true value or later use cases. The buyer may plan to divide the bought NFT to smaller fractions for reselling purposes only to find out it is impossible to do so after the purchase. The rules concerning reselling can vary by country, so both the issuer and the buyer must understand the rules and restrictions that stem from the applicable law and different marketplaces.

General ancillary obligations and notions

As already mentioned above, the parties operating in the NFT field must understand the possibility that tokens in question might be subject to additional obligations, such as registration obligation. It is also good to keep in mind both domestic and foreign legal systems and their (possibly) differing interpretations of the taxation of NFTs. Different jurisdictions have alternating views on what kind of a property an NFT should be considered as. Finnish issuers should remember that the created NFT must actually be a clearly separate and unique non-fungible token compared to traditional cryptocurrencies so that the obligations set to cryptocurrency providers are not imposed on the NFT creator, for example in the form of a registration obligation.

Regarding privacy and data protection, NFTs rarely contain any personal data and therefore generally fall outside the scope of the General Data Protection Regulation (GDPR). Data protection on the other hand, has a significant role in NFTs, and it is crucial to carefully consider beforehand the token standard to be used and how the NFT transactions are secured. Data protection has relevance to both the buyer and the issuer – an NFT acquired from a poorly secured marketplace can prove to be a scam and a poorly selected minter can lead to a failed NFT issuance.

Recognizing the boundaries of IPRs is a key part of the value of NFTs. Even though a certain person can be identified as the owner of a particular token, it does not mean that they would automatically be the owner of the IPRs of that token. A person interested in purchasing a certain NFT must understand and recognize the copyrights and other IPRs attached to the NFT. Usually, the issuer wants to cover their position by reserving all copyrights and by giving the NFT to the buyer’s personal use. It is also typical that the issuer has built a function to the NFT through a smart contract that grants the buyer a license to use the token for a certain purpose – to keep it on display in their personal NFT-gallery to be admired by others.

It is fairly common as well that an NFT having a strong brand has been coded to generate royalty revenue to the issuer upon sale – it is used as a way to include brand value directly to the NFT’s other properties. If the buyer does not comply with the terms of ownership, it is possible that the marketplace denies/suspends the rights to the token from the owner – not forgetting the possibility that the issuer institutes a litigation process against the owner and claim damages for a copyright violation. Inversely, the NFT buyer can present own claims in case thee think they have suffered damage in such a case. Thanks to blockchain technology, the interpretation of the matter is hardly ever a matter of evidence but instead of the interpretation of contractual nuances. Therefore, it is paramount that the issuer of an NFT understands what they are issuing, and the buyer understands what they are buying.

Due to the rapid advancement of technology, NFTs are still in a legal gray area and the regulation trend in Europe and the rest of the world is still unclear. The European Council released a proposal for a regulation of the European Parliament and of the Council on Markets in Crypto-assets (MiCA) on September 2020 and the draft proposals on the new money laundering regulation and directive.This legislation will substantially change the legal landscape in the EU for issuers of cryptocurrencies.

If the final version of MiCA will not regulate on a regulatory margin (or if it is not utilized nationally) for issuers, compliance with money laundering legislation or obtaining a license to conduct business other than issuing reference tokens or electronic money tokens will not be required in the future.

To conclude, the parties active within the field of NFTs, should not now or in the future think that innovative technology is a way to avoid regulation. Operators within the field should remember to conduct a thorough due diligence process before launching new business models to avoid possible legal repercussions and to avoid wasting resources.

As Finland’s leading law firm in Web3, we are more than happy to assist you with all NFT related questions starting from legal due diligence of the NFT all the way to the actual business operations.

A Legal Analysis of NFTs

May is almost at an end, and what a spring it has been!

This year we decided to launch an 8-part article series about different blockchain and crypto phenomenons, and what their legal implications are or might be. From the metaverse to filing your taxes, we aim to shed light on some of the most basic as well as the most novel topics revolving around and evolving in the blockchain and crypto sphere.

This article series will cover one phenomenon each month and, as it is tax season, first we delve into the taxation of cryptocurrencies in Finland. During the rest of the year we will cover hot topics, such as NFT:s, De-Fi and Web3 (don’t worry, we’ll surprise you with the rest).

At the moment, the taxation of cryptocurrencies in Finland is not specifically mandated by law, but rather by guidelines from the Tax Administration and rulings of the Supreme Administrative Court of Finland which equate income from cryptocurrency as income defined in the Act on Income Tax.

Currently, tax liability for crypto-related transactions can trigger in several ways. Retail investors and companies utilizing cryptocurrencies (including so-called NFTs) should keep in mind that their obligation to pay taxes can trigger, for example, in these situations:

Selling cryptocurrency in exchange for fiat currency;

Swapping one cryptocurrency to another (including, for example trading an NFT for another cryptocurrency such as Ethereum or Solana);

Buying goods with cryptocurrency (for example by utilizing a cryptocurrency-based payment card, such as a Binance Card);

Gaining possession of mining rewards from participating in a “proof-of-stake” or “proof-of-work” mining protocol;

Providing liquidity with cryptocurrencies;

Lending activities with cryptocurrencies;

Margin and futures trading with cryptocurrencies; and

For tax purposes, every instance of spending, using, realizing, selling or trading cryptocurrency that triggers tax liability is treated as a separate transaction. For example, in the case of gains from proof-of-stake mining, every time a miner receives a reward for staking their cryptocurrency, each reward gained is deemed as a separate, taxable transaction.

It is worthwhile to mention, however, that although every transaction generally triggers tax liability, transferring a cryptocurrency between a single owner’s wallets of the same cryptocurrency does not trigger tax liability.

For the average crypto taxpayer, the most common taxable income comes from selling your cryptocurrency in exchange for fiat currency. When a person sells cryptocurrencies with a profit, they are obliged to pay taxes on capital income for capital gains after the actual acquisition cost or a deemed acquisition cost is deducted from the selling price.

On the other hand, if cryptocurrencies are sold at a loss, the taxpayer has from a starting point a right to deduct the losses in their taxes. There are certain exceptions, such as margin and futures trading related losses, that may result in losses being nondeductible due to the current guidelines of the Tax Administration. However such questions should always be reviewed and interpreted on a case-by-case basis.

As is the case with regular assets, investors and companies dealing in cryptocurrencies should take great care when planning their taxes to optimize their yearly deductions. If a tax subject calculates their yearly tax position inaccurately, does not take advantage of possible losses or the cryptocurrency they invested in after taking profits from another one crashes in price, they might end up in a situation where their tax position exceeds their own liquid capital position. That, in turn, may result in personal financial liquidity issues (e.g. not sufficient amount of fiat currency to pay for all realized taxes), which would be avoidable with careful on-going tax optimization during the tax year.

The taxation of cryptocurrencies has maintained its status quo in Finland for quite some time. Our view is that the current treatment of cryptocurrencies with the same rules as capital gains and losses should be specifically included in the Act on Income Tax, as it would bring more certainty and clarity to the tax treatment of cryptocurrencies, as opposed to relying on a court ruling or guidelines. It will, however, be interesting to see how the tax landscape for cryptocurrencies will evolve within the next few years and whether the Tax Administration will also want to participate in the bringing of clarity to the taxation of cryptocurrencies.

If you have any questions regarding the taxation of cryptocurrency, do not hesitate to contact us.

Crypto Taxation in Finland

A Decentralized autonomous organization (DAO) is an internet-native, digital entity with no central leadership. DAOs are based on smart contracts that are deployed on a blockchain. DAOs are managed by their token holders who decide the actions DAOs take by voting on governance proposals.

The founders of a DAO set up the entity by creating a set of rules for it by using smart contracts. The founders then usually ‘raise capital’ by issuing tokens that give the owners voting rights in all issues regarding the governance of a DAO. After issuing the tokens, the DAO is deployed on the blockchain after which the founders pass on the power to decide on the future of DAO to the token holders.

DAOs are becoming increasingly more prevalent in virtual currency projects, which is why this article focuses on certain legal standpoints regarding DAOs and on categorizing DAOs in the Finnish legal system.

Due to their novelty and unique nature, DAOs are currently in a legal vacuum. When issuing DAO tokens, one must consider how to categorize this transaction. In light of standard IPOs (Initial Public Offering), the transaction would presumably fall under the applicable securities regulations (Finnish Securities Markets Act (746/2012) in Finland). DAO tokens do not, however, particularly fit under any definition found in the Finnish legal system and categorizing the asset must be done by interpreting the current legal framework surrounding the topic. The question is: are tokens securities or a cryptocurrency?

The current market standard dictates as a general rule that all tokens issued in the EU are cryptocurrencies and, as such, depending on the member state, the legal issuing of a token may require registration to the relevant authorities. In the United States, however, the situation is more complex, and the matter is solved using the so-called Howey test, which you can read more about in our Bitcoin analysis. It is worthy to mention that the United States Securities and Exchange Commission (SEC) deemed in its 2017 report that the tokens issued by an organization called “The DAO” were securities according to the Howey test.

Since the issuing of both cryptocurrencies and securities requires registration or a permit, DAOs invoke an interesting question: If DAOs are not seen as legal entities and the law does not recognize them as a legal person with certain rights and responsibilities, does the issuing of DAO tokens require registration or a permit and if so, how could such a requirement be enforced?

As stated above, new emerging legal phenomenons, such as DAOs, may be regarded to have an unclear legal status at the moment. Since the Finnish legal system (generally) requires that an organization must register in order to achieve legal personality, a decentralized organization such as a DAO cannot per definition satisfy these demands. This means that a DAO cannot by itself have ownership rights, do legal actions or gain rights or responsibilities. However, nothing prohibits a company from incorporating the use of a DAO in their business, although this might corrode the decentralized aspect of it.

In theory, DAOs could be categorized as unregistered associations according to the Finnish Associations Act (503/1989). For this to happen, a DAO would need to be a non-profit organization and all economic activities would need to be written in its rules. A DAO’s rules are etched to the blockchain but the requirement of non-profitability is probably not met in the majority of these projects.

As the situation stands, DAOs must be understood as coalitions of natural and legal persons that are acting on the basis of a blockchain based agreement to achieve a common goal. Therefore, it can be concluded that DAOs should be first and foremost be interpreted in light of basic principles of contract law.

The current Finnish legal system seems unable, at first sight, to direct and/or impose any legal effects on DAOs themselves, but is it possible to extend these effects on DAO token holders?

DAO token holders can either be natural or legal persons. The token holders agree together on the legal transactions they wish to do, after which one or several of them approach a third party with the intent of conducting a business transaction. For example, this could mean the trade of tangible property which is governed by the principles of contract law. In certain situations, the token holders who participated in the trade can be held jointly liable for the therein related obligations, for example when a breach of contract or a debt is at hand.

If DAO tokens are viewed as a cryptocurrency according to the Act on Virtual Currency Providers (572/2019) or obligations are imposed on them by securities market regulations being applicable, it is difficult to find joint liability justifiable – a DAOs’ minority token holders with little to practically no influence on the outcome of the votes would have to carry the same responsibility as large token holders regarding the decisions that the latter essentially makes. On the other hand, holding DAOs’ large token holders accountable for the decisions made could be better justified since they have an actual effect on the governance of the DAO. During the funding phase of a DAO, before deploying it on the blockchain, it would in theory be fair and possible to extend liability to the founders a DAO without having to assess the relative ownership of the token holders.

The above interpretation can find support in the guidance of the Financial Action Task Force (FATF). According to FATF, a DAO and the possible obligation to register as a virtual currency provider should be determined with the so-called owner/operator test. The test helps to ascertain whether a DAO has a (centralized) party involved that has effective control over a DAO, thus making it less decentralized – such a party might in theory be obligated to register as a virtual currency provider.

Because of the novelty of DAOs as a phenomenon, liability questions surrounding the topic are very much subject to interpretation. Projects that are considering including DAOs as a part of their business should always evaluate the planned DAO and its possible governance token on a case-by-case basis and assess the distinct features of it in advance, which consequently helps to identify the applicable regulation.

A DAO is to be regarded as a blockchain and smart contract based decentralized decision-making body that allows its token holders to decide together on the actions of the DAO by making governance proposals on the blockchain. The Finnish legal system does not currently recognize DAOs as legal entities and utilizing DAOs as independent tools will most likely lead to token holders’ personal liability.

The above being noted, DAOs unarguably offer very interesting and unique instruments essential to the so-called web3 development. Companies can use DAOs to diversify their fintech-structure, and DAOs can also be regarded to offer a viable modern alternative to the traditional Venture Capital and Private Equity investment models.

As a law firm specialized in projects evolving around fintech and blockchain technology, we at Nordic Law are happy to assist you in any DAO related matters.

The legal standpoints of DAOs in Finland

This is the final part of our article series on top 12 cryptocurrencies and their legal framework within the U.S. and the EU. Last time we wrote about Ethereum (ETH), the undisputed king of altcoins, and this time we close the chapter with a legal analysis of Bitcoin (BTC), the undisputed king of all cryptocurrencies.

BTC was launched in 2009 by Satoshi Nakamoto – an anonymous person or group. BTC is a decentralized peer-to-peer blockchain-based value, which may be used like a currency, and all its transactions happen directly between equal and independent network participants, without the need for permits or facilitation. Please see BTC’s whitepaper for more information.

It has been viewed that BTC’s main advantage in the cryptocurrency market is that it was the first (modern age) cryptocurrency in the market, without forgetting that it is decentralized and has sound technology behind it. While nowadays BTC might not be considered revolutionary anymore, it has inspired countless projects and has been the starting point to a new industry now worth more than 2 trillion dollars.

As we have already mentioned in our earlier articles, it is hard to find a uniform regulatory approach to cryptocurrencies in the U.S, where each State has their own regulation on money transmission and cryptocurrency. As cryptocurrency exchanges are usually involved in fiat-money transmissions, they are obligated to follow money transmission regulations. In addition and for example, New York and Louisiana have their own cryptocurrency licences, which are a stricter way of regulating cryptocurrency exchange operations.

The different interpretations of U.S. authorities do not either pave the way for regulatory clarity. For example, the Internal Revenue Service (IRS) sees cryptocurrencies as property and has issued tax guidance on the matter, whereas the Commodities Futures Trading Commission (CFTC) encompasses cryptocurrencies to be commodities as described in the Commodity Exchange Act. Meanwhile, the Securities and Exchange Commission (SEC) has been indicating that it considers certain cryptocurrencies to be securities by applying the so-called Howey Test, despite its origin in traditional investment contracts, e.g., securities. Under the Howey test, the following questions determine the legal nature of a transaction:

Did purchasers of a financial instrument contribute money (or valuable goods or services)?

Did purchasers invest in a common enterprise?

Were purchasers reasonably expecting to earn profits through that enterprise?

Were the expected profits derived from the efforts of others (e.g., a third party)?

As stated in our article on ETH, the former SEC director William Hinman has stated that ETH and BTC are not considered to be securities. Still, in an interview published earlier this December the current SEC Chair Gary Gensler called all cryptocurrency platforms to register and cooperate with the SEC to ensure investor protection. At the same time SEC approved BTC ETFs this autumn. It is clear that the SEC (and the CFTC) have a significant interest to regulate trading platforms and other cryptocurrency service providers to improve investor protection as well as transparency, but the scale of the regulations remains to be seen.

Based on the Fifth Anti-Money Laundering Directive of the EU (5AMLD), cryptocurrency is as a digital representation of value i) that is not issued or guaranteed by a central bank or a public authority, ii) is not necessarily attached to a legally established currency and does not possess a legal status of currency or money but is accepted by natural or legal persons as a means of exchange and iii) which can be transferred, stored, and traded electronically. Hence, as with all other cryptocurrencies, BTC falls within the 5AMLD’s definition of cryptocurrency.

The 5AMLD obligated the EU Member States to ensure in their national legislations that cryptocurrency service providers (e.g. exchanges and wallet service providers) are subject to similar anti-money laundering, Fit & Proper and customer funds obligations as other financial actors (e.g. payment institutions or electronic money institutions). Hence, the national laws of EU Member States regulate on the obligations related to cryptocurrency service providers.

As currently the national legislations of EU Member States regulate on the obligations related to cryptocurrencies, there remain certain discrepancies between the EU Member States crypto-legislations – though the legal regime can be described as quite uniform if compared to the situation in the U.S.

Certain Member States have established a stricter license system for cryptocurrency providers, whereas other Member States just require cryptocurrency providers to comply with general anti-money laundering obligations. From a longevity standpoint, it is recommendable to comply with the stricter legal regime, as approximately within 2 to 4 years’ time the upcoming EU regulation on cryptocurrencies (MiCa) is going to force the stricter obligations on to all EU Member States (similarly as the GDPR did for data protection).

With the end of this article series, we may say that all good things must come to an end. However, this does not mean that there is not room for new good things.

We found the writing of these articles so fascinating that we are currently on the drawing board planning on a new crypto related article series for 2022. As a lot happened in the cryptomarket in 2021, there are a wide range of topics to choose from – let’s see what we eventually come up with.

#1 Legal Analysis of Bitcoin (BTC)

Since the beginning of this year, we have been publishing articles on different cryptocurrencies and their legal framework within the EU and the U.S. Last month we wrote about USDT, and this month we assess Ethereum’s native token ether (ETH) – the world’s second largest cryptocurrency by market capitalization rate.

Ethereum is the world’s leading decentralized open-source blockchain network with smart contract functionality, initially described by Vitalik Buterin in Ethereum’s whitepaper in 2013. The network went live in 2015 allowing practically anyone to deploy permanent and decentralized applications on to Ethereum network. The users can interact through the applications, for example, by lending cryptocurrencies to each other. The Ethereum network is also suitable for, and currently widely used for, creation and exchange of non-fungible tokens (NFTs).

The network’s native token is ETH, with a current circulating supply of just over 118,5 million tokens. ETH is typically, amongst other things and besides usual trading and payments, used to cover transaction fees and mining rewards, deploy smart contracts, tokenize real-world assets as well as for NFT and stablecoin minting.

Ethereum’s nature as an immutable and transparent platform makes it ideal for a range of application fields, and it is today the most popular platform for decentralized finance (DeFi) application developers. The platform, i.e., the Ethereum Virtual Machine, has so far been used to launch over 10 000 decentralized applications.

As we have already mentioned in our earlier articles, it is hard to find a uniform regulatory approach to cryptocurrencies in the U.S, where each State has their own regulation on money transmission and cryptocurrency. As cryptocurrency exchanges are usually involved in fiat-money transmissions, they are obligated to follow money transmission regulations. In addition, New York and Louisiana have their own cryptocurrency licences, which are a stricter way of regulating cryptocurrency exchange operations.

The different interpretations of U.S. authorities do not in this situation pave the way for regulatory clarity. For example, the Internal Revenue Service (IRS) sees cryptocurrencies as property and has issued tax guidance on the matter, whereas the Commodities Futures Trading Commission (CFTC) encompasses cryptocurrencies to be commodities as described in the Commodity Exchange Act. Meanwhile, the Securities and Exchange Commission (SEC) has been indicating that it considers certain cryptocurrencies to be securities by applying the so-called Howey Test, despite its origin in traditional investment contracts, e.g., securities. Under the Howey test, the following questions determine the legal nature of a transaction:

Based on these four (4) criterias, it is clear that the test is constructed around centralized activities, whereby its overall applicability regarding decentralized cryptocurrencies can be rightly questioned from a legal perspective. It is easy to state that the Howey test with its origin in year 1946 is outdated in the assessment of crypto transactions anchored in blockchain networks such as Ethereum.

This being said, it is important to note that currently ETH is not considered a security by the relevant U.S. authorities. This position was first confirmed by the SEC in 2018 when the former director of the SEC, William Hinman, announced that the SEC will not treat ETH as a security. The direct quote of Mr. Hinman based on Reuters article was: “Putting aside the fundraising that accompanied the creation of Ether, based on my understanding of the present state of Ether, the Ethereum network and its decentralized structure, current offers and sales of Ether are not securities transactions.”

In a more recent event, the current CFTC Commissioner, Brian Quintenz, reaffirmed in his Tweet on 14 August 2021, that the CFTC considers ETH to be a non-security commodity.

Therefore, it can be claimed that currently ETH is not regarded as a security within the U.S. legal regime.

Within the EU, ETH has a clearer regulatory situation than in the U.S. due to the more coherent nature of the EU cryptocurrency legislation. As other altcoins, ETH falls within the scope of the EU Fifth Money Laundering Directive (5AMLD) and is considered a cryptocurrency. As described in the 5AMLD, cryptocurrencies are defined as a digital representation of value i) that is not issued or guaranteed by a central bank or a public authority, ii) is not necessarily attached to a legally established currency and does not possess a legal status of currency or money but is accepted by natural or legal persons as a means of exchange and iii) which can be transferred, stored, and traded electronically. Therefore, entities offering exchange services in regard to ETH, and other cryptocurrency service providers are obligated by the EU Member State’s implementation of the 5AMLD and other national regulation, being subject to conventional EU regulation on customer due diligence, risk assessments, Fit & Proper as well as other applicable national legislation.

Based on the 5AMLD certain Member States have established a stricter license system for cryptocurrencies, whereas other Member States just require entities to follow general money laundering regulations. However, from a longevity standpoint it is recommendable to comply with the stricter Member States cryptocurrency legal frameworks as a planned and upcoming EU legislation package is going to make the EU-wide cryptocurrency requirements quite similar to those of the stricter legal frameworks. You can find more information on the planned EU cryptocurrency regulation in our previous articles.

Stay tuned for our next article, which is also going to be the last one of this article series and cover the undisputed king of the cryptocurrency world: Bitcoin (BTC).

#2 Legal Analysis of Ethereum (ETH)

Changes proposed to the Finnish Lotteries Act

During the last week of September, the Finnish Government proposed major changes to the Finnish Lotteries Act. The goal of these changes is to reduce the adverse effects of gambling in Finland by strengthening the gambling monopoly of Veikkaus which is the Finnish national betting agency. The proposed changes are targeted to the advertising of gambling as well as redirecting Finnish gamblers to the games and services of Veikkaus.

The most central proposed change concerns restricting the advertising of gambling. According to the current Lotteries Act, only the gambling games and services of Veikkaus can be advertised but the prohibition to advertise other gambling games and services has been widely circumvented by many gambling service providers in Finland. Thus, the Finnish government has proposed that a payment transaction ban could be imposed on gambling service providers that circumvent the prohibition of advertisement which would mean that banks and other payment service providers cannot execute payment transactions to these gambling service providers. The ban would require that the gambling service provider is on a so-called ban-list which would be maintained by the National Police Board of Finland. Placement on the ban-list would require a separate injunction by the National Police Board. The prohibition of advertising and a possibility to impose a penalty payment would also be extended to private persons for example social media influencers.

In addition, the Finnish government has proposed that all gambling services must have a mandatory identification method for customers. The proposal does not however elaborate how this would be implemented to other gambling services than Veikkaus. The proposal would also allow the National Police Board temporarily to prohibit the offering of certain gambling services if the legal protection of consumers or the supervision ensuring this is compromised.

The proposed changes will make it significantly harder to offer any other non-Veikkaus gambling services in Finland and will strengthen the monopoly on Veikkaus in Finland. However, it remains to be seen for how long there exists valid grounds for the Finnish gambling monopoly, and whether gambling operators from other EU countries at some point start to dispute the legal grounds for the monopoly.

This article is a continuation of our article series on top 12 cryptocurrencies and their legal framework within the EU and the US. Though the current list of top 12 cryptocurrencies has changed quite a lot from the beginning of the year, we continue with the list as it was originally presented in February. Thus, this time we cover Tether (USDT).

USDT is a stablecoin pegged to the value of the US dollar, meaning that one USDT is worth one US dollar. For clarity, the purpose of stablecoins is to create stability and safety in an otherwise unstable (cryptocurrency) market.

USDT is the most used stablecoin in cryptocurrency transactions, and it is issued by a Hong Kong based company named Tether. Originally USDT was built solely on the Bitcoin blockchain, but nowadays it functions also on Ethereum, EOS, Tron, Algorand and OMG.

Tether has during recent years been surrounded by controversy in regard to whether Tether actually has in its possession the fiat reserves backing the circulating supply of USDT. Tether claims that every USDT is always backed by their reserves, which include traditional currency and other assets. Unlike with USDC (the second-largest stablecoin), Tether’s reserves are not audited by neutral third parties, and thus, there are widespread rumors and doubts that Tether would not in reality have 70 billion dollars in their reserve matching the 70 billion circulating supply of USDT. Also, unlike with USDC, the holders of USDT do not have any guarantee for redemption or exchange of USDT to fiat currency by Tether.

As stated in our previous articles, there is no uniform regulation or regulatory authority for cryptocurrencies in the U.S. and each state has their own regulatory regime. The Financial Crimes Enforcement Network (FinCEN) has stated that based on their interpretation, the Bank Secrecy Act applies to cryptocurrencies. This also means that FinCEN has interpreted that its money services business regulations apply to cryptocurrency exchanges and administrators. U.S. states have also applied their own regulations on money transmission to cryptocurrencies and created cryptocurrency specific regulation. For example, New York and Louisiana have their own cryptocurrency licences, which are a stricter way of regulating cryptocurrency exchange operations.

The Office of the Comptroller of the Currency (OCC) has stated that national banks and federal savings associations supervised by the OCC are authorized to receive deposits from stablecoin issuers, including deposits that are considered stablecoin reserves, and may engage in activities that are incidental to accepting deposits from stablecoin issuers. The OCC has emphasized that the banks and federal savings associations must be vigilant with anti-money laundering regulations and Know-Your-Customer procedures prescribed under the Banking Secrecy Act and other federal banking laws. This OCC statement is, however, limited to stablecoins associated with one fiat-currency and redeemable by the holder with a 1:1 ratio, whereby it applies to USDT among others.

The Securities and Exchange Commission (SEC) has stated that stablecoins may be characterized as securities depending on the facts and characteristics of the stablecoin, and whether market participants may structure and sell a digital asset in a way that it does not constitute a security. SEC mainly determines assets as securities if they fulfill the so-called Howey conditions, which determine whether a transaction represents an investment contract, whereby such transactions are also considered as securities subject to applicable securities regulation.

Calls for a more comprehensive regulation scheme on stablecoins have increased lately as different government officials, including the SEC and the Federal Reserve, have called for stricter regulation for stablecoins in light of the already large stablecoin market growing rapidly, and the fact that stablecoins might have a significant part in facilitating payments in the near future. This stricter regulation might include mandatory regular audits or even bank-like regulations.

In the EU, the regulation of cryptocurrencies is somewhat more straightforward and will most likely remain so for a while. Cryptocurrencies (including stablecoins) are defined in the Fifth Money Laundering Directive (5AMLD, EU 2018/843) as a digital representation of value i) that is not issued or guaranteed by a central bank or a public authority, ii) that is not necessarily attached to a legally established currency and does not possess a legal status of currency or money but is accepted by natural or legal persons as a means of exchange, and iii) that can be transferred, stored, and traded electronically. Thus, the EU’s anti money laundering regulations including customer due diligence, risk assessments, fit & proper test for directors and other regulations apply to cryptocurrency exchange operators and custodian wallet providers.

Based on the 5AMLD, some Member States have established a stricter license system for cryptocurrencies, and some Member States just require entities to follow general anti-money laundering regulations. The state of cryptocurrency regulation within the EU will, however, change significantly if/when the EU’s preliminary proposed cryptocurrency regulation (MiCA Regulation) is passed. As per the draft regulation, the definition of cryptocurrency will be amended (e.g. stablecoins shall be separately defined), stricter regulations to cryptocurrency operators will be implemented and new measures to prevent cryptocurrency market manipulation will be introduced.

The EU Commission has also introduced a new legislation package for preventing money laundering and terrorist financing that will also change cryptocurrency regulation in the EU. The extensive regulatory package seeks to extend the KYC obligations of cryptocurrency exchanges as well as to prohibit anonymous cryptocurrency wallets (which most likely is technically impossible). The package is, however, not finalized and thus might be subject to change during the legislative process.

As always, we shall keep you posted on the regulatory changes of cryptocurrencies.

Finally, our article series is approaching its final stages, whereby the only remaining cryptocurrencies are the original crypto heavy-hitters Ethereum and Bitcoin. Thereby stay tuned for the two remaining articles.

#3 Legal Analysis of USDT

This article is a continuation of our article series on the legal analysis of 12 top cryptocurrencies based on their market cap. Though the current list of top 12 cryptocurrencies is not the same as it was in the beginning of the year, we shall proceed according to the original list as it was presented in February. Thus, this time we cover XRP. 

XRP is a digital asset that is built for facilitating trustless, instant and cheap cross-border payments on a digital payment platform called RippleNet. All of this is managed by Ripple Labs, Inc.

XRP is issued on the XRP Ledger, which is an open source, permissionless and decentralized distributed ledger database. The ledger database does not utilize mining and the ledger is maintained by independent participants of a global “XRP Community” where independent validator nodes come to an agreement on the order and validity of XRP transactions. This agreement, called consensus, serves as a final and irreversible settlement. The ledger reaches consensus on all outstanding transactions every 3-5 seconds, at which point a new ledger is issued.

Ripple and XRP are currently in the centre of the most interesting legal dispute in cryptocurrency history. The main legal question of the lawsuit filed in December 2020 by the U.S. Securities and Exchange Commission (SEC) against Ripple Labs is:

The SEC considers XRP to be a security while Ripple, naturally, is of a contrary opinion. The SEC mainly determines assets as securities if they fulfill the so-called Howey conditions which determine whether a transaction represents an investment contract, whereby such transactions are also considered as securities subject to applicable securities regulation. Under the Howey test, the following questions determine the legal nature of a transaction:

Based on the above criteria, it is evident that the Howey test has been constructed around centralized traditional investment activities, whereby its overall applicability regarding decentralized cryptocurrencies can be questioned from a legal perspective. As Ripple Labs steers the development of XRP, the question of whether XRP is centralized is one of the focus points in the SEC’s lawsuit against Ripple Labs. All in all, the case and its final outcome will, not only be highly interesting, but also determine the regulatory situation of all cryptocurrencies similar in nature to XRP.

As stated in our previous articles, there is no uniform regulation or regulatory authority for cryptocurrencies in the U.S. and each state has their own regulatory regime. The Financial Crimes Enforcement Network (FinCEN) has stated that based on their interpretation, the Bank Secrecy Act applies to cryptocurrencies. This also means that FinCEN has interpreted that its money services business regulations apply to cryptocurrency exchanges and administrators. U.S. states have also applied their own regulations on money transmission to virtual currencies and created virtual currency specific regulation. For example, New York and Louisiana have their own cryptocurrency licences, which are a stricter way of regulating cryptocurrency exchange operations. These approaches to cryptocurrency regulation are also backed by the Office of the Comptroller of the Currency which has emphasized that the banks and federal savings associations must be vigilant with anti-money laundering regulations and Know-Your-Customer procedures prescribed under the Banking Secrecy Act and other federal banking laws.

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