What you need to know about crypto exchange control regulations

Wiehann Olivier is partner and fintech & digital assets lead for Forvis Mazars in South Africa

Some South African natural persons have leveraged cryptocurrency arbitrage opportunities using their R1m single discretionary allowance (SDA) and R10m foreign investment allowance (FIA).

These opportunities arise because exchange control regulations limit the amount of South African assets natural persons can externalise annually, creating price differences between local and international cryptocurrency markets.

The SARB monitors these externalisation events, requiring natural persons to apply for their FIA through Sars e-filing.

The shift from RMS to RM: What it means for South Africa’s debit orders

2 Aug 2024

Arbitrage traders use their SDA, FIA, and South African rands (ZAR) to purchase foreign currencies like US dollars (USD) through brokers.

They send the USD to foreign cryptocurrency exchanges to buy digital assets like Bitcoin (BTC) or US-dollar-backed stablecoins.

These digital assets are then returned to South Africa via the respective blockchains, which are not governed or controlled by any international intermediary and are liquidated in the local market for profit.

Passive and bot trading

Apart from these arbitrage opportunities, many engage in passive trading between local and international exchanges, exploiting price differences in various cryptocurrency markets.

Investors also use techniques like high-frequency bot trading, where automated software executes high-volume trades based on predefined criteria, identifying opportunities and executing trades faster than humans.

Source: Traxer/Unsplash

SARB’s oversight of blockchain-based digital assets has been limited as it does not oversee, supervise, or regulate crypto assets, as it is not considered legal tender.

Despite the Financial Sector Conduct Authority (FSCA) regulating crypto asset service providers, no dedicated laws govern cryptocurrency use in South Africa.

Consequently, natural and non-natural persons can legally move digital assets from local to foreign exchanges or self-custody solutions without restrictions, as local exchanges do not limit the transfer of digital assets to other sources.

This allows natural and non-natural persons to “externalise” an unlimited value of digital assets beyond the restrictions imposed by the SARB.

However, issues arise when investors buy foreign currency using these “externalised” digital assets.

Challenges in monitoring and compliance

Concerns emerge when traders buy BTC locally using ZAR, send it to a foreign exchange, and then use it to purchase foreign currency.

This triggers an externalisation event under exchange control regulations (ECR), contributing to why local exchanges do not facilitate liquidating digital assets into foreign currencies.

Possible contraventions of ECR occur when natural persons exceed their annual SDA and FIA allowances through arbitrage trading and conduct trading between crypto and foreign currencies or when natural or non-natural persons purchase foreign currency on foreign cryptocurrency exchange platforms without the required approval

However, traders can circumvent triggering this externalisation event by swapping BTC for a USD-backed stablecoin if this does not affect the profitability of the trade, as these asset-backed cryptocurrencies fall within the definition of crypto assets and not foreign currency, irrespective of the fact that they are linked to the value of a specific foreign currency.

Source: Dylan Calluy/Unsplash

SARB faces significant challenges in accurately monitoring and restricting the “externalisation” of blockchain-based digital assets, as it cannot effortlessly request transactional data from foreign cryptocurrency exchanges.

To address this, the bank may need to mandate local cryptocurrency exchanges to monitor and limit the value of assets “externalised” to foreign platforms within the allowed thresholds for natural persons.

Inflow and outflow

A critical consideration is how to will handle cryptocurrency returning to South Africa amid high-volume trades between local and foreign exchanges.

With foreign currency, these inflow and outflow movements cannot be netted against each other in relation to the allowed thresholds.

If similar rules are applied to digital assets, it could severely impact these trading activities.

Kganyago unpacks R100bn reserve fund withdrawal

Katja Hamilton  31 Jul 2024

Additionally, SARB must determine how to treat the transfer of cryptocurrencies from local exchanges to self-custody solutions, such as hardware wallets.

These devices, which can be easily transported and used abroad, allow digital assets to be offloaded and exchanged for foreign currency without SARB’s knowledge.

Self-custody

The bank will likely consider the movement of digital assets to a self-custody solution as an externalisation of assets, necessitating stringent monitoring and regulation to prevent unauthorised externalisation events.

Finally, the ability to externalise assets within the allowed thresholds applies to natural persons only, raising the question of whether SARB will disallow non-natural persons, such as trusts and companies, to purchase cryptocurrencies on local exchanges and move these assets to self-custody solutions or send these blockchain-based digital assets to a foreign source as means of payment.