The astronomical increase in prices of digital assets in late 2017 and the ensuing mainstream frenzy caught the attention of financial regulators around the world due to concerns of consumer protection and money laundering. While attention from the media has faded due to the precipitous drop in the prices of digital assets, those of the regulators have not. Within Southeast Asia alone, Thailand and Indonesia have introduced laws in the past year to regulate certain aspects of distributed ledger technology and digital assets.
Change is also imminent in Singapore. The Payment Services Act (“PS Act”), which will establish a new regulatory framework that, inter alia, imposes requirements and restrictions on certain digital assets intermediaries, has been passed and is awaiting commencement. The PS Act will supplement the traditional Securities and Futures Act (“SFA”) in the regulatory landscape for distributed ledger technology and digital assets. Taken together, they appear to reflect the Monetary Authority of Singapore’s (“MAS”) conceptual understanding of how digital assets are to be categorized and thereby regulated.
In an interview with Bloomberg News, Mr. Ravi Menon, Managing Director of MAS, stated MAS’s view that digital assets fall into three categories, namely utility tokens, payment tokens and security tokens. Utility tokens are “used in blockchain technology for purposes including payment for computing services [and] needs hardly any regulation”, security tokens are “digital tokens that have the characteristics of securities” and Bitcoin was given as an example of a payment token. The intention, therefore, is for the SFA to regulate security tokens and for the PS Act to regulate payment tokens. Utility tokens, conspicuous by its absence, appear to be intended to fall outside the purview of MAS. There is, therefore, no legislative definition of utility tokens. The above categorization closely mirrors that of the Financial Market Supervisory Authority (“FINMA”) of Switzerland, which has recognized that the categories are not mutually exclusive and may be cumulative.
Whilst an overlap in itself is not an issue, it appears that “digital payment tokens” has been given an expansive definition. The PS Act currently defines digital payment tokens as any digital representation of value that (i) is expressed as a unit; (ii) is not denominated in any currency, and is not pegged by its issuer to any currency; (iii) is, or is intended to be, a medium of exchange accepted by the public, or a section of the public, as payment for goods or services or for the discharge of a debt (the “payment limb”); and (iv) can be transferred, stored or traded electronically. If one adopts Mr. Ravi Menon’s definition of utility tokens, it appears that a utility token which can be used to pay for computing services should also satisfy the payment limb based on the plain meaning of the words. Hence, it would seem that “digital payment tokens” is wide enough to encompass certain utility tokens.
At first glance, one may attribute the extensive scope of “digital payment tokens” to the payment limb because the ability to use a digital asset for payment need not be an inherent characteristic of the digital asset. While Bitcoin would be regarded by most to be the quintessential payment token, the position is less clear for the majority of digital assets. Take Ethereum for example. The Ethereum network is a platform that allows users to execute smart contract transactions. Yet, apart from smart contracts, Ether is also accepted by third parties for payment, including major retailers such as Overstock.com. In other words, a digital asset that is not intended to be used to make payment may nevertheless be used by other parties to make payment, as long as the parties agree. This is a natural consequence of digital assets being transferable electronically. It is therefore theoretically possible for all digital assets that are transferable and fungible to be digital payment tokens.
The above issue is exacerbated by the absence of any limitation on the scope of the payment limb, unlike “non-monetary customer loyalty or reward points”, which is a type of “limited purpose digital payment token”, where the payment obligation specifies the issuer or its merchant as the payee. The payment limb of “digital payment tokens” does not place any restriction on the identity of the payee. Therefore, the use of a digital asset, by any person other than the issuer, to make payment appears to be sufficient to satisfy the payment limb. This would render that digital asset a digital payment token under the PS Act.
The ease with which the payment limb may be satisfied is not merely academic. With the emergence of decentralized exchange protocols, there is a real possibility that a digital asset, that was not originally intended to be used as a medium of exchange for payment, may morph into a digital payment token in the next instant. Decentralized exchange protocols, whether through the involvement of decentralized liquidity providers or the implementation of a bonding curve mechanism, enable anyone to create a market for a digital asset. These protocols may then be integrated into payment solutions that enable a payor to pay in his desired digital asset to a payee that only accepts payment in another digital asset, or even fiat currency. As the conversion of the digital assets is executed on the back end, the payee need not agree to, and may not even be aware of, the payor’s use of another digital asset for payment. This can be analogized with the currency conversion in traditional online payment methods, such as credit cards or PayPal, except that the fiat currencies are now replaced by digital assets. In essence, these services are capable of transforming any digital asset into a medium of exchange for payment, and therefore a digital payment token.
For the abovementioned reasons, the payment limb may seem to be almost synonymous with the transferability of a digital asset in practice. If a digital asset is transferable, it is also likely to be capable of satisfying the payment limb at any juncture, if it does not already do so. Conversely, if a digital asset satisfies the payment limb, it must necessarily be transferable in order for value to flow from one party to another. One may, therefore, view the payment limb as a derivative of the transferability of a digital asset. As such, the true reason why the definition of “digital payment tokens” appears to be too wide may be that it practically catches all digital assets that are transferable in the light of technological developments.
Therefore, intermediaries that are dealing with digital assets (including utility tokens or security tokens) and do not wish to be licensed under the PS Act may, therefore, have to closely monitor the digital assets they are dealing with to ensure they are not digital payment tokens. Even if it is possible to track whether a digital asset is being used for payment, it is likely to result in disproportionate compliance costs. As a result, such intermediaries may conclude that it would be easier to simply apply for a license under the PS Act. It will, therefore, be of utmost importance to carefully calibrate the licensing requirements. If the requirements are too lax, it may place an excessive burden on the regulators. On the other hand, overly onerous requirements may stifle innovation and reduce Singapore’s attractiveness as a global hub for distributed ledger technologies and digital assets.
Given the breakneck pace at which innovation is taking place in the digital assets industry, the concerns raised in this article may be moot by the time the PS Act commences. Furthermore, as MAS has been given the power to prescribe additional characteristics for digital payment tokens, there may yet be further changes to the definition of digital payment tokens. Importantly, this flexibility provides room for the definition of “digital payment tokens” to evolve timeously, and will be a valuable tool in ensuring the definition keeps up with technological developments. In a 2015 article that discusses the interaction between law and technology, Mr. Simon Chesterman, dean of the National University of Singapore Faculty of Law, presciently observed that “law often lags behind technological innovation”, with Bitcoin given as an example. To ensure laws remain current, “legislatures should adopt a principled approach to regulation that establishes rules that are clear” and the law “should be sufficiently up-to-date to deal with emerging technology”. As Singapore stands on the cusp of introducing a regulatory framework that deals with digital assets such as Bitcoin, the above statements are a timely reminder.