DIFC’s Crypto Regulatory Update: Expanded Investment Horizons for Domestic Funds

Key Takeaways

• The DIFC has amended its existing regulatory framework to allow investment funds to deal in additional crypto assets. Now, in addition to the five recognised crypto tokens, domestic funds can invest in non-recognised crypto tokens.
• Qualified investors will now be allowed to invest in non-recognised crypto tokens in the DIFC.
• The updated amendments have introduced a nuanced approach, allowing domestic funds to make controlled and regulated investments in unrecognised crypto tokens under specific conditions.

 

1. Background

On 3 June 2024, the Dubai Financial Services Authority (“DFSA”) announced major enhancements to its crypto token framework. The modifications aim to advance the regulatory landscape for crypto within the DIFC Freezone.[1]

These amendments were preceded by a detailed consultation with the relevant stakeholders of the industry via ‘Consultation Paper 153 – Updates to the Crypto Token regime’ released by the DFSA in January 2024.[2]  It was followed by Consultation Paper No. 154 – Proposed Changes to the DFSA’s Audit Regime,[3] which eventually led to the legislative changes enforced from 3 June 2024.

This article focuses on the amendments to the permissibility of investments in Crypto Tokens.

2. Amendments to the Domestic Funds Regime

The DFSA has introduced a significant change allowing domestic funds to invest in unrecognised crypto tokens under specific conditions. The original rule strictly limited the use of crypto tokens within the DIFC to the Recognised Crypto Tokens.[4] The newly added subrule introduces a more flexible framework for domestic funds, which fall within the definition of Qualified Investor Funds, allowing them to invest in unrecognised crypto tokens under controlled conditions.[5]

A brief comparative analysis of the previous and the new rule is as follows:

Aspect	Existing Rule 3A.2.1[6]	New Addition in Rule 3A.2.1(3)[7]
General Prohibition	Only recognised Crypto Tokens can be used in the DIFC for specific activities.	Exception introduced to the prohibition involving unrecognised crypto tokens.
Activities Prohibited with Non-Recognised Tokens	i. Conducting financial services related to the crypto token.   ii. Making or approving financial promotions related to the crypto token.   iii. Offering the crypto token to the public.   iv. Engaging in the above activities for a fund that invests in the crypto token.   v. Engaging in these activities for derivatives or instruments related to the crypto token.	The activities remain prohibited, with an exception for certain domestic funds.
Custody Exception	Exemption for authorised persons providing custody of a crypto token.	No Change
Exception for Domestic Funds	Not applicable.	Introduced for domestic funds under specific conditions.
Conditions for Exception	Not applicable.	i. The fund must be established or domiciled in the DIFC and classified as a Qualified Investor Fund.   ii. The fund can invest no more than 30% of its gross asset value in non-recognised crypto tokens.   iii. The fund Manager must provide unitholders, upon request, with relevant information about the main characteristics and risks associated with investments in unrecognised crypto tokens.   iv. The fund manager must conduct daily valuations of the fund’s investments in non-recognised crypto tokens and maintain records of these valuations.

3. Amendments to the External Funds Regime

Certain significant changes to the regulations concerning foreign funds that invest in crypto tokens have also been introduced. Previously, Rule 6.2.4 of the Collective Investment Rules of the DFSA Rules stated that a fund manager could not manage an external fund that invested in crypto tokens under any circumstances.[8] The updated regulations now provide specific conditions under which such investments are permissible. Below is a brief overview of the permissibility of the investments:

1. Permissible Investment Conditions[9]:

• Recognised Crypto Tokens: The investment must be in a Recognised Crypto Token.
• Investment limit: The investment in recognised Crypto Tokens must not exceed 20% of the fund’s Gross Asset Value (GAV).

2. Restrictions on fund offerings:[10]

• Private Placement: The fund’s units must be offered to investors through private placement.
• Professional Clients only: The units can only be offered to individuals or entities that meet the criteria to be classified as ‘Professional Clients’. These clients typically have higher levels of financial sophistication and risk tolerance.
• Minimum subscription: The minimum initial subscription requirement is USD 50,000 for each investor to become a unit holder in the fund.

3. Fund Management Requirements:[11]

• Eligible Custodian: The fund manager must ensure that an eligible custodian safeguards and administers the fund’s Recognised Crypto Tokens. An Eligible Custodian is typically a regulated entity that meets specific standards set by the DFSA.
• Information Disclosure: The fund manager must provide unitholders with relevant and up-to-date information about the performance and management of the fund’s Recognised Crypto Tokens upon request.
• Daily Valuations: The fund manager must conduct daily valuations of the fund’s investments in Recognised Crypto Tokens and maintain records of these valuations.

4. Conclusion

The recent regulatory changes made by the DFSA represent a progressive move in the direction of updating the financial environment in the DIFC. Tokens on the cryptocurrency market that are not yet recognised can be purchased with domestic funds of Qualified Investor Funds (QIFs). This modification seeks to promote a more dynamic and creative financial environment in conjunction with improvements to the custody and transparency requirements for investments in cryptocurrency tokens. However, it comes with stringent conditions, including detailed disclosure requirements and daily valuations, to ensure that these investments are managed responsibly.

Allowing domestic funds to invest in unrecognised crypto tokens can lead to several positive outcomes, such as increased investment opportunities, attraction of high-net-worth investors, and overall market development. However, it also introduces potential risks related to market volatility, regulatory compliance, and investor protection. The DFSA’s balanced approach ensures that while the market becomes more flexible and innovative, it remains underpinned by strong regulatory safeguards. In line with the DIFC’s objective of leading the way in global financial innovation, the new framework aims to guarantee a stable and safe financial environment in addition to fostering the market’s sustainable expansion.

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[1]The DFSA Enhances Its Crypto Token Framework, Fostering Innovation, DUBAI FINACIAL SERVICES AUTHORITY (Jun. 03, 2024, 10:43 AM), https://www.dfsa.ae/news/dfsa-enhances-its-crypto-token-framework-fostering-innovation#:~:text=Recognition%20of%20Crypto%20Tokens%3A&text=Over%20the%20past%20two%20years,international%20standards%20have%20evolved%20significantly.

[2] Consultation Paper No. 153 – Updates On The Regulation Of Crypto Tokens, DUBAI FINANCIAL SERVICES AUTHORITY (Jan. 04, 2024).

[3] Consultation Paper No. 154 – Proposed Changes to the DFSA’s Audit Regime, DUBAI FINANCIAL SERVICES AUTHORITY (Jan. 02, 2024).

[4] Bitcoin, Ethereum, Litecoin, Toncoin and Ripple.

[5] The Dubai Financial Services Authority Rulebook, General Module, Rule 3A.2.1(a).

[6] The Dubai Financial Services Authority Rulebook, General Module, Rule 3A.2.1.

[7] The Dubai Financial Services Authority Rulebook, General Module, Rule 3A.2.1(3).

[8] The Dubai Financial Services Authority Rulebook, Collective Investment Rules, Rule 6.2.4 (repealed and replaced by Collective Investment Rules (CIR) Rule-Making Instrument (No. 377) 2024)

[9] The Dubai Financial Services Authority Rulebook, Collective Investment Rules, Rule 6.2.4(1)(a)

[10] The Dubai Financial Services Authority Rulebook, Collective Investment Rules, Rule 6.2.4(1)(b).

[11]The Dubai Financial Services Authority Rulebook, Collective Investment Rules, Rule 6.2.4(2).