CONCEPT AND TYPES OF DIGITAL ASSETS
The wave of general transition on internet in 2020 also affected crypto or digital assets, which existed somewhere between the positive legal regulations and the gray zone, and its unresolved status gave headaches to both legislators and investors. It has long been clear that cryptocurrencies, as one form of digital asset, are there to stay and that the whole process cannot be undone or reversed. Only knowledge and vision were necessary to find a way to adapt existing and enact new regulations in order for this type of assets to be recognized as a legal and stable form of ownership, which the current practice and market development of this type of capital imposed as inevitable.
In the light of this trend, the Republic of Serbia also came out with a draft of this act, which, after a short public debate, entered the parliamentary procedure and thus finally became one of the countries that will regulate the digital assets market.
The primary task of this act will be to define digital property and its forms and to create a clear distinction between official means of payment that are recognized in our country and abroad. After the legal mapping of terms that are the most important for understanding the entire matter, but also for the adequate application of this law, the part that regulates the issuance of digital assets is equally important, i.e. it prescribes who and under what conditions can issue it. Trade of already issued digital assets, i.e. related transactions, are also areas that needed to be introduced into the legal framework, in order to avoid fraud, money laundering and all other risks that the unregulated secondary market bears.
The legislator also calls digital assets “virtual”, which makes these two phrases synonymous, and implies digital representation of value which may be purchased, sold, exchanged or transferred electronically (digitally), and which may be used as a means of exchange or for purposes of investment. It is important to emphasize that digital assets do not include digital representations of currencies that are legal tender and financial assets that are regulated by other laws, unless indicated otherwise in law on digital assets. Also, in the sense of the law, digital assets will include all assets that fulfill the elements defined by the law, regardless of the technology on which that digital assets is based.
The law distinguishes two basic forms of digital assets, which differ in their purpose and characteristics, the virtual currency and the digital token.
Virtual currency is a form of digital asset suitable for payment, but not issued by a central bank or other government agency, that would guarantee its value and maintain its stability. Therefore, virtual currencies are not necessarily linked to a legal tender, i.e. they do not have the legal status of money or currency. However, as they are factually and technologically similar to money, due to their convenience, legal entities and individuals tend to accept them as a means of exchange, i.e. a means that can be sold, bought, exchanged, transferred and stored in electronic form. The legislator also limits the virtual currency by the rule that they cannot be entered as a contribution to the company’s initial capital, but can eventually be exchanged for an official means of payment and only then paid into the company’s initial capital as a pecuniary contribution.
On the other hand, digital tokens, as another form of digital assets, may be a suitable means of investing a non-pecuniary contribution in a company, except for tokens not related to the provision of services or work that can be a non-pecuniary investment only in partnerships and limited (liability) partnerships. Tokens, suitable for this purpose, must be approved by the Securities Commission, and published on the official list of permitted tokens. The legislator defines a digital token as a type of digital asset that represents an incorporeal right that is stored in digital form and which represents one or more other property rights, which may include the right of the digital token-holder to be provided with specified services.
Issuing digital tokens is a method for legal entities to obtain capital, i.e. to help realize their business plans and strategies. That is why digital tokens are associated with crowdfunding, i.e. a chance for startups around the world to acquire capital with facilitated procedures. Issuance of digital tokens or “initial coin offering” in practice is also known as ICO.
ICO projects began to develop in parallel with the expansion of virtual currencies and blockchain technology, mostly by startup companies that thus issuing their own digital token in exchange for pecuniary capital, thus allowing investors to invest in their projects. Whether investing in a specific ICO product will be profitable or not, directly depends on the success of the company that issuing it.
As can be concluded, the ICO is actually a modified IPO (Initial Public Offering) institute adapted to cryptocurrencies and new technologies that are increasingly taking their place in the world of economics and investment. If we look at it from the point of view of the way of raising capital and risk, the IPO institute has a lot of similarities with the ICO. However, the IPO is a process regulated in detail by strict legal regulations, and each individual company that joins such an investment fundraising project have to pass rigorous control of state institutions and fulfill the explicit requirements of the laws governing the capital market and securities business. This has not been the case with ICO so far, so many companies have taken advantage of the lack of legal regulations and issued their tokens in this way. Thus, in the light of blockchain technology as a new technological solution, ICO began to function globally without defining a clear status and prior regulation. This was one of the main reasons for the instability of the digital assets market and the large fluctuations in token prices.
New regulations governing this area greatly limit ICO and bring order to the primary issuance and secondary digital assets market. However, it turned out that any regulation is better than the gray zone and the potential prohibition that was speculated about, so the recognition of digital tokens as official evidence of the existence of rights or financial instruments instilled a sense of confidence in investors who now find it easier to invest in this form of assets.
DIGITAL ASSETS SERVICES
In order to understand what types of services are related to digital assets and which the legislator strictly regulates, it is important to distinguish between the concepts of owners and users of digital assets. Thus, the user of digital assets is a natural person, entrepreneur or legal entity that uses or has used a service related to digital assets i.e. has contacted the provider of services related to digital assets in order to use the digital services. On the other hand, the holder of a digital asset is a broader term and means both the user of the digital asset and the person who acquired the digital asset independently of the business relationship established with the service provider related to such asset or transactions made through that provider. Therefore, this includes a person who has acquired digital assets by participating in the provision of computer confirmation services for transactions in information systems related to certain digital assets, i.e. by participating in the so-called procedure “mining”.
The total digital assets owned by one person at his disposal are called the portfolio. Portfolio management can be a special type of service, which is based on the approval or instructions from a special contract concluded with the user of digital assets.
In addition to portfolio management, digital asset-related services are implied:
- The execution of orders for sale and purchase of digital assets on behalf of third parties;
- purchasing and selling services of digital assets for a fee;
- The exchange of digital assets for other digital assets;
- The storage and administration of digital assets;
- The sponsorship (service related to the offer and sale of digital assets with the obligation to purchase those assets by the sponsor of the emission);
- The agency (service related to the offer and sale of digital assets without the obligation to purchase those assets by the agent of the emission);
- managing of the pledge registry on digital assets;
- managing portfolios of digital assets;
- the acceptance and transfer of digital assets;
- operating a digital asset exchange platform.
The acceptance and transfer of digital assets is a service provided by the digital assets service provider to the trader in terms of the Law on Trade which implies accepting the appropriate value of digital assets from the customer, which corresponds to the price of goods sold (services provided) to the customer, exchanging digital assets for legal tender and transferring the proceeds to the trader.
Distinction of these services is necessary due to the fact that different conditions for providing these services are applied to the provider of each of them. Also, the digital asset services provider must have the legal form of a company and an initial capital that varies from EUR 20,000 to EUR 125,000 depending on the nature of digital asset services provided. Thus, the execution of orders for sale and purchase of digital assets on behalf of third parties and purchasing and selling services of digital assets for a fee requires the initial capital of minimum EUR 20,000, while the highest initial capital requirement of EUR 125,000 applies to the services of operating a digital asset exchange platform.
HOW CAN I PAY WITH VIRTUAL CURRENCY?
As we stated before, virtual currencies (digital assets) are not an official means of payment and they cannot be used for direct purchase of goods or payment for services. However, this can be resolved by the digital assets provider between the customer and the seller, by providing them with the acceptance and transfer of digital assets service which is explained above. Thus, the digital asset service provider first trades digital assets for money that is the official means of payment, so that the money can be used for a legal payment for some goods or services later on.
Digital assets can be bought or sold through platforms specialized for that purpose, but also through the so-called cryptocurrencies (crypto exchange offices), which include automated electro-mechanical devices through which the acquisition or disposal of digital assets can be made for cash or the exchange of digital assets for each other. On the other hand, the digital asset trading platform is a multifunctional system used for organized digital asset trading, administered by the platform organizer, all with the aim of facilitating the connection of third parties interested in buying, selling and exchanging digital assets.
The digital asset trading platform has to be in accordance with the previously adopted binding rules in order to create a contractual relation between the parties who trade digital assets in this way. The process of buying, selling, accepting, transferring or exchanging digital assets is called a transaction. Trading through the platform is allowed to companies that have a license from the supervisory authority to provide services related to digital assets, as well as to all other legal entities, entrepreneurs and individuals. When it comes to digital assets, it is necessary to mention its primary issue, the so-called White Paper. The White Paper is a document that is published during the issuance of digital assets and which contains information about digital assets, their issuer and the risks. So, the White Paper allows investors to be properly and thoroughly informed before making a decision on a possible investment. You can read more about the initial offer in the text from the blog, from 2017.
PRINCIPLE OF TECHNOLOGICAL NEUTRALITY AND BLOCKCHAIN
As already mentioned, digital assets do not depend on or are conditioned by the technology by which they were created. However, many forms of these assets are based on technology based on the so-called smart contracts – computer protocols or programs, based on distributed database technology or similar technologies, which, in whole or in part, automatically executes, controls or documents legally relevant events and actions in accordance with an already concluded contract, whereby that contract may be concluded electronically through that program or protocol. Therefore, the legislator has prescribed that the use of smart contracts in secondary trading of digital assets is allowed, provided that the digital assets provider who provides services involving the use of smart contracts, previously obtains the consent of users of digital assets to use smart contracts. Smart contracts can also be defined as a set of rights and obligations contained in the program code or as parts of software, where the consent of the will, the content of rights and obligations as well as proof of conclusion of the contract are expressed through program code and presented in a blockchain database.
Namely, the technological solution suitable for issuing and transferring digital assets is actually a decentralized digital database, which uses cryptographic algorithms for recording and confirming information trafficking on the network, and which consists of records, grouped into blocks, which form a chain. That is why this way of noting digital data is also called blockchain. It can also be defined as a distributed, shared and encrypted database that serves as a public storage of information that is not subjected to subsequent changes and corrections.
The term of digital assets is closely related to the notion of the so-called addresses, as unique place marks in the virtual space where the data of a specific virtual (digital) assets are contained. Storage and management of digital assets on behalf of users of digital assets and providing related services imply control over the so-called cryptographic keys, and security administration service is related to that.
DIGITAL ASSETS WITH FINANCIAL INSTRUMENT STATUS
The term financial instrument is defined by the Law on Capital Market and includes, among other things, securities such as shares, bonds, futures, options, etc. If digital assets have the status of a financial instrument, the law regulating the capital market shall apply to their issuance as well as trade on the secondary market, unless the law regulating digital assets as a lex specialis law prescribes otherwise.
The law governing the capital market will not apply if the following conditions are cumulatively met:
- digital assets have no share (stock) features;
- digital assets are not exchangeable for shares;
- the total value of digital assets issued by one issuer during a period of 12 months does not exceed the amount of EUR 3,000,000 in dinar equivalent at the official middle exchange rate of the National Bank of Serbia on the day of issue, i.e. during the initial sale.
Therefore, for legal entities who issue digital assets that meet all three required conditions, the issue can be made according to a significantly simplified procedure, fulfilling only the requirements of the lex specialis of the Law on Digital Assets, without the obligation to formally and substantially comply with much stricter rules of the Law on Capital Market.
Supervision of digital assets with the status of a financial instrument will be performed by the Securities Commission, while the cryptocurrency market will be supervised by the National Bank of Serbia.
IMPORTANT AREAS REGARDING DIGITAL ASSETS NOT COVERED BY THE LAW
The law did not regulate the area of the so-called mining or cryptocurrency mining, the activity that has significant specifics.
Also, the tax aspect of the primary and secondary digital property market is not particularly regulated, which means that existing legal regulations and solutions will be applied in this area, until new ones are adopted or amendments are made to the current ones.