What are our Future FinTech Champions learning at the moment? And what are their thoughts on the current development of FinTech? Read through this submission from one of our FFCs, Tavish Bhikea, currently studying @ University of Mauritius.

Insight of the Digital Asset Market 

According to the “Digital Asset Management Market: Global Industry Trends, Share, Size, Growth, Opportunity and Forecast 2020-2025″ report by ResearchAndMarkets.com, the global Digital Asset Management (DAM) market size is expected to expand from USD 3.4 billion in 2020 to USD 6.0 billion by 2025. Adding up to this, measured through the total cryptocurrency market capitalisation, the overall digital asset market is currently valued at US$ 239bn. The reasons for this are mainly the digitalisation of many sectors and the dire need for the harmonisation of corporate assets. Companies involved in this market are Adam Software, Canto Inc, Celum, Cognizant Technology Solutions, Oracle Corporation, IBM Corporation, Widen Enterprises among others. Partnerships by some of these Companies with cloud service providers such as Google and AWS are being stirred up.

The International Monetary Fund (IMF) has defined digital assets as digital representations of value, made possible by advances in cryptography and distributed ledger technology. They are denominated in their own units of account and can be transferred from peer-to-peer without an intermediary.” This signifies that such kinds of assets are intangible in nature. This definition is not general and varies throughout jurisdictions. In a 2020 paper by the Dubai Financial Services Authority and Deloitte Middle East, Digital assets have been broken into 5 categories: Security tokens, Cryptocurrencies (or exchange tokens), Stablecoins, Utility tokens and E-Money tokens.

Digital Asset Custodians 

Digital asset custodians known as third party custodians are institutions that are responsible for safekeeping the investor’s digital assets temporarily using a safe key management system which means that the assets are secured cryptographically. In return, the custodians charge a fee to maintain these assets safely. This is done through an agreement with the aim to reduce the risk of fraud and theft amongst others. This type of custody normally fits institutional investors.

The custody of the digital assets is in terms of the fact that the private key of the digital assets is kept by the institution and it limits the access to other parties. The risk that remains is the theft or misplacing of the key which can make the regaining of the asset hard. Security tokens can be an exception since a new token can be issued and hence, the asset will remain secure. Therefore, ensuring that the digital asset is safe is of paramount importance for an investor and the choice of custodian should be made wisely. However, protection is provided through distributed ledgers (in the form of random binary digits) since alteration is quite tough as transfers are recorded on ‘independent’ ledgers.

As for individual investors, self custody and exchange wallet solutions is an option. The latter refers to the handing over of the management of the public and private key to an exchange but the individual may have access through an online wallet. The Swiss bank Vontobel is a custodian that has put in place its Digital Asset Vault whereby it allows its clients to get instructions from over 100 banks and wealth managers in line with the purchase, custody and transfer of digital assets using the institution’s existing infrastructure and regulated environment. Another example is Coinbase Custody that has kept into custody 11% of all Cryptocurrency Assets in 2020. The value of the assets in custody has been taken to approximately $90 billion in the last quarter of 2020 making it the world’s largest crypto custodian.

The need for a regulatory framework for Digital Asset Custodians 

Though custodians are striving to offer safety, stability as well as certainty which are cardinal factors for investors, there are still loopholes since their unstable control on the markets makes it difficult to meet all these criterias. In addition to the emerging digital asset market, a regulatory regime for digital asset custodians will allow investors to achieve these criterias especially certainty. Nevertheless, the regulatory framework for digital assets especially for custodians is still unfolding.

Mauritius’ regulatory framework for Digital Asset Custodian services 

Defined by the Financial Action Task Force report on Virtual Currencies of June 2014, digital assets had been recognised as “an asset-class for investment by sophisticated and expert investors” by Mauritius’ ‘Fintech and Innovation-Driven Financial Services Regulatory Committee’ in September 2018. This class also includes cryptocurrencies. After international consultation with the stakeholders such as Organisation for Economic Cooperation and Development (OECD) on the proposed regulatory framework for the licensing of digital assets custodian services, in 2019, the Financial Services Commission (FSC) of Mauritius issued the Financial Services (Custodian Services (Digital Asset)) Rules. The FSC is the “integrated regulator for non-banking financial services and global business sectors and is encouraging Fintech-related initiatives.

The regulatory framework established has put the Mauritius International Financial Centre (IFC) as the first jurisdiction to have enacted regulations for the custody of digital assets. Mauritius demonstrated the importance of setting up a secure and conducive environment for global promoters as well as clients in the Fintech Industry. As a whole, the Financial Services (Custodian Services (Digital Asset)) Rules requires custodian institutions or services to comply with the legal framework Anti-Money Laundering (AML) and Combatting the Financing of Terrorism as well as international best practices. This is so because the custodian of digital assets are considered as financial institutions for the purposes of the Financial Intelligence and Anti-Money Laundering Act 2002 and the Financial Intelligence and Anti-Money Laundering Regulations 2018. These custodian services rules are also applicable to holders of the Custodian Services (Digital Asset) Licence that allows them to provide services of safe-keeping of Digital Assets.

Procedures and Requirements for a Digital Asset Custodian services licence 

As per these rules, Mauritius has defined ‘Digital Asset’ as tokens that can be in electronic or binary form that can be used as a medium of exchange, store of value, unit of account. An example of this is cryptocurrencies. Secondly, Digital assets should represent assets such as debt or equity. Moreover, they can be used to provide access to blockchain-based applications, services or products. However, there are two categories that are excluded from the definition of digital assets: transactions emanating from a business as part of an affinity or reward programme, grant value which cannot be exchanged for legal tender, bank credit or any Digital Asset; Digital representation of value issued for use within an online gaming platform.

The procedures and requirements to acquire a licence are as follows: If the custodian satisfies the requirements of the Financial Services Act 2007 and the Custodian Services Rules, the FSC may issue a letter of intent to the applicant. The latter will then have to demonstrate that it possesses the required resources, infrastructure and staffing to commence business within 6 months from the date of the letter of intent: Adequate staffing of the institution shall be in terms of having persons that are ‘fit and proper whereby they have the the appropriate qualifications, experience to properly perform the core functions of a custodian of digital assets with a certificate of morality showing that the person has not been previously convicted especially for any financial crime. Moreover, the custodian should always have a representative that has adequate knowledge of the operations with regards to the custody of digital assets in Mauritius

The registered office and place of business of the custodian should at all times be maintained in Mauritius. The minimum capital requirement to start the business for custodian services is 35 million Mauritian Rupees or an amount representing 6 months’ operating expenses as reported in the audited financial statements submitted to the FSC. The custodian should have set up a redundancy system in place to ensure continuity of its operations in case of any unavailability of equipment, software or primary staff, appropriate disaster recovery facilities. A risk management system and proper infrastructure to facilitate continuous operations should also be established. After ensuring all these criterias are met, the FSC shall grant the licence.

Challenges faced by Mauritius 

As mentioned above, Mauritius adopted the regulatory framework in order to curb the risks by individual or institutional investors, there are still many risks present that have not been extensively covered under the current regulatory framework for digital asset custodian services. One of the most prominent ones remains cyber-security and AML and Terrorist Financing issues. The FSC should be looking into structures to constantly monitor that Custodians have proper cyber-security and cyber-resilience policies.

Unlike Countries such as Switzerland whose banks themselves are custodians for digital assets, in Mauritius, businesses trading in digital assets might face challenges to open a banking account. Hence, a harmony in both the regulatory framework with regards to AML and terrorist financing for both banking and non-banking financial services should be put in place since for custodians to operate, such facilities should also be ensured. The FSC is at the time working to establish guidelines for investment in cryptocurrencies as well and this might solve the challenges for investors to a certain extent. Since the FATF advanced that: “Mauritius has taken steps towards improving its Anti-Money Laundering/Combating the Financing of Terrorism (AML/CFT) regime, including by developing a risk-based supervision plan for the global business and management companies”, with these further regulations for digital assets and the fintech sector in genral, this will be a way forward for Mauritius to exit the FATF “grey list”. This list meant that Mauritius required increased monitoring. The risk based supervision of custodian services will add up to the measures that will help Mauritius address its strategic deficiencies.

While the Fintech sector is still emerging in Mauritius with many innovations that are yet to be brought, it will be interesting to see how the regulatory framework put forward by the FSC will really be applicable and effective. The path towards the adoption of blockchain technology as well is becoming quite visible in Mauritius. Hence, Mauritius is showing its initiative taking approach by embracing certain opportunities to improve its attractiveness and competitiveness, as a jurisdiction of choice for FinTech related activities. With the rules of the digital asset custodian services, Mauritius has demonstrated the ability to build an open and transparent regulatory regime.

Kim Dotcom, the CEO of MegaUpload once said that: “[Bitcoin] is a very exciting development, it might lead to a world currency. I think over the next decade it will grow to become one of the most important ways to pay for things and transfer assets.” 

In a nutshell , from the above and this quote about bitcoin, a leading cryptocurrency and digital asset, the speculations and rapid nature of the financial sector makes the adoption of such types of digital assets highly probable. The ‘doubtful’ questions and uncertainties are what makes the evolution of Fintech, especially digital assets difficult to embrace. Mauritius has therefore set the stepping stone by putting a legal framework for the custody of digital assets to mitigate these concerns.