Regulating Cryptocurrency and Initial Coin Offerings: The Nigerian Perspective

Friday, September 18, 2020 / 12:00PM /
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Cryptocurrency has revolutionised the global monetary system and slowly
evolved into a viable legal tender. Noting the increasing use of cryptocurrency
in Nigeria, it is imperative that the Central Bank of Nigeria and the
Securities and Exchange Commission establish regulations on the use of digital
currency and clearly define what cryptocurrency is under the Nigeran financial
regime.

 

In this article, we explore the evolution and make-up of
cryptocurrencies, and the current Nigerian legal framework.

 

 

Humble Beginnings

On 31 October 2008, Satoshi Nakamoto (a person or a group of people)
sent a white paper titled “Bitcoin: A Peer-to-Peer Electronic Cash System.”
1 to the subscribers of a
cryptography mailing list. The document, described a decentralized system that
would allow peer-to-peer payment of money without the interference of a third
party (banks and financial institutions) and the government.

 

That white paper which introduced block chain based-cryptocurrency, has
revolutionised the global monetary system and today, the cryptography-based
currency has evolved into a $267,000,000,000 (two hundred and sixty-seven
billion Dollars) industry
2.
Cryptocurrency has disrupted finance as we know it and with the usage of it to
create new methods of achieving financial goals and targets for businesses,
cryptocurrency is slowly evolving into a viable legal tender.

 

This article is divided into two parts. The first part will discuss what
cryptocurrencies are, how digital coins and digital tokens make up the
ecosystem of cryptocurrency and the Nigerian legal framework on cryptocurrency.
The second part will explore Initial Coin Offerings (ICOs), how it is used to
raise funds, the Nigerian legal framework on ICOs, and the pros and cons of
ICOs.

 

 

What is Cryptocurrency?

To understand what cryptocurrency is, there has to be an understanding
of the technology that cryptocurrency is built on. The technology includes:

 

1. Cryptography

Rivest Ronald defines cryptography as the practice and study of
techniques for secure communication in the presence of third parties
3. It can also be described
as the art of writing and solving codes
4.

 

These definitions are central to modern cryptography as computer codes
and algorithms are written in such a way around computational hardness assumptions
5, making such algorithms
and codes hard to break by third parties therefore making them computationally
secure.

 

2. Decentralized Networks

Decentralized networks or decentralized computing is a computer network
where the nodes (computers) within the network function as a separate authority
with independent decision-making power regarding how it interacts with other
systems
6.

 

The network shares data and processing power among nodes through
connected servers. The fundamental principle of a decentralized network is that
all nodes are independent and connected. Since each node is independent, every
one of them can set their own rules regarding data and workload availability
7.

 

3. Blockchain Technology

Blockchain is a decentralized ledger of all transactions across a
peer-to-peer network
8.
With blockchain, various transactions can be carried out without the
interference of a third party, regulatory body or clearing party. Blockchain
technology is being considered for use in a number of sectors, from encrypting
patient information in the health sector, to voting during elections to ensure
votes are not duplicated.

 

With the brief explanation above of the technology that drives
cryptocurrency, it can be defined as a digital currency secured by cryptography
9. It is a medium of
exchange, created and stored electronically in the blockchain, using encryption
techniques to control the creation of monetary units and to verify the transfer
of funds
10.

 

With the blockchain technology, transactions of cryptocurrency can be
made from one person to another. However, no physical currency moves under this
transaction. All the “currency” exists as data on a global database
(blockchain). This blockchain keeps track of all the transactions and is
checked and verified by computers around the world.

 

 

Coins and Tokens

In the cryptocurrency ecosystem, cryptocurrency is referred to as a coin
or token. Although these names are sometimes used interchangeably, they are two
different types of the cryptic currency.

 

A coin is a unit of value or digital asset that is native to a
blockchain
11.
It is a means of exchange used within a blockchain to enable the participants
exchange value. So, for example, a cryptocurrency like Bitcoin operates and
functions on the Bitcoin blockchain for the purpose of exchanging value. Coins
function like regular money and are used solely for monetary purposes like
purchasing goods and services.

 

A token on the other hand does not have its own blockchain. Rather it is
an asset built on top of an existing blockchain, which has the ability to
replicate such functionality or assets.

 

Another thing to note is that coins are usually used for payments.
However, while a token can be used for payments and can be used as a unit of
value it has more uses like utility tokens that are used to access products and
services. Thus, when one creates a token on a blockchain, the asset or the
functionality will usually be exchanged, sold or bought with the native coin of
the blockchain that the token resides in. Startups and companies have decided
to take advantage of the creation of tokens on blockchains and are generating
their own assets. An example of such is Ethereum’s
12 smart contract
functionality. By building decentralized applications on top of Ethereum,
companies are creating their own tokens for various purposes.

 

An example of an ingenious use of a token is the web browser called
Brave that removes advertisement (ad) trackers and attempts to stop fraud that
affects majority of all online advertising. Brave created a token called the
Basic Attention Token (BAT) that rewards advertisers if an online ad gets a
user’s attention
.13
If the ad receives user attention, the advertising company receives the token
as a form of payment. This way, the advertisers are incentivised to provide
meaningful and relevant ad content. Symbiotically, a user benefits from the new
browser by experiencing faster browsing speeds as the browser is not riddled
with incessant ads and has content tailored for the users.

 

The Nigerian Legal Framework on
Cryptocurrency

The definition of cryptocurrency establishes the inherent nature of it.
Cryptocurrencies are considered in many jurisdictions as either:

1. Money; or

2. An Asset

 

Therefore, we have to look at the definitions of these terms under the
Nigerian financial framework as cryptocurrencies are not classified in Nigeria.

 

Money

According to the Central Bank of Nigeria Act 2007, only the apex bank
has the sole right to issue legal tenders of any kind in Nigeria
14 and no other person or
authority can issue tokens which are likely to pass as legal tender in Nigeria
15.

 

Consequently, on 12 January 2017, the Central Bank of Nigeria (CBN)
issued a Circular
16
stating that because transactions with cryptocurrencies or virtual currencies
are almost untraceable making them susceptible to abuse by criminals and
terrorists, there is a need to protect the integrity of the Nigerian financial
system, therefore, pending the release of a legislation or regulation guiding
the use of virtual currencies CBN advised that:

1.      Banks and other
Financial institutions must not use, hold or trade and transact in anyway with
virtual currencies.;

2.     Customers who are
virtual currency exchangers must comply with the relevant anti-money laundering
and combatting the finance of terrorism (“AML/CFT”) provisions;

3.     Banks and Financial
Institutions can discontinue their relationship with the currency exchanger if
they are not satisfied with their AML/CFT framework;

4.     The CBN reiterated
that cryptocurrency is not a legal tender and anyone who uses it transacts at
his own risk.

Based on the above, whilst the CBN recognises cryptocurrency and its
impact on the financial sector, it warns users that there is no legal redress
when used as a legal tender and transactions are made at the user’s peril.

 

Assets

In finance, a financial asset is a non-physical asset that derives its
value from a contractual right or an ownership claim
17. Therefore, securities
such as shares and bonds are regarded as financial assets.

 

The regulatory framework for securities in Nigeria is governed by the
Investment and Securities Act 2007 (“ISA”) and the Rules and Regulations of the
Security and Exchange Commission 2013.  The ISA defines ‘security’ to
mean:

1.      debentures, stocks
or bonds issued or proposed to be issued by a government;

2.     debentures, stocks,
shares, bonds or notes issued or proposed to be issued by a body corporate;

3.     right or option in
respect of any such debentures, stocks, shares, bonds or notes; or

4.     commodities
futures, contracts, options and other derivatives

The definition of securities in the ISA included those securities which
may be transferred by means of any electronic mode approved by the Securities
and Exchange Commission (SEC) and which may be deposited, kept or stored with
any licensed depository or custodian company as provided under the ISA
18.

 

The inference that may be drawn from the foregoing provisions may be
that cryptocurrency can be used freely as a form of security in Nigeria but
this appears not to be the case. In 2017, the SEC as the apex regulatory body
for investments and securities in Nigeria, took the position that none of the
persons, companies or entities promoting cryptocurrencies had been authorised
or recognised by it to provide any investment in Nigeria and it warned the
general public of the risk in investing in cryptocurrencies.

 

However, although it appeared that regulatory bodies were not so keen to
accept the use of cryptocurrency in Nigeria, the SEC established the Fintech
Roadmap Committee in 2019 to analyse the impact of fintech on securities and
investments in Nigeria. Part of the findings
19 of the Committee was on the regulation of crypto
currencies and virtual financial assets. The Committee recommended that
cryptocurrencies be expressly classified as securities or commodities in the
SEC regulations. Currently the SEC is also working to ensure that a framework
for the regulation of virtual currencies is being put in place in Nigeria
20.

 

 

The Existing Reality in Nigeria

Though the Nigerian regulators have warned that there are no existing
frameworks to protect consumers from the risks of cryptocurrency, Nigeria is
rife with cryptocurrency users.

 

According to Bitcoin.com, 11% of connected Nigerians use
cryptocurrencies
21
and Coinmarketcap, a platform for tracking the price of cryptocurrencies,
reports that the tracking of the prices of cryptocurrency in Nigeria grew to
211%. Binance research also highlights that there has been an increase in
interest in cryptocurrency and Nigeria leads the pack of the countries who are
showing interest in cryptocurrency
22.

 

Also, cryptocurrency exchange platforms and apps are on the rise in
Nigeria. Buycoins, an exchange platform for cryptocurrency processed over
N500,000,000 (five hundred million Naira) worth of cryptocurrency in the space
of 3 months
23
while other platforms such as Patricia, Binance and Quidax record
cryptocurrency transactions daily in Nigeria.

 

One of the major reasons why Nigerians seem to use cryptocurrency more
than ever is because cryptocurrency is a seamless way for them to instantly
exchange value during cross-border transactions as international money transfer
services may delay transfers. Also, some Nigerian start-ups are using
cryptocurrency as an innovative way to raise funds through Initial Coin
Offerings (ICO)
24 which
will be discussed in the second part of this article.

 

 

Conclusion

The Nigerian finance regulators constantly warn consumers about the
inherent risk of using cryptocurrency and their fears are not wrongly
misplaced. Cryptocurrencies have led to one of the biggest fraudulent
activities of 2019. Two ICOs, run by the same company operating out of Vietnam,
are believed to have swindled around 32,000 investors of a combined
$660,000,000 (sixty-six million Dollars)
25. But risk is always inherent in business and it is
the job of the regulators to worry.

 

The above notwithstanding, given the increased use of cryptocurrency by
Nigerians, it can be argued that there is a need for the Central Bank of
Nigeria and the Securities and Exchange Commission to establish regulations
guiding the use of digital currency in Nigeria and clearly define
.

 

 

Footnotes

1.      
Bitcoin: A Peer-to-Peer Electronic Cash System by
Satoshi Nakamoto https://bitcoin.org/bitcoin.pdf

2.     
Market Insider for Business Insider https://markets.businessinsider.com/currencies/news/bitcoin-price-crypto-market-grows-billions-breaks-threshold-value-total-2020-5-1029182471#
accessed 25 June 2020

3.     
“Cryptography” by Rivest, Ronald L.. (1990).  In
J. Van Leeuwen (ed.). Handbook of Theoretical Computer Science.

4.     
The Oxford English Dictionary, Third Edition,
published by the Oxford University Press.

5.     
Computational hardness assumptions is a hypothesis
that a particular problem will not be able to be solved efficiently by a
computer.

6.     
Centralized vs Decentralized Network: Which One Do You
Need? by Alan Seal for Vxchnge. Accessed 25 June 2020

7.      
Centralized vs Decentralized Network: Which One Do You
Need? by Alan Seal for Vxchnge. Accessed 25 June 2020

8.     
Making sense of bitcoin, cryptocurrency and blockchain
by PWC United States. Accessed 25 June 2020

9.     
Jake Frankenfield, reviewed By Michael Sonnenshein, 5
May 2020 “Cryptocurrency” on Investopedia https://www.investopedia.com/terms/c/cryptocurrency.asp
Accessed 25 June 2020

10.  
Making sense of bitcoin, cryptocurrency and blockchain
by PWC United States  Accessed 25 June 2020.

11.   
Rob Massey, Darshini Dalal, Asha Dakshinamoorthy, Eric
Piscini, Will Bible, Wendy Henry, “Initial Coin Offering A new paradigm” for
Deloitte https://www2.deloitte.com/content/dam/Deloitte/ru/Documents/risk/deloitte-blockchain-initial-coin-offering.pdf

12.   
Ethereum is a cryptocurrency platform (native
blockchain) that allows users to create smart contracts. It is an open source
decentralized cryptocurrency platform that is programmable meaning the
blockchain can be modified for various purposes from financial services to applications.
The coin used on the Ethereum blockchain is called Ether.

13.   
Rob Massey, Darshini Dalal, Asha Dakshinamoorthy, Eric
Piscini, Will Bible, Wendy Henry, “Initial Coin Offering A new paradigm” for
Deloitte https://www2.deloitte.com/content/dam/Deloitte/ru/Documents/risk/deloitte-blockchain-initial-coin-offering.pdf

14.   
Brave Software, “Basic Attention Token (BAT),” May
2017, https://www.basicattentiontoken.org/BasicAttentionTokenWhitePaper-4.pdf.

15.   
Section 2b and Section 17 of the Central Bank of
Nigeria Act.

16.   
Section 17 of the CBN Act.

17.   
Circular to Banks and Other Financial Institutions on
Virtual Currency Operations in Nigeria https://www.cbn.gov.ng/Out/2017/FPRD/AML%20January%202017%20Circular%20to%20FIs%20on%20Virtual%20Currency.pdf

18.  
Financial Asset by James Chen https://www.investopedia.com/terms/f/financialasset.asp
accessed 25 June 2020
.

19.   
Section 315 of the Investment and Securities Act. https://sec.gov.ng/report-of-the-fintech-roadmap-committee-of-the-nigerian-capital-market/

20.  
https://diutocoinnews.com.ng/sec-will-release-cryptocurrency-regulations/07/32/ 
accessed 26 June 2020.

21.   
https://news.bitcoin.com/south-africa-leads-crypto-revolution-in-africa-challenges-spur-and-slow-adoption/
accessed 26 June 2020.

22.  
https://nairametrics.com/2020/03/29/nigerians-the-attractions-to-bitcoin/
accessed 26 June 2020.

23.  
https://technext.ng/2018/10/19/nigerian-cryptocurrency-app-buycoins-hits-milestone-processes-over-n500-million-worth-of-cryptocurrency-in-9-months/
accessed 26 June 2020.

24.  
https://disrupt-africa.com/2018/01/nigerias-sureremit-raises-7m-via-ico/
accessed 26 June 2020.

25.  
https://cointelegraph.com/news/vietnam-pincoin-ifan-icos-exposed-as-scams-that-allegedly-stole-660-million
accessed 26 June 2020.

 

 

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