A guide to understanding major cryptocurrency issues and regulatory framework: NT & PBO briefing

Meeting report

The Chairperson opened the meeting by welcoming everyone. He said the Parliamentary Budget Office (PBO) and the National Treasury would inform Committee Members about cryptocurrency and broader digital banking issues. These were technical issues the Committee felt it needed more exposure to for better understanding.

The topic of showing appreciation for civil servants diligent in carrying out their duties was brought up. Mr Ismail Momoniat, Deputy Director-General: Tax and Financial Sector Policy, National Treasury, argued that the Public Finance Management Act (PFMA) was being implemented as if it was the Exchequer Act, and this would impact on delivery. He was concerned that there was “a fear of God in the public sector” that the Auditor-General would regard everything as irregular or frivolous. He wished that Parliament would have a discussion on that because it was an important topic if delivery was wanted. The Chairperson asked Members to think about this comment and to approach the National Assembly Committee. “It shouldn’t be left hanging in the air.” He asked for it to be put on the agenda for the next quarter.

The Chairperson requested that a maximum of 45 minutes be spent on each presentation. This was to ensure that there was enough time for both presentations and for Members to engage with the presenters. 

Presentation by the Parliamentary Budget Office

The presentation was led by Dr Dumisani Jantjies, Director, PBO, followed by Mr Siphethelo Simelane, Finance Analyst, PBO.

The Committee heard that the presentation aimed to provide an introductory background on cryptocurrency and the government’s stance on cryptocurrencies. It would furthermore provide an update on the regulatory considerations while sharing international experiences on cryptocurrencies and regulatory considerations. This briefing was based on desktop research.

Dr Jantjies thanked the Committee for giving PBO the opportunity to do the presentation. He said the topic was continuously developing. The PBO would treat this presentation as their initial input and come back later. Hopefully by the time the PBO returned to brief the Committee again there would be development around regulations both domestically and internationally.

Cryptocurrency was a form of digital money. It was not a mainstream currency, because it was not recognised like government backed currencies domestically and globally. There had been public debate around cryptocurrency and how it was developing. There was serious criticism about using cryptocurrency because of the high volatility in its value and the lack of regulatory measures. Many argued that this threatened the viability of crypto assets in the markets, and there is also the issue of protecting the players in the markets.

Since cryptocurrency was not a mainstream currency it used a highly sophisticated type of encryption called cryptography to secure and verify transactions. This security and governance would have otherwise been provided by government, as with mainstream currencies. Cryptography also controlled the creation of new units of the currency. The technology behind it created a trusting-system that created value within the crypto assets for investment. One commentator had recently said that the “cryptocurrency market should be seen as more like a community” - a place where members of the community trusted one another over time and knew one another. There was growing interest from retail investors and other institutional players, putting pressure on regulatory bodies to become innovative in addressing the risk imposed. Regulators around the world had grappled with the challenges associated with the regulation of cryptocurrencies.

Blockchain technologies enabled cryptocurrency. Blockchain referred to the whole network of distributed ledger technologies. A ledger could be a computer file that recorded transactions. Blockchain aimed to eliminate data tampering. It created trust in the data presented; therefore centralised third parties were not necessary. Blockchain technology had been used over the years long before its use in cryptocurrency.

It was shown in the literature that the idea of the virtual coin was noted in the early 1980s. The idea of cryptocurrency was invented in the late 1990s. The actual creation of the currency was largely linked to the post 2008 global financial crisis. There were concerns about the collapse of the financial system. In 2017 Initial Coin Offering (ICO) grew significantly and market capitalisation peaked. Over the years the market had continued to look for more secured assets. More innovations came into the space to create more secure assets over time.

Slide seven of the presentation showed a recent snapshot of the virtual currency variants. Bitcoin remained the dominant currency with a 34 percent market share value.

Cryptocurrencies lacked intrinsic value because they were not backed by government. Cryptocurrencies were regarded as high risk due to high volatility. Value might be easily eroded and gained within a short period of time. This made it difficult to draw market assumptions about cryptocurrency valuation, unlike other mainstream assets. Certain factors of cryptocurrency value originated from the image and efficiency of the private blockchain-related corporations. The issue was around how much community members trusted each other. There were also stablecoin cryptos, whose value was pegged to fiat money or traded commodities. The biggest debate was around how to establish a clear understanding of how the value of cryptocurrency was created.

There were players and jurisdictions and countries who continued to advocate the use of cryptocurrency. The benefits of using cryptocurrency included the use of technology and innovation to enhance efficiency in the market. It eliminated extreme money printing, gave individuals control of their own money rather than regulators, cut out the middleman and widened access to financial services.

The myths on cryptocurrencies included the assumption that they were only good for criminals, that anonymous transactions could be made, that Bitcoin was the only application of blockchain and that all blockchain activities were private.

With the benefits of cryptocurrencies came risk. There was a regulatory risk, meaning that governments were unable to monitor or protect users of the cryptocurrencies. There was a security risk; the scamming of potential investors and the hacking or theft of data or information had been common risks in the cryptocurrency market since its inception in 2009. There was the volatility risk in unexpected market movements. High uncertainties brought about by cryptos required constant monitoring and regulations.

Cryptocurrencies had a risk of not being able to sell an investment quickly at a reasonable price. Different cryptocurrencies were regularly introduced into the market; many might disappear from the market while others continued to flourish. There was underreporting in relation to cryptocurrency investment because of the lack of prescribed regulatory environments. Slide 12 of the presentation broke down what a cryptocurrency transaction would typically look like in a simplified sense.

Initial coin offering (ICO) was equivalent to an initial public offering for a new start-up. An ICO was crowdfunding, using other cryptocurrencies, for a new cryptocurrency that was connected to a particular product. Slide 14 gave an example of how other cryptocurrencies were created within the system and how they gained value.

The two most common digital based assets or currencies were the digital currency “coin” or the “token”. The cryptocurrency coins (i.e. Bitcoin, Ethereum) had their own blockchains whereas the cryptocurrency token (Maker, Augur) did not operate its own Blockchain but had its own network.

In order to trade cryptocurrencies the traders used a cryptocurrency exchange. Cryptocurrency exchange was more like a market. There could be centralised exchanges where most of the supply of coins and assets was managed by a single entity. There could also be decentralised exchanges where no single entity managed the crypto coins.

Mr Simelane touched on issues around the challenges in “accounting for cryptocurrency” in financial reporting and the challenges in policy development. The Committee was told that cryptographic assets had generated a significant amount of interest  recently given their rapid increase in value and volatility. This had attracted regulatory scrutiny in many different jurisdictions. Since there was no accounting standard that explained how cryptocurrency should be accounted for, one must look into the existing International Financial Reporting Standards (IFRS).

There was much judgment and uncertainty involved in recognition and measurement of cryptocurrency. Slide 23 illustrated the means by which cryptocurrency could potentially be classified and what this would mean. Slide 24 showed the South African stance on cryptocurrency from 2014 to 2020. In 2018 the Crypto Asset Regulatory Working Group (CARWG) was established to review South Africa’s position on crypto assets. The ability to make payments using cryptocurrency was currently not provided for under the existing regulatory framework. It was legally possible to buy immovable property using cryptocurrency as a means of payment. It was however very risky, because when using cryptocurrency you removed the usual means of securing the transaction. Since cryptocurrency was not held in a financial institution, a guarantee against such funds could not be issued.

Countries like Algeria, Bolivia, Morocco, Nepal, Pakistan and Vietnam had completely banned the use of cryptocurrencies. Bangladesh, Iran, Thailand, Lithuania, Lesotho, China and Colombia imposed indirect restrictions by barring financial institutions within their borders from facilitating transactions involving cryptocurrency. Spain, Belarus, the Cayman Islands and Luxembourg saw a potential in the technology behind crypto assets and were developing a cryptocurrency-friendly regime as a means to attract investment in technology companies. The Marshall Islands, Venezuela, Eastern Caribbean Central Bank member states and Lithuania sought to go even further and develop their own system of cryptocurrencies.

Presentation by National Treasury

 

The presentation was led by Ms Olaotse Matshane, Chief Director, National Treasury. 

The presentation set the scene by giving a brief introduction on Fintech - technologically enabled financial innovation - and the Intergovernmental Fintech Working Group (IFWG). Ms Matshane discussed the definition and use of crypto assets, the South African regulatory landscape and the “South African crypto assets journey”. The presentation furthermore examined issues of tax treatment, money laundering, financial surveillance and domestic payments.

Ms Matshane said that the term “crypto-assets” would be used in the presentation. Crypto assets were a subset of Fintech. Fintech was technologically enabled financial innovation which resulted in new business models, products or services with a material effect on financial markets (see definition on slide 4). Crypto assets had taken the definition to a whole other level, hence the complexities. The applications and processes with crypto assets were far more complex than other Fintech innovations. In 2019 the National Treasury, as part of the IFWG, commissioned research into the South African Fintech landscape. The research found that Fintech activities had been on the rise in South Africa. The study uncovered over 220 Fintech companies. At least 30 percent of the Fintech activities involved payments. Another 20 percent of companies were in the business to business technical support sector. Other players were in the space of insured tech lending. One of the key Fintech players in South Africa was Luno, a digital currency platform or exchange. If you wanted to buy and sell your Bitcoin you would go to Luno. Sun Exchange was another interesting player. It was a solar leasing platform. Using Bitcoin, you could buy solar electricity cells.

Since its establishment in 2016 the IFWG had grown to include the National Credit Regulator (NCR), the South African Revenue Service (SARS) and the Competition Commission (CC) with other members under consideration. The IFWG had what was called the Innovation Hub, which was a centralised innovation capability shared by all the participating regulators. The Innovation Hub had three components, the Regulatory Sandbox, the Regulatory Guidance Unit and the Innovation Accelerator (see slide 9).

The term “crypto asset” was used instead of “cryptocurrency”. The term “currency” meant money which was legal tender - banknotes and coins - issued by the South AFrican Reserve Bank (SARB). Crypto assets were not money; they were not legal tender and were not issued by a central bank. This presentation would speak about crypto assets that were not issued by a central bank. It was important to note that there could be some crypto assets that were issued by a central bank.

Crypto assets had thus far largely failed in their ambitions to be a widely used payment instrument. Crypto assets had however grown rapidly over the years in South Africa and posed a number of risks to consumers if not regulated.

Practical Examples

The Committee heard that Pick n Pay successfully tested Bitcoin as a payment instrument in 2017. Pick n Pay however did indicate that they were unlikely to roll out the solution until the payment industry and regulatory authorities had established a framework for managing the risks associated with crypto assets. Some of the risks, such as volatility, could not be removed by regulation. 

South Africa had no choice but to regulate crypto assets. To mitigate against risks such as fraud, cybercrime, maladministration and excessive fees, the Financial Sector Conduct Authority (FSCA) had issued two warnings on crypto assets. It was currently embarking on a process to designate crypto assets under the Financial Advisory and Intermediary Services Act (FAIS) to enable greater regulatory oversight. Slide 29 illustrated the top 10 cryptocurrency investment scams of 2020.

Key considerations

The Committee was told that the decision to regulate crypto asset service providers did not suggest endorsement of crypto assets. The regulation was not on the product but on the activities of crypto asset service providers. Crypto assets remained highly volatile and were inherently risky. The crypto asset space was rapidly evolving. Crypto asset marketing often highlighted only the potential upside of crypto assets with no consideration of the massive potential downside. Crypto assets were not recognised as electronic money.

Discussion

Mr D Ryder (DA, Gauteng) thanked the PBO and the National Treasury for their presentations. He was pleased that the discussion around cryptocurrency was happening and that Members were becoming informed. He particularly enjoyed Ms Matshane’s presentation. Many of his questions had been answered by the presentation from the National Treasury. It was really informative and answered most of the questions he had written down. He was pleased to learn of the existence of the Fintech working group because it meant that there was a degree of productivity and “cross-pollination”. Intergovernmental cross-pollination was important. Entities tended to work in isolation but were intrinsically linked.

He asked Mr Brandon Topham, Divisional Executive: Enforcement, FSCA, to tell the Committee more about the FSCA’s role. There were some really serious issues such as exchange control, revenue collection and investor protection. Everyone had seen advertisements about buying cryptocurrency. “Every time you pick your cellphone up there’s an advert playing that says that this is where you can get and store your cryptocurrency.” Was there a role for the FSCA to play? Particularly given that cryptocurrency was not a currency but rather a commodity. He hoped that Mr. Topham would give the Committee guidance regarding the FSCA’s role. He enjoyed the fact that different regulation trends internationally were pointed out.

The presentation had spoken about “listening to the noise”. There was a huge amount of noise out there at the moment and many people were getting involved without information. This was why the Committee wanted to have this presentation so Members could understand a little bit better. What was being done from the government's point of view in terms of protecting people and protecting the economy to a degree as well? There was the revenue collection problem and the exchange control issue. Retailers like Pick n Pay had started considering or piloted accepting Bitcoin for groceries. This was a big and sudden move from retailers and a bold move on their part. It showed that there was a general acceptance of cryptocurrency. He stated that the move to ban crypto assets, cryptocurrency, and crypto exchange is shortsighted because “clearly there is a need for it”.

Mr Ryder said it had become so easy to trade and transact. “You can tap and go with your card, everyone can get a check or debit card these days for any type of account, you can buy things online, you can send money without having a bank account, without using a card.” It had become incredibly easy to perform transactions so what purpose would there be for the use of cryptocurrency? He reasoned that the only distinguishing feature of cryptocurrency would then be the lack of regulation. Was the biggest selling point of cryptocurrency the fact that it had a lack of regulation? Was there space for government-backed cryptocurrency or government-backed crypto assets? Was there space for a government-backed crypto exchange? What was the potential to take the leading edge on this thing?  Was South Africa embracing cryptocurrency or were we restrictive or “putting up with it”? Where would South Africa fit in from a National Treasury perspective, from a SARS perspective and from a planning perspective going forward? He concluded by stating that he really appreciated the information that had been shared with the Committee and thanked the Chairperson for scheduling the meeting.

Mr W Aucamp (DA, Northern Cape) thanked the presenters of the PBO and National Treasury for an “excellently presented” briefing on cryptocurrency. It had really given him some insight. He admitted to the Chairperson that he joked about being “technologically disadvantaged”. The presentations were very informative. He understood that taxation on crypto assets could easily be done with the “end-seller”. He gave an example of someone selling soap who accepted cryptocurrency as a method of payment. He wanted to know what the taxation regulations were when it came to trading with cryptocurrencies. “Explain it to me as if I am a 50 year old.”  If he bought “x” amount of Bitcoin and in a month’s time sold it for R5000 more than what he had bought it for, what was the taxation on that and how would it be regulated? It was easy to regulate the tax with an end-seller like the soap seller example he had given, but how would the taxation be regulated with people trading with cryptocurrency and the profits made from it?

 

Mr M Moletsane (EFF, Free State) stated that the presentation from National Treasury covered most of his questions. Slide nine of the PBO presentation listed myths. Were they just myths or was there some truth to what was mentioned there? He directed this question to Dr Jantjies.

 

Mr E Njadu (ANC, Western Cape) welcomed the presentations.  He said that it was important that the Committee became well aware of the cryptocurrency matter in advance. In terms of the presentation, there was “a no turning point” because cryptocurrency had gone global and was affecting South Africa. Cryptocurrency already had a big number of consumers in South Africa. The presentations highlighted a lot of important things, such as there being no banks for cryptocurrencies. The money was being stored somewhere. The interest that was being created by the companies and also the scams coming forward often resulted in people losing a lot of money. This matter was very serious. The Committee needed to look at it as a point of importance. Issues around the taxation of cryptocurrencies had been raised, as well as the non-regulation of them and most importantly, the issue of how the matter would be dealt with moving forward. How were the public and communities to be protected by the government? The government had to make sure people were protected so that the economy of the country was not negatively affected. There was a need to move with speed. Government needed to look at ways to inform the communities in order to “bring our people on board”.

 

Mr Z Mkiva (ANC, Eastern Cape) said that he also wanted to add his voice. He welcomed the presentation by the presenters. He asked why it had taken so long for the Committee to be shown the presentation on cryptocurrency. In some of the countries that had been mentioned where cryptocurrency exchanges were happening, those exchanges were backed by the countries’ assets, including mineral deposits and oil deposits. From a South African point of view, was cryptocurrency backed by any assets right now?  In the manner in which cryptocurrency exchange was happening, a duty-free kind of processing was used. Why was this allowed? There were regulations that governed currencies. Why was cryptocurrency being treated “as something that is operating in an ivory tower” or in a stateless kind of space.

 

Mr Mkiva said there was a financial charter which dealt with issues of transformation in terms of the participation of previously disadvantaged people. He expressed concern about cryptocurrency being ahead of a majority of South Africans. Had there been any consideration about cryptocurrency being included within the transformation region? Would there be a wait until certain sections of society were empowered while others were disadvantaged, with transformation being brought in later? Was it not always better to preempt these things,  given that there was a new dispensation? The manner in which new things came into the economy must happen within the confines of the regimes that had been established to address the issues of historical imbalances.

 

The Chairperson responded to Mr Mkiva’s questions about why it had taken so long for the Committee to be briefed on cryptocurrency. This was not a question that should have been put to the PBO or National Treasury; it is a question that should have been put to the Committee to answer. The Chairperson was ultimately held responsible for the Committee. When quarterly programme drafts were done Members were free to raise the cryptocurrency topic. Cryptocurrency had been put down as a pending item for the last quarter. There had been exchanges on cryptocurrency. The South African Reserve Bank Governor had touched on the topic of cryptocurrency about two years ago and around 2017/2018 there had also been input from the National Treasury and others. “We were in fact expecting legislation to come to us from the National Assembly side.” It had been on the agenda but the slot was only found now.

 

He said that National Treasury spoke about crypto assets being “highly volatile and inherently risky”. Those were very powerful words. Scams were also mentioned in the presentation. On balance, given that you could do so many things without crypto assets because of how advanced cell phone banking had become, cryptocurrency seemed to be redundant. Maybe people were doing it because it was not regulated? Maybe when it was regulated they might do it less? Or maybe they would do it more because it was now regulated. He was surprised to hear that only one country considered crypto assets an electronic currency.

 

He asked for the concept of blockchain to be explained because he battled with it. What was good about blockchain was that it was an open and transparent system of transactions and accounting. Blockchain was good because it avoided misdemeanours, wrongdoing, corruption, and lack of transparency. That was what he had understood blockchain technology to be. It was like a building block so you could trace things back to the origins of the issue and in between, once something was put in it was a building block sort of thing, and then you could not alter what happened in the past. This made it more open and transparent.

 

He was curious about why people would go for cryptocurrency. He was amazed that Pick n Pay had piloted the exchange of cryptocurrency for the purchase of groceries. Soon Checkers would be doing the same and Spar would be doing it.

 

The Chairperson said cryptocurrency needed to be regulated. When the South African Reserve Bank Governor, Mr L Kganyago, had come to the Committee about two years previously he had said that regulations were being planned. The Chairperson said he had considered including the Reserve Bank in the discussion but reasoned that it would’ve been overwhelming to have the Committee briefed by three entities.

 

He was not absolutely clear on how cryptocurrency could help “poorer, more disadvantaged people”. New banks like TymeBank and Capitec appealed to people from the lower income strata. The Standing Committee on Finance had in the previous term had a massive financial sector transformation report done based on hearings. The ANC wanted to see African ownership of the financial sector. It was so difficult to start a bank especially where there were such high levels of monopoly. He knew that the National Treasury’s view would be that “banks are inherently monopolistic and it’s difficult to get in and what about the poor people who join a new bank and then lose all their money”. Nevertheless, the ANC was saying that they would like to see African and black ownership of the banks. There was a bank in India with 160 million clients and they didn't pay a penny. How would cryptocurrency help people in the lower income strata who could only become clients of a bank like TymeBank. He concluded by stating that the presentations on cryptocurrency were stimulating.

 

Mr. Ryder asked about the mining of Bitcoins. Who controlled that scarcity? Who was the person at the centre of Bitcoin? “What’s to say he doesn’t issue himself with two million Bitcoin tomorrow and flood the market?” This was something that bothered him.

 

Responses

 

Ms Matshane (NT) wanted to clarify the issue of Pick n Pay. She said that they had done a test trial on using Bitcoin as a payment method. Pick n Pay said that they were however unlikely to roll out the solution until there was a clear regulatory framework in terms of how the risk of crypto assets would be managed.

Where was South Africa in terms of being restrictive, facilitative or accommodative? South Africa was being facilitative. It wanted to allow the activity but the activity must be responsible with the consumer being protected. South Africa was being very cautious. When it came to retirement funds and collective investment schemes, until proper research had been done, exposure to these crypto assets would not be allowed. She concluded by stating that “our stance is a facilitative one. We are neither too restrictive nor too accommodative”.

Mr Franz Tomasek, Head: Legislative Policy Tax, Customs and Excise, SARS, said that he was responsible for taking care of legislative policy at SARS. The question was, “someone buys crypto and sells the crypto a month later, what’s the tax you pay”? From an interpretative point of view that looked like a speculative transaction. The person bought and sold to make money and that would be considered taxable in the normal course of trade or speculation in crypto assets. The deeper underlying question was, how would SARS detect that? SARS depended to a very large extent on voluntary compliance. People should be willingly declaring things. What would happen if this person who got the R5 000 in Mr Aucamp’s scenario did not declare it ? The person would have R5 000 that they didn’t have before. SARS would see this in their bank account and would question where the amount came from. He said that “the string would be there for us to pull on to unravel the transaction”.

The point was being made that crypto was often looked at because of its anonymity. That depended on the nature of the crypto asset one was looking at. Some were more strongly anonymous than others. Several of the more popular ones were not as anonymous as people might think. Those who were interested should Google “Bitcoin Silk Road Seizure” and have a look at what happened to some Bitcoins that were used in an illegal underground economy known as Silk Road. Silk Road was closed down by the United States authorities. It took authorities seven years to track the money down “but track it down they did”. They were able to seize the Bitcoin and sell it. Anonymity was variable. If there were sufficient reasons to try and work out who lay behind a particular account on the blockchain, which was public knowledge, there were techniques for unravelling that. More realistically, for smaller issued amounts, the normal-size investigative tools would be very effective in picking up undeclared transactions.

Mr Brandon Topham, Divisional Executive: Enforcement, FSCA, said that when it came to revenue transactions, the FSCA communicated with the revenue authorities and the exchange control authorities. Crypto assets were being watched very carefully. “If one of us doesn't get you, the other one will definitely get you.” The FSCA did not like crypto assets. They accepted that they were here but remained sceptical about them. They realised that they involved 2.9 trillion US dollars and there were 55 million accounts worldwide. This was growing very fast, so the FSCA could not “play ostrich” with cryptocurrency; it could not be ignored. The approach of the FSCA had been to push the idea of regulating the people who were in the middle. As Mr. Njadu had correctly pointed out, you were not dealing with a bank. In many cases you were dealing with something like a bank. You were giving your money to exchangers and hoping that they would  honour the commitment.

 Many South Africans were giving their money to companies dealing with crypto assets. He had been on an international call and there were complaints about Cyprus. Money had been given to companies in Cyprus and would disappear. The FSCA wanted to protect users “because our Constitution allows you to throw your money away if you want to throw your money away, if you want to gamble it you’re allowed to gamble it”. He urged people doing this to at least use a South African registered financial service provider who would be registered with FSCA. This would help ensure that anonymity fell away. Even though the FSCA could trace where money flowed through the blockchain, they did not always know whose it was. “But if you open up your wallet in South Africa, it will be a requirement with the Financial Intelligence Centre (FIC) regulation changes that are coming across, that they need to know who that money belongs to.” It would make it easier for law enforcement to be able to track money that was based in South Africa. If the money, for instance, hit a Cyprus account it was gone and could not be tracked easily. The FIC, however, had a sophisticated intelligence database and would sometimes know where the money was. The database from FIC, however, could not always be used by the FSCA.

 How did cryptocurrency or assets help lower income people? South Africa’s banks were accessible to the lower income population. There were certain countries in Africa who were worse off. In those countries, they were finding that crypto payments could be useful for individuals in the lower income strata. South African banks were inclusive of the lower income strata. At the moment it took 50 minutes for a transaction on the crypto wallet to be properly approved if it was used as a payment mechanism. This was probably why it would not be able to fulfil that “inclusivity” role in South Africa.  Of the 2.9 trillion dollars in payments the previous year just 0.34 percent was illicit. The majority of people currently using crypto were the “man in the street”. The hype or noise was driving up the prices. Whilst crypto assets were by themselves not bad, the underlying different crypto assets were dangerous for consumers. By regulating the middle man, making sure that the advice given was proper and that the people South African citizens were dealing with were legitimate, the chances that they would lose their money in the exchange risk was much lower. Consumers could not, however, be protected from losing money when crypto assets collapsed. The best the FSCA could do was to warn people about crypto assets being a high risk investment.

Mr Tim Masela, Head of the National Payment System Department (NPSD), SA Reserve Bank, addressed the question about what was broken in the current system that created a need for crypto assets. He said the current payment system had intermediaries. As an example, if one transferred money from one's own account at one's own bank to the bank of a seller or service provider, a third party, the bank, was in the equation. In this equation there was someone who had to facilitate the movement of those funds - the bank. If the seller and buyer were at different banks, the money was moved from the bank of the buyer into the bank of the seller and into the seller’s pocket. Payment with crypto assets got rid of those intermediaries. “Money will move as though I’m handing over cash in my hand to someone else’s hands.” No third party was involved. Blockchain distributed ledger technology came in here. When cash was handed over through a distributed ledger there is this consensus of the “block” that is added to the “chain. It meant the two people were just using the systems and no other parties were involved. This was where the use of cryptocurrency was said to be different from the current system. The fact that the use of cryptocurrency was different to the current system did not make it more efficient.  “Why do we need this (cryptocurrency) while we have systems that work currently?”

The Reserve Bank had launched a project to test the feasibility of the NPSD issuing a central bank digital currency (CBDC). This was to ensure that digital currencies were issued by a central bank which was trusted and which had controls, rather than being issued by the private sector. The aim was not to ban the private sector but to fulfil the need that was out there. If the project worked and the feasibility was proven it is possible that the Reserve Bank might decide to issue a CBDC which would fulfil the role of cryptocurrency.

Most of the currencies out there were not necessarily trying to resolve the “payment use” case. They were seen as investments, “people getting money overnight”. The “payment use” case was not pronounced but the Bank recognised that it could be there and that something should be done about it so that the transacting public was offered facilities to enable transactions. The Reserve Bank wanted to test how to enable peer-to-peer payment without anybody in between and facilitate efficient payments. A question confronting many jurisdictions around the world was, “do you want to be the leader of the world and break ground so that everybody learns from you or do you want to be a fast follower such that you observe these things closely and you move with speed to embrace the benefits of this technology?”The Bank was observing matters very closely and would move with the agility that was required. There are two areas of concern. The number of monetary policy implications still needed to be better understood before the project could be embraced. There could be financial stability risks “that we don’t understand well and we need to understand them”.

The position that has been acceded to by the executive of the Reserve Bank was that the private sector bodies issuing cryptocurrency should be invited to go into a controlled environment called “the Sandbox”. Private bodies would be allowed to test cryptocurrency with the regulators to understand “some of these things that we do not understand” so that if cryptocurrency was embraced, “we have a good understanding”. The SARB had opted to invite a number of the issuers of crypto assets to go into a “Sandbox” or controlled environment with SARB as the regulators. If it was seen that the benefits outweighed the risks and things were under control, it was possible that a robust regulatory stance would be adopted to embrace cryptocurrencies.

The Chairperson thanked Mr Masela for explaining everything nicely and simply.  

Mr Pieter Smit, Executive Manager: Legal and Policy, FIC, confirmed that there were definite plans underway in bringing intermediary cryptocurrency service providers under the net of the Financial Intelligence Centre Act 38 of 2001. They would be required to comply with the same type of obligations and requirements that financial institutions had to comply with. From an anti-money laundering and anti-terror financing point of view the FIC would be treating cryptocurrency service providers as if they were providing a financial service even though the FIC did not necessarily consider the asset that they dealt with to be funds or money. The net effect of what cryptocurrency service providers did was equivalent to the types of services that financial institutions provided and therefore the FIC believed that cryptocurrency service providers should be subject to the same regulation.

The Blockchain, the underlying technology that allowed crypto asset transactions, actually became one of the FIC’s most powerful weapons in tracing individuals that were involved in transactions. Blockchain was a massive bookkeeping system that kept track of each and every transaction. If one could tie the identity of the persons to the transaction information in the ledger it actually told you the whole story of how the crypto asset moved and who was involved in every step of the transaction chain. This was the sort of objective the FIC was working towards with the proposal to bring cryptocurrency service providers into the same set of regulations that applied to financial institutions. “We have had fairly good successes in the FIC over the past.” Some of those successes had been reported in their last annual report. They were, for instance, able to trace transactions, identify persons and actually launch successful forfeiture proceedings through the Asset Forfeiture Unit (AFU) where crypto assets were used in illegal schemes.

 Mr Ismail Momoniat, Deputy Director-General: Tax and Financial Sector Policy, National Treasury, said the critical aspect was that cryptocurrency was a product that was being sold as a financial service. Cryptocurrency needed to be regulated. “Too many people are buying it.” Even if just one person bought cryptocurrency it would still need to be regulated. One was dealing with unknowns so this was a difficult area. There was an “element of forbidden fruit”. People liked the anonymity that came with cryptocurrency. It was not something that should be encouraged. Bitcoin required a high level of electricity use. There were a lot of elements around cryptocurrency that needed to be looked at. “It’s not like we have all the answers, I think we’re also learning.” The aim was “beginning to understand how to regulate it more effectively and protect people from big potential abuses”.

The Chairperson said that the more he thought about it the more he realised that this was a big issue. It was a difficult area to navigate. There needed to be a broader discussion with several affected Committees in both the National Assembly and National Council of Provinces. He gave the PBO the opportunity to respond to questions.

Dr Jantjies said that cryptocurrency was seen as an innovation that came from financial technology. Slide 33 of the presentation indicated that some of the countries recognised this innovation to the extent of using it to develop their central banks. Cryptocurrency had identified a need in the markets that had not been fulfilled. Many countries did not recognise cryptocurrency as a currency. Cryptocurrency did not pose risks to the financial system. There were elements where one would recognise that cryptocurrency was becoming more mainstream. If one allowed innovation to take place it needed to be within boundaries to ensure other systems would not be compromised and that many people were allowed to benefit from it.

He made reference to slide nine of the presentation which highlighted the benefits and myths surrounding cryptocurrencies. Many people were engaging with cryptocurrency without understanding how technical it was. He addressed the issue of whether the myths had any truth to them as Mr Moletsane had asked. Were cryptocurrencies only good for criminals? He confirmed that cryptocurrencies had been used for criminal activities, but it had also been used for other reasons which could be regarded as investments. All cryptocurrencies did not guarantee anonymity. The blockchain technology did allow for some monitoring and tracing of transactions to understand who the players were. There was a need for information about cryptocurrency to be distributed in an accessible language, in layman’s terms. It was important for society to understand how the entire system worked, and its effects.

Mr Topham answered the question on scarcity asked by Mr Ryder. He said that thousands of crypto assets had different rules. Bitcoin had programmed into its calculation a maximum of 21 million crypto coins to be created.  Ethereum, which was the second largest cryptocurrency, had an 18 million limit per year. The argument people raised as to why Bitcoin for instance went up in value was because of the scarcity issue. A month previously, a Bitcoin was worth R820 000, today it was worth R520 000. He said that he could not justify how that scarcity as a utility method could move a price up in a few years. The scarcity argument which was put forward by users of crypto assets must be taken with a pinch of salt. A majority of users around the world were not using cryptocurrency as a payment method; they were using it for speculation and to store wealth. That was the danger, “when people are storing wealth that doesn’t exist”.

Dr Seeraj Mohamed, Deputy Director: Economics, PBO, wrote in the Zoom Chatroom as his microphone was not working. He was concerned about the “extent of macroeconomic implications of crypto currencies” not having been adequately explored. Government’s focus is too much on cryptocurrency as a financial services issue and not a monetary system issue. There should be a government research project led by National Treasury and SARB on the macroeconomic implications of increasing the use of crypto assets. This should include the functioning of the monetary system, the efficacy of monetary policy, the impact on banking and finance markets and financial stability. The importance of macroeconomic policy for supporting South Africa’s economic development and inclusive growth should be central to such a study. As it became more widespread and mainstream, crypto increased systemic financial risks because of the volatility and difficulty in valuing it, and also related to the delays within the system of trading and converting it into the sovereign or other currencies. The same issues that were problems for the financial assets used during the subprime bubble and led to the crash could apply to cryptocurrencies as they were being used now – for speculative purposes - and increasingly by institutional investors and exchange traded funds. The crypto was being used as collateral that increased leverage of these institutions.

Mr Ryder responded by asking whether it was “a giant Ponzi scheme”?

The Chairperson said that what Dr Mohamed and Mr Ryder had said was something that everyone in the meeting had been saying in different ways. Put in those harsh and direct words “it hits you a bit more”.

Mr Momoniat said that it had been reiterated in this meeting that there were a lot of risks around cryptocurrency depending on the volume. If the volume scaled up it would become a macro-risk. The growth of cryptocurrency could be a future risk but in many instances some countries were going to accept this medium. It was better to regulate cryptocurrency than to leave it unregulated. The potential risk could be very significant but “on the other hand we can’t cut ourselves from it”. The hard question would be, “what is the right balance, how do you do all of that”? For the moment the regulators needed to come up with a coherent framework. It would be easier to engage with Parliament once there were clear proposals and Members were mindful of the risks.

The Chairperson said that the previous Committee had raised this issue and at that time the SARB and National Treasury had said that they were working on some regulatory framework. It was now three or four years later and, with the Covid-19 Pandemic, people are getting desperate. On the one hand people were functioning from their homes and using more internet and on the other hand money was being lost. People wanted to find ways of making easy money and others were vulnerable and could be exploited. For those reasons the preparation of papers needed to be escalated. He suggested that the Committee work with the National Assembly Committee and others “to take this thing forward”. The Committee would wait on the SARB and the National Treasury ‘to get their act together’. If there is a draft a hearing could at least be held so that Parliament can hear other viewpoints, such as  academics and NGOs, apart from the views of state institutions. Parliament needs to hear from a wider range of stakeholders and experts in the area.

Dr Mohamed sent a link in the Zoom Chatroom for more information on the power consumption of Bitcoin mining (https://www.visualcapitalist.com/visualizing-the-power-consumption-of-bitcoin-mining/)

Mr Ryder said that the briefing was an “excellent interaction”. He suggested that further interaction would possibly be more suited to the National Assembly than to the Committee but the Committee must be informed. He concluded by stating that “today was needed and greatly appreciated”.

The Chairperson asked where the term “Bitcoin” originated from and where the name “Crypto” also stemmed from.

Mr Ryder responded by saying that the term “Bitcoin” was just a brand name.

Mr Momoniat said that he was no expert but he believed that the term crypto assets described the entire phenomenon.

Mr Masela speculated that Bitcoin came from the bits and bytes in a machine. “Crypto” came from cryptography which was the exchange of keys. It was the phenomenon that safeguarded distributed ledgers in a blockchain environment.

Mr Herco Steyn, Senior Fintech Specialist, SARB, commented on the financial stability and monetary policy considerations from the perspective of the Bank. One Bitcoin was broken up into 100 million Satoshis (named after the creator of Bitcoin Satoshi Nakamoto).  It spoke to the divisibility of a Bitcoin. On the question of inaccessible wallets, he said there were quite a few accounts of people who realised they actually had some Bitcoin stored on an old computer that they had thrown out. There was a well reported case of a CEO who died and was the only person who had the private keys to unlock the omnibus account for all the crypto assets exchanges held on behalf of clients.

If one looked at the kind of private key that enabled the spending of value in a cryptocurrency wallet, it consisted of around 50 alphanumeric upper and lower case characters. One had a better chance at winning the Lotto around six times in a row than cracking the code to the private key. It was very difficult. Technological development such as quantum computing might change that over time but if you lost the private key “it’s gone forever and you don’t have any recourse”.

Mr Steyn said the Reserve Bank monitored the financial stability and monetary implications very closely. He referred to the two largest crypto assets, Bitcoin and Ethereum, by value and market capitalisation. Currently, around 100 million dollars of value was created through crypto asset mining just from those two assets on a daily basis. If you extrapolate that over the course of a year it meant that around 120 billion dollars of value was created through crypto asset mining of Bitcoin and Ethereum. This value excluded over 10 000 other crypto assets out there. If one looked at the broad definition of money, in excess of 100 trillion dollars was probably sitting around at the moment. An annual addition to that in the region of 120 billion was not systemic at this stage. Crypto asset mining was not widespread in South Africa because of the price of electricity which made it economically non-viable. In terms of monetary policy implications, for now it was definitely something that the Reserve Bank would continue to monitor. For the time being, the value being created outside of the traditional financial and banking system was not of immediate concern. The assessment of the Financial Stability Board (FSB) continued to be that even with the recent increase in price and value, the current market capitalisation or total value of all the crypto assets in existence today currently sat at around 1.5 trillion dollars. That was not systemic at the moment but that assessment might change over time.

The Chairperson said that he regretted not having exposed the input on cryptocurrency to a wider audience. Many Members could learn so much from this input regardless of which Committee they were on. The brief on cryptocurrency had been very stimulating. He thanked everyone who had contributed towards the discussion. He thanked the Members.

The meeting was adjourned.