ADGM Navigating Change: Key Proposals in FSRA Consultation Paper No. 11 for Virtual Asset Regulation

The Financial Services Regulatory Authority (FSRA) of the Abu Dhabi Global Market (ADGM) has released Consultation Paper No. 11 of 2024, outlining proposed changes to its regulatory framework for businesses involved in virtual assets.

The paper seeks feedback on potential amendments to the rules governing authorised entities conducting regulated activities related to virtual assets in ADGM.

Key proposed changes include revisions to the process for accepting virtual assets for use within ADGM, along with adjustments to capital requirements and fees. The FSRA is also seeking input on emerging trends in the virtual asset space, including staking and new business models.

Additionally, the consultation invites feedback on the criteria for determining whether non-ADGM-issued Fiat-Referenced Tokens should be allowed in ADGM. Another proposal aims to expand the range of investments that Venture Capital Funds in ADGM can make.

According to RASMA LEGAL, entities such as Virtual Assets (VAs) firms, Authorized Persons intending to conduct Regulated Activities involving Fiat Referenced Tokens (FRTs), Fund Managers of Venture Capital (VC) Funds, applicants considering these activities, and generally other persons active in the VAs sector should take note of the proposed amendments to the FSRA’s regulatory framework for Authorized Persons conducting Regulated Activities involving Virtual Assets in ADGM. 

The deadline to submit comments on the ADGM proposal is 31 January 2025.

Section A

With the launch of the VAs regulatory framework in 2018, the FSRA has distinguished itself as a pioneer in implementing a bespoke regulatory framework for VAs.

However, as with any nascent regulatory initiative, the FSRA’s initial framework introduced a single Regulated Activity, “Operating a Crypto-Asset Business (OCAB)”. Firms engaging in this activity were required to use only “accepted” VAs.

In 2020, the FSRA broadened its regulatory framework, introducing a suite of Regulated Activities in relation to VAs, namely: (i) Dealing in Investments as Principal; (ii) Dealing in Investments as Agent; (iii) Advising on Investments or Credit; (iv) Arranging Deals in Investments; (v) Managing Assets; (vi) Providing Custody; (vii) Arranging Custody; and (viii) Operating a Multilateral Trading Facility (MTF).

This expansion brought much-needed legal certainty for market participants and aligned with the global trajectory of VAs regulation. It is a natural progression and an anticipated step in the FSRA’s proactive regulatory approach.

Notably, throughout ADGM Consultation Paper No. 11 of 2024, we can observe how the FSRA is moving away from its previously conservative approach as the VAs market matures. The proposed amendments signal a shift from the FSRA holding sole responsibility for roles as the assessment of VAs, to granting greater autonomy to VAs firms; thus, fostering a more collaborative and industry-driven approach.

However, the FSRA also maintains a careful balance and control through its gatekeeping role. The FSRA has strengthened its regulatory toolkit by introducing a new power that allows it to intervene in certain situations as outlined in greater detail below.

Section B

Section B.1: Proposed revisions to the VA framework

Revisions to the process whereby VAs are accepted for use in ADGM

The proposed amendments to the current FSRA-led Accepted VAs (AVAs) approval model require VAs firms to self-assess each VA they intend to use in the conduct of a Regulated Activity in ADGM.

Moreover, several obligations apply to VA firms in this regard. First and foremost, they must continue to conduct due diligence and risk assessments. Each VA firm would also be required to notify the FSRA and provide information on its due diligence process and demonstrate how the AVA assessment criteria have been met. As a further on-going obligation, each VA firm has to monitor its AVAs to ensure that they continue to satisfy the assessment criteria.

Beyond that, every VA firm must publish an up-to-date list of the AVAs it uses on its website.

Ultimately, the FSRA will retain its role in mitigating risks and preserving market confidence through compliance oversight and the following measures:

• imposing enhanced reporting requirements for VA firms regarding their use of AVAs; and
• taking regulatory action if a particular VA no longer qualifies as an AVA.

Enhancing FSRA powers in relation to VAs and introducing express prohibition on the use of privacy tokens and algorithmic stablecoins in ADGM

Product intervention power

The FSRA proposes to introduce the product intervention power to halt dealings in a particular VA (including FRTs) when it identifies risks to the public, such as anti-money laundering (AML) concerns.

This power represents a broad-based regulatory tool, which applies across all persons in ADGM and not only Authorized Persons conducting a Regulated Activity. It also reflects the FSRA’s alignment with global regulatory standards, similar to those in the UK Financial Services and Markets Act 2000, where the Financial Conduct Authority (FCA) has the authority to make general rules including product intervention rules for the purpose of, inter alia, advancing one or more of its operational objectives among which is the consumer protection objective.

Furthermore, the FSRA proposes explicitly prohibiting in the Financial Services and Markets Regulations (FSMR) the use of algorithmic stablecoin tokens, privacy tokens, or any digital asset employing similar technology in carrying on any Regulated Activity in ADGM.

Algorithmic tokens attempt stabilization through algorithms that may control the supply of the tokens to influence price. If the algorithm fails or is manipulated, significant volatility can occur. A notable example of this is the Terra Luna crash, where the algorithm behind its stablecoin, UST, failed, causing it to lose its peg to the dollar. This led to massive inflation of the linked token Luna, which also lost value rapidly.

Privacy tokens, which enhance anonymity and obscure transactions’ trails, make Customer Due Diligence (CDD) more challenging. Such opaque tokens make it difficult to trace and monitor transactions. This can create a lack of transparency and hinder compliance with AML and Know Your Customer (KYC) regulations.

The FSRA seeks to address these risks of volatility and obfuscation of VA financial flows.

Notably, the Central Bank of the UAE (CB UAE) also takes a firm stance against Algorithmic Stablecoins and Privacy Tokens, imposing a prohibition that leaves no room for ambiguity.

This prohibition extends to all individuals and entities, in the UAE or engaging with individuals or entities in the UAE, including those engaging in Virtual Asset activities under a license or regulation issued by the SCA or any authority competent to regulate Virtual Assets in the concerned Emirate in accordance with Cabinet Resolution No. 111 of 2022 Concerning the Regulation of Virtual Assets and their Service Providers, as amended. The CBUAE expressly prohibits:

1. The issuance of Algorithmic Stablecoins or Privacy Tokens and any services related to them.
2. The promotion of such tokens, whether in the UAE or directed to persons in the UAE.

The FSRA’s proposed prohibition also aligns with the Financial Action Task Force (FATF) requirements to prevent the misuse of VAs for illicit finance (particularly, Recommendations 10 and 15). Furthermore, it strengthens customer identification, verification of the source of funds, transaction monitoring and suspicious transaction reporting (STR). This prohibition is an additional regulatory measure aimed at strengthening AML/CFT systems, particularly in relation to the Travel Rule, which mandates the secure collection and transmission of originator and beneficiary information.

Section B.2: Discussion points relating to the VA framework

Scope of the Regulated Activity of Providing Custody

The FSRA seeks feedback on whether Authorized Persons engaged in Providing Custody should be allowed to hold digital assets other than AVAs.

We are of the opinion that expanding the scope to include non-AVAs could invite new risks, particularly in terms of volatility and security.

Staking and other emerging business models for VA Firms

Staking is a process by which users or participants of a blockchain network or protocol participate in a Proof-of-Stake (PoS) consensus mechanism. Staking participants help validate transactions and secure the network, earning staking rewards usually in the form of additional virtual assets.

Key factors for determining whether an activity involving staking should be considered a Regulated Activity in future include:

1. The level of intermediation, control over the staked VAs (e.g., through custodial staking) and discretion over the deployment of clients’ VAs (e.g., deploying VAs into decentralized financial (DeFi) protocols). Solo staking, for example, whereby participants are carrying on staking on their own account, should not be classified as a Regulated Activity.
2. The extent to which the staking activity is carried out by way of business for non-related participants.

Pool Operators and Centralized Intermediaries: FSRA requires that these entities hold a Financial Services Permission (FSP) since they maintain custody over staked VAs or discretion in respect of the deployment of such VAs. The FSRA considers that such staking activities may come within the scope of either the Regulated Activity of Providing Custody or that of Managing Assets.

Additionally, the FSRA is considering permitting an Authorised Person which holds an FSP to Provide Custody and/or Manage Assets in respect of VAs to be able to undertake staking activities on behalf of their clients.

By bringing staking activities under its regulatory ambit, the FSRA addresses the growing demand for staking services and provides clarity by defining the regulatory obligations for entities offering these services. This ensures that Pool Operators and Centralized Intermediaries are subject to regulatory oversight, with activities conducted within a structured framework, which in turn helps mitigate potential risks.

Staking-as-a-service: Technology service providers that only offer the staking infrastructure, without maintaining control over the participants’ VAs, should be excluded from the FSRA’s regulatory perimeter.

Requirements and restrictions for staking activities

The FSRA may also consider introducing staking-specific requirements, such as disclosure of staking-specific risks, due diligence obligations in respect of the custodian’s/validator’s suitability in providing the staking services, also due diligence and risk assessment on the relevant PoS protocol. A requirement for insurance coverage to address slashing risks, penalties, and loss of staked assets is also crucial to mitigate potential financial setbacks.

Restrictions on the business models of Authorized Persons undertaking staking activities could also be implemented to mitigate contagion and prudential risks, ensuring that such activities do not jeopardize the stability of the broader financial ecosystem.

It is worth noting that the FATF standards require robust risk assessments and mitigation measures for VAs financial activities and providers, ensuring they are subject to supervision and monitoring. Hence, the FSRA’s proposed amendment is particularly important as a supervisory measure, focusing on consumer and investor protection, as well as ensuring prudential safety and soundness.

Other yield-generating strategies

The FSRA recognizes other yield-generating strategies, such as yield farming and liquidity mining, as distinct from staking, given the significant differences in their risk and reward profile.

Until the FSRA formalizes a regulatory framework and introduces regulatory certainty for these activities, it will engage with firms interested in offering such services on a case-by-case basis.

VA borrowing/lending services and margin trading

The FSRA draws parallels between VA borrowing and lending and traditional Securities borrowing and lending.  It highlights the similarities in stakeholders (i.e., (i) owner/ lender, (ii) intermediary, and (iii) borrower) and key elements (e.g., yield payment and collateral).

Consequently, the FSRA is considering allowing an Authorized Person holding an FSP to Deal in Investments or Providing Custody in respect of VAs to engage in VA borrowing and lending on behalf of their clients.

While this proposal is a significant step toward integrating VA borrowing and lending into the regulatory fold, its implementation must address the unique legal and operational risks inherent to VAs to ensure a balanced and effective regulatory approach.

Revisions to Capital requirements for VA Firms and fees

The FSRA is also proposing revisions to its capital requirements and fee structures, to ensure that VA firms maintain adequate financial buffers to mitigate risks related to market volatility and regulatory compliance.

Section C

With regards to the Criteria for Acceptance of Fiat-Referenced Tokens (FRTs), the proposed amendments in Consultation Paper No. 11 of 2024 of ADGM build upon the regulatory framework outlined in Consultation Paper No. 7 of 2024. The prohibition on Authorised Persons transacting in FRTs unless explicitly listed as “Accepted FRTs” by the FSRA reinforces regulatory oversight and mitigates risks associated with unregulated tokens. The centralized list of Accepted FRTs, maintained and published by the FSRA, serves as a critical mechanism for fostering trust, transparency, and market stability among participants.

The amendments also clarify the distinction between Domestic FRTs (issued within ADGM and subject to FSRA standards) and Foreign FRTs (issued outside ADGM). While Foreign FRTs may be approved as Accepted FRTs, Authorised Persons must disclose to Clients that such tokens are not subject to the same rigorous FSRA requirements applicable to Domestic FRTs. Although this disclosure requirement increases transparency, it may not fully address potential consumer protection risks, particularly given the variability in regulatory standards across jurisdictions.

In addition, the FSRA proposes that Accepted FRTs will be assessed against similar criteria as Virtual Assets (VAs), focusing on stability, governance, operational resilience, and compliance with anti-money laundering (AML) and counter-terrorism financing (CTF) standards. Notably, FRTs will undergo individual assessments rather than standardized reviews, ensuring a tailored approach to evaluating their unique risks. The case-by-case assessment method is currently manageable but could become resource-intensive if demand grows. Developing a streamlined assessment framework with pre-defined criteria could improve scalability.

To further strengthen consumer protection, we recommend complementing the disclosure obligations for Foreign FRTs with enhanced monitoring, issuer accountability measures, or additional safeguards, such as periodic audits of approved FRTs. These steps would address the regulatory gap and ensure Clients have confidence in using both Domestic and Foreign Accepted FRTs within ADGM.

Section D

The FSRA aims to expand the scope of permissible investments for Venture Capital (VC) Funds within ADGM. The proposed revisions include allowing VC Funds to invest in VAs, instruments enabling the acquisition of securities or VAs, governance tokens, utility tokens, and other digital tokens that represent value, and rights to purchase certain digital tokens. In addition, the revisions include permitting VC Funds to engage in agreements such as SAFEs, SAFTs, and token warrants, which allow the fund to acquire Securities or digital tokens issued by start-up businesses in the future.

These changes aim to provide VC Funds with greater flexibility, enabling portfolio diversification and capturing emerging opportunities. The revisions also reflect the evolving dynamics of start-up financing and the increasing prominence of digital assets.

Based on RASMA LEGAL’S analysis, the FSRA should introduce periodic reporting requirements for VC Funds investing in digital tokens to ensure ongoing compliance. Furthermore, effective risk management, regulatory clarity, and robust investor protection mechanisms are essential for ensuring the initiative’s long-term success and stability.

The proposed amendments to the FSRA’s regulatory framework highlight the authority’s proactive approach to fostering a more dynamic and industry-responsive environment for virtual assets in ADGM. 

By granting greater autonomy to virtual asset firms, the FSRA aims to encourage innovation and adaptability within the sector while still maintaining crucial oversight to mitigate risks and preserve market integrity. The introduction of self-assessment processes, expanded regulatory powers, and more robust requirements for virtual asset providers demonstrates a commitment to striking a balance between flexibility for businesses and necessary safeguards for investors and the broader financial system.

The FSRA’s ongoing efforts to adapt its regulations highlight the authority’s recognition of the evolving nature of the virtual asset landscape, including the rapid growth of new business models like staking and the increasing sophistication of financial products like Fiat Referenced Tokens. 

By aligning its framework with global standards and addressing emerging risks such as privacy tokens and algorithmic stablecoins, the FSRA is positioning ADGM as a leading jurisdiction for virtual asset regulation that is both forward-looking and globally competitive. These amendments aim to create a secure and transparent ecosystem that can support sustainable growth in the virtual asset market, ensuring that ADGM remains a hub for innovation while safeguarding the interests of all market participants.