The untold story of Exchange Control Regulations.
Cryptocurrency traders in South Africa have focused on understanding the tax implications of their transactions relative to the Income Tax Act.
This has proved challenging, as SARS has merely stated that “the normal rules apply” without providing authoritative guidance concerning the various cryptocurrency-related transactions, and when profits are considered capital or income.
However, Exchange Control Regulations are equally important for traders especially those using foreign cryptocurrency exchange platforms, as the South African Reserve Bank (SARB) is now paying close attention.
Arbitrage opportunities and Exchange Control Regulations
Some South African natural persons have leveraged cryptocurrency arbitrage opportunities using their R1 million Single Discretionary Allowance (SDA) and R10 million Foreign Investment Allowance (FIA).
These opportunities arise because Exchange Control Regulations limit the amount of South African assets natural persons can externalise annually, creating price differences between local and international cryptocurrency markets.
The SARB monitors these externalisation events, requiring natural persons to apply for their FIA through SARS e-filing.
Arbitrage traders use their SDA, FIA, and South African rands (ZAR) to purchase foreign currencies like US dollars (USD) through brokers. They send the USD to foreign cryptocurrency exchanges to buy digital assets like Bitcoin (BTC) or US-dollar-backed stablecoins.
These digital assets are then returned to South Africa via the respective blockchains, which are not governed or controlled by any international intermediary and are liquidated in the local market for profit.
Passive and bot trading
Apart from these arbitrage opportunities, many engage in passive trading between local and international exchanges, exploiting price differences in various cryptocurrency markets.
Investors also use techniques like high-frequency bot trading where automated software executes high-volume trades based on predefined criteria, identifying opportunities and executing trades faster than humans.
Regulatory gaps and implications
The SARB’s oversight of blockchain-based digital assets has been limited, as it does not oversee, supervise, or regulate crypto assets, since these are not considered legal tender.
Despite the Financial Sector Conduct Authority regulating Crypto Asset Service Providers, no dedicated laws govern cryptocurrency use in South Africa.
Consequently, natural and non-natural persons can legally move digital assets from local to foreign exchanges or self-custody solutions without restrictions, as local exchanges do not limit the transfer of digital assets to other sources.
This allows natural and non-natural persons to ‘externalise’ an unlimited value of digital assets beyond the restrictions imposed by the SARB. However, issues arise when investors buy foreign currency using these ‘externalised’ digital assets.
Challenges in monitoring and compliance
Concerns emerge when traders buy BTC locally using ZAR, send it to a foreign exchange, and then use it to purchase foreign currency. This triggers an externalisation event under Exchange Control Regulations, contributing to why local exchanges do not facilitate liquidating digital assets into foreign currencies.
Possible contraventions of Exchange Control Regulations occur when natural persons exceed their annual SDA and FIA allowances through arbitrage trading and conduct trading between crypto and foreign currencies, or when natural or non-natural persons purchase foreign currency on foreign cryptocurrency exchange platforms without the required approval.
However, traders can circumvent triggering this externalisation event by swapping BTC for a USD-backed stablecoin if this does not affect the profitability of the trade, as these asset-backed cryptocurrencies fall within the definition of crypto assets and not foreign currency irrespective of the fact that they are linked to the value of a specific foreign currency.
Future considerations for SARB
The SARB faces significant challenges in accurately monitoring and restricting the ‘externalisation’ of blockchain-based digital assets, as it cannot effortlessly request transactional data from foreign cryptocurrency exchanges.
To address this, the SARB may need to mandate local cryptocurrency exchanges to monitor and limit the value of assets ‘externalised’ to foreign platforms within the allowed thresholds for natural persons.
A critical consideration is how the SARB will handle cryptocurrency returning to South Africa amid high-volume trades between local and foreign exchanges. With foreign currency, these inflow and outflow movements cannot be netted against each other in relation to the allowed thresholds.
If similar rules are applied to digital assets, it could severely impact these trading activities.
Additionally, the SARB must determine how to treat the transfer of cryptocurrencies from local exchanges to self-custody solutions, such as hardware wallets. These devices, which can be easily transported and used abroad, allow digital assets to be offloaded and exchanged for foreign currency without the SARB’s knowledge.
The SARB will likely consider the movement of digital assets to a self-custody solution as an externalisation of assets, necessitating stringent monitoring and regulation to prevent unauthorised externalisation events.
Finally, the ability to externalise assets within the allowed thresholds applies to natural persons only, raising the question of whether the SARB will disallow non-natural persons (such as trusts and companies) to purchase cryptocurrencies on local exchanges and move these assets to self-custody solutions, or send these blockchain-based digital assets to a foreign source as means of payment.
WRITTEN BY WIEHANN OLIVIER
Wiehann Olivier is a fintech and digital assets specialist.
This article is a general information sheet and should not be used or relied on as legal or other professional advice. No liability can be accepted for any errors or omissions nor for any loss or damage arising from reliance upon any information herein. Always contact your adviser for specific and detailed advice. Errors and omissions excepted (E&OE).