Produced in partnership with Binance
A watershed court judgment last week, ruling that cryptocurrency purchases fall outside the country’s exchange control rules, has shone the spotlight on a loophole in South African regulations.
The ruling in the high court in Pretoria means, according to one regulator who spoke to Currency, that the authorities are now scrambling to close this gap as fast they can, as the risk of a “free for all” on using cryptocurrency offshore has spiked.
In this case, Standard Bank was owed R41m by a company called Leo Cash & Carry, a wholesaler in Rustenburg that was placed under liquidation in December 2021.
The sticking point was, Leo Cash & Carry had used the money it had borrowed from Standard Bank, in part, to buy bitcoin on a foreign crypto exchange. These were large amounts too: in 2019, for instance, Leo sent 4,405 bitcoins worth R556m to a company called Huobi Global, according to forensic investigators at PwC.
As the court put it, Leo was involved in a scheme [or] used as a conduit to directly or indirectly export funds, foreign currency, and capital from the Republic”.
But when the South African Reserve Bank (SARB) spotted this, it froze the money on the basis that Leo had broken exchange controls in doing so. This money would be “forfeited to the state”.
The question was, had Leo broken the rules? This was tricky to answer, as exchange control rules are an anachronism, implemented in 1961 to prevent capital flooding out of South Africa after the Sharpeville massacre the year before, where 91 people were killed when police opened fire on protestors.
While exchange control rules have been diluted since then, they remain in place – and appear ill-suited for the modern South African economy.
Standard Bank, which wanted to be repaid what it was owed, challenged the SARB in court. Africa’s largest bank argued that exchange control rules don’t apply to cryptocurrencies, which “are operating in a legal vacuum”.
While the bank’s lawyers said, “the full legal ramification[s] for a lack of regulation still remain unknown”, they were adamant that cryptocurrency such as bitcoin cannot be considered “capital”, nor is it a conventional “currency or even “intellectual property”.
Judge Mandlenkosi Motha agreed. “The construction that cryptocurrency is money … is strained and impractical,” he said. “There is no room for an unnatural and fictitious reading into the regulations to cover cryptocurrency.”
It would be practically impossible to declare that cryptocurrency is “money”, he said: how would you “deposit” bitcoin, for instance, or “declare” it when you leave the country?
For this reason, Motha said crypto deals would not fall under the exchange control rules – but, aware of the implications of this, he said regulators need to address this, quickly. “A regulatory framework addressing cryptocurrency is long overdue,” he said.
It is a ruling that looks set to be appealed by the SARB, but it has many implications. The first and most obvious is that it illustrates that South African regulators may be moving too slowly to effectively provide oversight of a financial world where cryptocurrency innovations take place every week.
Law firm Baker McKenzie, while describing this as a “landmark ruling” on exchange controls, warns that “an avalanche of cryptocurrency export is imminent”.
The lawyers say the judgment immediately removes the need to get SARB approval to export cryptocurrency, but add that the “the relief may be short-lived” as it is likely that the authorities will move quickly to close this loophole.
Until then, however, “it is possible and likely that a similar mass export of currency, through the use of cryptocurrency, may occur”.
Keeping pace with digital innovation
While cryptocurrencies have long been depicted as the Wild West of finance, South African crypto companies have welcomed the ruling’s insistence on greater regulation.
Hannes Wessels, the general manager for Binance South Africa, tells Currency that “proactive and clear regulatory frameworks are essential for fostering innovation while protecting users”.
Wessels says South Africa isn’t the only country where legislation has battled to keep pace with the evolution of digital assets. But he says the evidence is clear that in countries with strongly defined rules, there are higher levels of trust and investment.
“Markets with well-defined crypto regulations tend to experience faster adoption and greater inflows of capital,” he says.
Marius Reitz, Luno general manager for Africa & Europe, underscores this sentiment. He says the regulatory gap creates an ambiguity, which “discourages investment by collective investment schemes and pension funds”.
Reitz says updated laws, along with the technically correct designation of cryptocurrency as “onshore”, will allow the industry to “contribute more significantly to economic growth in South Africa”.
The upsides are many: once it is regulated, you’ll be able to collect tax more efficiently, and remove much of the suspicion over the role of cryptocurrency in illicit financial flows.
The question is, can regulators move swiftly enough to do so? As Motha pointed out, they knew of this risk for at least five years, but hadn’t done anything about it.
In a 2020 discussion paper, the SARB flagged the “lack of proper regulatory legal framework” for cryptocurrency. That paper said there was no regulatory protection for any crypto loss, and explicitly stated that “exchange regulations do not govern the transfer of cryptocurrencies in and out of South Africa”.
And yet, nothing happened. As has often been the case, it is South Africa’s courts which may have finally lit a fire under the regulators. Fingers crossed, it is a fire that can forge a much more watertight system for a new era of digital assets.
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