Israel Fintech Regulation Part II
Since its peak in January 2018, the global cryptocurrency market cap has declined dramatically, freefalling by 80%. Concurrently, the number of Israeli blockchain companies is growing rapidly, standing presently at more than 130 companies, a whopping four and a half times the number of companies in the field that existed in 2014.
Blockchain has a well-established presence in the ecosystem, with a variety of use cases across a broad range of sectors, including fintech, advertising, security, telecommunications and others. Speaking at Money 2020 in October 2018, Ripple’s CTO David Schwartz was quoted saying that “blockchain will do to payment systems what email did to traditional post”. Despite this, blockchain companies today often find it difficult to even open a single bank account in Israel.
Start-Up Nation Central asked Dr. Zvi Gabbay, Partner and Head of the Capital Markets Department at Barnea, to give us an overview of the latest developments regarding blockchain regulations in Israel.
The Potential of Blockchain
Blockchain technology is one of the most fascinating technologies in the current market. It has the potential to truly guarantee the transparency of transactions, and make them more secure, democratic and decentralized. Investors, entrepreneurs, financial bodies, and governments have all identified blockchain as a revolutionary technology, and they all want a part of it.
Driven by its unconventional technological military units, advanced defense industry, and high-end technological schooling, Israel became the hub for such innovation. The Start-Up Nation’s in-depth experience with Fintech technology, cyber security, and cryptography has positioned it as a blockchain innovation center, with many successful blockchain ventures developed in Israel, including Coti, Colu, Kin, Orbs and Cedex, among many others.
Over the past year, Israeli financial regulators have published several financial rules and regulations, in order to keep up with the evolving technology and be the forefront of financial regulation legislation. The chief goal is to deliver regulatory certainty for Israeli ventures that will enable them to continue providing the world with home-grown, cutting-edge technology. Israeli financial regulators are aiming to achieve this by amending legislation on three major aspects of blockchain and digital currencies: financial service providers and anti-money laundering, securities, and taxation. Israel’s courts have also ruled on several related cases in the banking field.
Financial Service Providers and Anti-Money Laundering
With the development of blockchain technology and the emergence of robust activities relating to the use and trading of digital currencies, a need has also increased for various brokers, exchanges, and service providers that aid and promote the use of these virtual currencies.
While with most of the world there is still uncertainty with regard to the regulatory regime that applies to service providers in the field of digital currencies, in Israel, there is a new Regulation of Financial Services Law. This law establishes a mandatory licensing requirement for financial asset service providers, and defines “financial assets” to include also virtual currencies. The new law came into effect in October 2018, its purpose being to set the regulatory framework of such financial asset service providers, mainly in the areas of anti-money laundering, information security, mandatory polices, and minimum reserve capital.
With progress in blockchain technology and the development of new protocols, initial coin offerings (ICOs) have become a more and more popular unregulated alternative method for raising public funds for ventures. Regulators around the world have published warnings about the risks involved in
investing in ICOs, since many are not regulated, and some actually offer tokens that are basically securities, without adhering to any relevant securities law. These warnings, together with enforcement actions initiated largely by the United States Securities and Exchange Commission, have dramatically reduced the number of unregulated ICOs.
The Israel Securities Authority (ISA), a leading financial regulator, has attempted to dispel uncertainty and strike a balance between technological innovation and the protection of investors. In March 2018, it published an interim report to determine the right balance for of regulation of ICOs. According to ISA recommendations, not all cryptocurrencies will be considered securities. Examples of those that will not be considered securities are tokens that are: designed to be used exclusively as a medium of payment, clearing, or exchange; not limited to a specific venture; those that do not confer additional rights; and those that are not controlled by a central entity. The ISA chairman has also publicly declared that the ISA is aiming to reduce regulatory barriers for Israel-based companies seeking to raise funds via an ICO.
As part of the national effort to set a regulatory framework, the Israel Tax Authority (ITA) has published circulars about the taxation of a decentralized method of payment activity. This type of taxation also pertains to ICOs. In doing this, the ITA has distinguished between taxation that applies to service providers (and others) who receive digital currencies as payment for services, and taxation that applies to companies that issue digital currencies (utility tokens) for future services. In addition, the ITA also distinguishes between services or products promised to be delivered in the future and services that were already provided. In the former case, tax will be determined according to the development stage of the said service or goods. These tax circulars create additional certainty for service providers, ventures issuing utility tokens via an ICO, and purchasers, thereby enabling all parties to function within a secure tax-regulated environment in Israel.
A major source of uncertainty in the cryptocurrencies industry is the counterparty to the transaction and the source of the funds of such counterparty. Banks, which are subject to stringent anti-money laundering policies and operate under the strict supervision of the Bank of Israel, are currently trying to avoid any association with cryptocurrencies for fear of compliance risks. In recent years, there has been an uptrend in compliance risks at financial institutions (including in relation to money-laundering risks), which has manifested in high volumes of monetary penalties being imposed. As a result, most banking institutions do not permit transactions related to cryptocurrencies.
In 2018, both the Israeli Supreme Court and a District Court in Israel were approached by clients wishing to deposit proceeds from the sale of digital currencies in their respective bank accounts. The respective banks refused, and the clients commenced legal proceedings against the banks. In February 2018, the Israeli Supreme Court prohibited a bank from restricting activities related to bitcoin trading in a company’s account, claiming that the client’s operations do not violate any law. A few months later, in another case, a District Court adopted the aforementioned Supreme Court ruling, and ordered a bank to accept a deposit of proceeds from the sale of digital currencies into a client’s account.
By acting on the efforts mentioned above, as well as implementing the many other initiatives being developed by Israeli regulators, Israel will continue to serve as a pioneer in high-end technology. In order to be a world leader in Fintech, Israel needs great minds in the fields of technology and computers. What is less obvious is that the right regulatory framework can provide these great minds with the optimal environment in which to innovate.
Dr. Zvi Gabbay, Partner and the Head of the Capital Markets Department, Barnea
Dr. Zvi Gabbay is a partner and the head of the Capital Markets Department at Barnea. Prior to this, Dr. Gabbay served as the Head of Enforcement and a member of management at the Israel Securities Authority (ISA). Dr. Gabbay is an expert in the fields of financial regulation and securities enforcement, both in Israel and the United States. Dr. Gabbay advises corporate clients on operations relating to capital markets, corporate and securities law, and financial regulatio