DFAs in Russia: Challenges for retail investors and businesses

The first digital financial assets, or DFA, on Russian blockchain platforms can be issued before the end of 2022. The new type of assets is likely to open up unique opportunities to attract cheaper and more accessible financing. Moreover, it can become an additional way of generating income for an investor, including retail investors, because a wide pool of capital holders will be able to invest in digital tokens. However, a new tool that many have a problem understanding can generate serious risks. We have listed the main challenges that financial market participants may face when dealing with DFAs, businesses and retail investors alike. Participants in a recent conference on DFA Circulation in Russia: Problems and Prospects of Legal Regulation, organized by the Segodnya conference center, have shared some of their thoughts.

Beware of misleading advertising

According to Artem Genkin, Doctor of Economy, Professor, President of the NPO “Center for Protection of Bank Clients and Investors,” the market is on the brink of events of major importance as digital financial assets receive a significant advantage in the national investment space. Due to the well-known geopolitical disturbances, the traditional tools of the financial market, including currency, can become less accessible and attractive for private investors.

However, transactions with digital assets can become a new, serious challenge for them.

“The experience of countries where the crypto industry has actively attracted private investors is raising serious concern,” Artem Genkin notes.

Thus, scam can be disguised as advertising that promises greater revenue. Unfortunately, people might trust even obviously made up projects: the Idiot Coin token, despite its name and public warnings of its creator, the New York Times reporter David Segal, got 300 potential buyers. The losses can be huge – the PlusToken “crypto saving project,” in reality a ponzi scheme, duped tens of thousands of private investors of a total of $3 bln.

Volatility is another challenge: even a Twitter post can affect the price of crypto assets. In May 2021, Elon Musk made Bitcoin prices crash by 13% in one day after posting a tweet saying that the cryptocurrency was bad to the environment. Gossips can also affect the prices: when there was rumor that Amazon would accept cryptocurrencies in July 2021, the Bitcoin gained another 15 percent.

“A market where information costs so much, even information obtained from not the most important people on the planet, requires a greater focus and regulating when it comes to advertising,” the expert notes.

Barriers to promotion

Businesses that consider launching their own digital financial assets might face risks when promoting the project. The market already has mandatory restrictive regulations. For instance, a serious obstacle is the ban on crypto ads forecasting the exchange rate, and in many cases it is prohibited to promise the payment of revenue, Artem Genkin says. Business will have to learn how to create advertising campaigns within these borders.

It is also mandatory to make a reference to the website that published the decision about launching a cryptocurrency and name the individuals who issue it. And, of course, it will be mandatory to mention the operational risks surrounding cryptocurrencies.

Not only regulations can be problematic: the choice of influencers is not always obvious, let alone reaching agreements with platforms for efficient promotion.

“The position of the promotion platform or channel can not only determine the fate of the ad campaign, but also the investment attractiveness of a product,” the expert says.

New rules of the game?

In the future, unfinished regulations can become a challenge for the investors.

In particular, requirements that concern the inspection of the issuer of digital financial assets are still unfinished, says Dmitry Kozlov, task leader at the Center for Legal Support of the Futures and Options Market and Client Operations at Sberbank. If the market continues to grow and the small companies or startups begin to launch cryptocurrencies, the issue of regulations will become very relevant.

Another issue is that as compared to the digital financial assets, the current regulations regarding public securities are more focused at protecting investors.

For instance, the law on digital financial assets uses numerous terms related to the security market, from acknowledging the issuance to the period and conditions of canceling, but does not set the rules of the game, and there is no telling whether this could hurt the investor.

“The law on DFAs does not prohibit acknowledging an emission as revolving as part of a single decision on the emission in relation to investments from each individual investor. This is a very interesting point that we think has yet to be settled by law,” Dmitry Kozlov says, adding that there are many similar issues emerging in the new sector.

The taxman is at your door

Accounting treatment and taxation of digital assets are expected to become a particular challenge. As regards DFAs, the tax levy procedure has yet to be determined, with a corresponding draft bill currently under consideration by the State Duma, notes Alexander Belyayev, Head of Tax Consulting at Lemchik, Krupsky & Partners. It is assumed that DFAs will be subject to VAT, personal income tax, and income tax.

As for digital currencies, they should be considered as property in accordance with the position of the Ministry of Finance, with corresponding tax accounting rules, the expert clarifies. Yet, he says, those who have owned assets for a period of at least three years will not be able to use the property tax exemption. A clear understanding is also lacking as to VAT payments during transactions that involve digital currencies; the positions of the Federal Tax Service and the Ministry of Finance are different in this regard – yet, VAT and income tax will still be applicable, the expert clarifies.

There is also a lack of a general consensus on the accounting treatment of digital currency. According to Belyayev, the asset cannot be registered as ‘income-bearing investments in tangible assets’ or ‘monetary assets.’

“In my opinion, there are two ways of handling this: digital currency treated as a tangible asset and as reserves,” the expert says.

Inheritance disputes

Issues can also arise as regards digital assets inheritance. According to Andrei Tugarin, Managing Partner at GMT Legal, cryptocurrency can be legitimately included in the estate as property – but notarial officers often have no understanding of the concept of cryptocurrency, let alone of the ways this asset can be included in the estate.

In addition, there is a practical difficulty in detecting the presence of crypto assets during inheritance disputes, says Yekaterina Korniyenko, expert in digital finance, arbitration manager, and member of the all-Russian public organization Delovaya Rossiya (Business Russia). Yet, she says, a legal mechanism is already available for interacting with exchanges, and lawyers can file requests through courts for availability of digital currency or wallet for a particular person.

“As regards cold wallets or other unauthorized wallets, we are facing a practical issue. Even in case of inherited property, finding and taking possession of such wallets will turn to be extremely difficult,” Yekaterina Korniyenko emphasizes.

Investment window for business

Efforts to attract investments through DFAs can become a challenge in itself. According to Roman Prokhorov, Board Chairman of the Financial Innovations Association, the approach may turn out to be utopian, and the tool irrelevant.

“Attracting investments is determined not by tools but by the economic situation,” Roman Prokhorov explains.

Yet, for small and medium-sized businesses, the new instrument will at least open up the possibility for raising finances more promptly, and most importantly, at less cost by doing it through digital bonds issuance, noted Igor Kuzmichev, Director General of Distributed Registry System/Masterchain. Also, due to a wider scope of investors, the amount of raised finances may be increased. A DFA-based instrument such as a digital promissory note could also be relevant – but so far it cannot be used due to the current regulations.

“Most importantly, digital financial assets exist in the Russian legal environment as an instrument. Further development of regulations can make it an immensely popular tool in the Russian market,” Kuzmichev concludes.

By Olga Blinova

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