Expert opinions, FINANCE

Russian market for digital assets: Factors that can promise a bright future

In early November, Russia’s Central Bank released a public consultation report, Development of the Digital Asset Market in Russian Federation. Over the following weeks, the paper became the subject of discussion among the expert community. The deadline for sending answers to the questions raised, comments and proposals to the regulator is December 7, 2022. Below, I would like to offer a few assessments and proposals concerning the Central Bank report.

General remarks

First of all, I wholeheartedly agree with the Bank of Russia experts’ view of priorities for all financial market regulators, which are to “ensure financial stability, protect the rights of consumers of financial services, comply with the AML/CFT requirements and minimize risks.” This puts the interests of financial services’ consumers at the forefront, although in practice, not all regulators always put these priorities first in their policies.

According to the report, “financial instruments and platforms based on distributed ledger technology have not yet become widespread in the Russian market. Only 6% of financial market participants use this technology on an ongoing basis; another 13% of respondents are currently implementing pilot projects.”

These figures would be more telling if compared with the available international statistics. According to the results of the 2021 MHI Annual Industry Report, Innovation Driven Resilience, where MHI and Deloitte surveyed more than 1,000 supply chain professionals from around the world, 10% of the companies surveyed planned to invest in blockchain and DLT before 2024; 12% were using blockchain as of the end of 2021; and 41% intended to use it within the next five years.

Similar international statistics are probably available for the finance industry.

I would suggest including in the CBR report a brief description of hybrid blockchains, along with the definitions of open and closed networks. Otherwise, people not directly involved in the industry will have difficulty understanding it.

In my opinion, when describing the benefits of digital financial assets (DFA) for the issuer and for investors, two diverse advantages are mixed together in one paragraph: attracting new sources of capital and new types of assets. Instead, it would be better to mention 1) “expanding the scope of investors and raising additional capital” and 2) ensuring the “supply of assets with limited liquidity,” and consider them separately.

On page 7 of the report, which refers to “the availability of an appropriate regulatory framework, as well as business processes and infrastructure that will ensure <…>,” I would add, at the end of the list: “providing investors with complete, reliable and up-to-date information to make well-founded investment decisions.”

When analyzing the regulatory framework for digital assets in the United States, in addition to considering such major agencies as the Financial Crimes Enforcement Network (FinCEN), the New York State Department of Financial Services (NYDFS) and the Securities and Exchange Commission (SEC), I would also mention the activities of the Commodity Futures Trading Commission (CFTC).

While I generally agree with the authors of the report that “Russian laws do not provide for specific regulation of stablecoins or NFT tokens,” I would add “at present,” because initiatives to introduce various special regulations for these assets have already been voiced more than once in the expert community.

Considering that “there are 67 registered operators of investment platforms, but attracting investments using the Utility Digital Rights (UDR) mechanism has not become widespread,” according to the report, it would be interesting to see at least a brief comment suggesting the possible reasons for such unpopularity of this obviously necessary and innovative tool.

It is not clear what is meant by stating “performing fiduciary obligations” as one of the goals in harmonizing regulation of digital assets with conventional financial instruments.

Over the year since the adoption of Resolution 779-P [1], it would have been good to understand (in an anonymized form, obviously) if organizations operating DFA have deviated from the target indicators of uninterrupted service and if they have, how frequently. Have they managed to meet the Bank of Russia’s requirements?

I would prefer to see more specifics when it comes to the bill developed in cooperation with the Bank of Russia and what form of taxation has been proposed for transactions with UDR.

Convergence with the conventional financial market: Looking for a clear and reliable itinerary

In 2022, we have found ourselves in a situation when the Russian financial market has reached maturity. As of the beginning of the year, Russians held around 3 mio private investment accounts and, according to different estimates, 10 to 14 mio cryptowallets.

The markets trading conventional financial assets and cryptoassets have already attracted substantial funds from a significant number of Russian investors, accumulating infrastructure. But the spring and summer of 2022 brought the risks of shrinking and investor and finance drain. The former was caused by geopolitical reasons and sanctions and the latter by unfavorable conditions and the crisis of trust after the collapse of one prominent cryptocurrency exchange.   

A substantial part of Russian investors’ withdrawn funds could seriously fuel the emerging and barely standing on its feet Russian digital financial asset market – but only if there are favorable conditions for that. This is the angle I would propose for the analysis of the measures included in the report.

In particular, I fully support the report authors’ proposal to create regulatory conditions for tokenization of other assets such as conventional financial instruments (e.g. private securities and bonds), third-party debt, tokenized precious metals and stones, and primary NFTs. The market will have to learn about tokenization, its simplicity, low cost and benefits. The regulatory body’s methodological support would be quite helpful here.

As concerns creating conditions for participation of the conventional trade and billing infrastructure in the UDR implementation, I agree that this measure is proposed timely and, in fact, find it a forced measure to a certain degree, although it obviously redistributes the market in favor of conventional financial market players, leaving the last mile for DFA market infrastructure operators. Saving the Russian investor as a class is more achievable, of course, if the investor’s trusted professional broker offers them the new product en masse. Out of the two optional approaches suggested in the report, I would support direct circulation of digital rights in the stock exchange infrastructure.

Similarly, I support the report authors’ proposal to grant information system operators and DFA exchange operators rights to simplified identification of their clients and wider opportunities for delegating identification to professional securities market participants.

I also support the package of measures described in the report on implementing a DFA listing with quality degrees assigned to such instruments.

It is not quite clear, however, what is meant by “the list of digital rights available to non-qualified investors.” The report mentions an extension of this list. Does it already exist or is it still in development?

As concerns developing DFA tax regulation and specifically applying the private investor regulation to DFA owners (we know that the Central Bank conducted preliminary consultations with the Finance Ministry and the Federal Tax Service), can we expect a favorable or at least neutral response from them to this initiative? (I personally believe it is time.)


“The creation of the circulation mechanism for digital assets issued in the information systems organized in accordance with foreign law,” which was announced in the report, does not seem to be a cakewalk. Certain issues that the report suggests should be discussed with the community already look quite challenging (not unsurmountable but bound to trigger a heated debate). At the same time, the statement “the implementation of this initiative will allow Russian investors to conduct transactions with foreign digital assets that meet the formal quality criteria (for instance, the presence of an issuer, backing and so on)” looks quite encouraging for the market.

The report raises the question, “What additional legislative measures need to be taken in order to create a favorable tax regime for digital rights?” I don’t have the full picture, given there have been the updated editions of both 259-FZ federal laws, the Tax Code and other relevant legal acts. But I believe that the two following principles must be provided for all kinds of digital financial assets and digital rights:

  • the possibility of deduction when assessing the tax base of the personal income tax on the initial cost of purchasing an asset;
  • the possibility to generally reduce the tax base of the personal income tax on a negative financial result on investment in an asset for a period (for instance) of three years from the initial purchasing of an asset.

On page 31 of the report, there is a question: “What other issues should be dealt with in order to create conditions for the circulation of foreign digital financial assets in the Russian infrastructure?” I consider two issues the most pressing. First of them is the issue to be discussed with the community related to the access to a foreign information system (and, probably, verification of data received – for various purposes, from confirming the transfer of ownership rights for an asset to accounting and tax bookkeeping). The second one is the fate of all other (that are not included in the whitelist) foreign digital financial assets. The reason they are not listed can be different: the absence of an expressly specified issuer, poor credit quality, etc. What will be the consequences? The adoption of a regulatory legal act often divides the formerly shadow market into the white and black markets. Or will there be a milder scenario which “merely” strips all deals with the assets of such issuers of legal protection in Russia? It is the Russian crypto market’s nightmare – to be criminalized, you know that as well as I do. Will the Bitcoin and Ethereum be whitelisted? I suppose not. This is where the exotic (but already caught up by some experts) take on the Bitcoin as one of the traditional, reputable national currencies (because the Bitcoin has been deemed a legal tender in El Salvador and one of the African countries) is coming from.

Truth be told, we have to note that during the discussion at the Russian Chamber of Commerce and Industry, the regulator representatives said that the report is probably reading not about digital currencies (as defined in the 259-FZ federal law), but solely about digital assets issued in information systems organized in accordance with the legislation of other countries – but then it at least requires an explanation with concrete examples, and, admit it, does not clarify the fate of the traditional crypto assets in at least 10 million wallets of Russian crypto investors. I recently suggested at the Kommersant FM radio the mechanism of organization at the legislative level of a one-time, time-restricted gateway – with mandatory identification, declaring and tax amnesty – to transform Russians’ crypto currencies into the tools of the Russian digital asset market, and honestly, my proposal seems to be much more transparent and rational solution.

Smart contracts and more

I would prefer to see more specifics on regulatory plans regarding “the procedure for deploying smart contracts on storefronts of information system operators that issue DFAs, as well as regarding distribution of risks, liability and compensation for damage incurred due to errors in operation of a smart contract.” Realizing that this may be a long-term task for the regulator, we are aware that the Central Bank’s report on a specific field of regulation is a discrete event; there is a risk that further efforts to streamline the issues in the future will occur outside the public and expert fields. Plus, the issue of security and reliability of smart contracts is of paramount importance for protecting the rights of consumer (investor).

As to the question at the end of the report – “Who do you think should determine relevant standard terms of a smart contract: a) market participants; b) the operator of the information system where digital assets are issued; c) Russia’s Central Bank; d) other option?” – my answer would be d) the issuer.

Let me elaborate on how I see it.  

Preliminarily, the Central Bank draws up a framework list of standard terms of a smart contract as a recommendation document to be presented by all future issuers – or a list of minimum essential circumstances to be disclosed in the smart contract, a sort of smart contract passport; the document should obviously be formulated in a clear language comprehensible to any investor, rather than in the code language. The compliance of the smart contract passport with its code should be checked by an IT auditor or a self-regulatory organization recognizable in the market.

Optionally, the information system operator may also be required to conduct an initial audit of the smart contract code before deciding on a specific issuer listing – which, however, would substantially increase expenses for the listing procedure and may also demotivate issuers.

The report includes another question, “Who do you think should have the right to develop and deploy smart contracts in the DFA information system? How should the liability for correct operation of a smart contract be distributed between the system developer, operator and user?”

In my opinion, the right to deploy a smart contract should belong to the issuer – a legal entity or a private entrepreneur. I support the need to confirm their software IP rights. I rather support software rights registration in the Federal Institute for Industrial Property (subordinate to Russian Federal Service for Intellectual Property), an agency that operates in this field without unnecessary delays. I do not support the need to enter all smart contracts into the register of Russian software, as well as any excessive requirements for developer accreditation and certification. I believe that developer liability to the client/issuer under labor or civil laws as well as legal liability to investors in certain cases, such as with intentional backdoors and stealing funds from smart contracts, serve as sufficient tools.

The operator’s API could serve as the limitation of liability between the issuer and the operator, who should not be responsible for the issuer code. It may be necessary to provide mandatory IT audit and/or a positive opinion from a relevant and recognized self-regulatory organization (as mentioned above) and/or liability insurance (for both the issuer and the operator).

The limitation of liability between the user (investor) and the operator can be determined similarly to Article 9 of the Law on National Payment Systems.

By Artem Genkin, Doctor of Economics, Professor, Member of the Central Bank’s Expert Council for Financial Consumer Protection, Member of the Council for Financial, Industrial and Investment Policy at the Russian Chamber of Commerce and Industry

[1] The Central Bank’s Provision No. 779-P of November 15, 2021, “On Establishing Mandatory Requirements for Operational Reliability for Non-Bank Financial Organizations in Implementing Activities Envisaged in Pt.1 of Article 76.1 of Federal Law No. 86-FZ of July 10, 2002, “On the Central Bank of the Russian Federation (Bank of Russia)”, in Order to Ensure the Continuity of Financial Services (Excluding Banking Services).”

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