Brazil Moves Towards New Digital Asset Framework, With Support From Coinbase

February 13, 2024
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The Central Bank of Brazil has closed a consultation on an incoming regulatory framework for virtual asset service providers, winning support from Coinbase — a growing presence in the Brazilian market.

The Central Bank of Brazil (CBC) has closed a consultation on an incoming regulatory framework for virtual asset service providers (VASPs), winning support from Coinbase — a growing presence in the Brazilian market.

At the end of January, the CBC wrapped up a public consultation that proposes to introduce a new bespoke regulatory framework for VASPs that operate in Brazil.

The seven-page consultation covered eight themes and posed 38 questions to respondents.

The eight themes signal priority areas that the central bank intends to design policy for, as listed below:

  1. Asset segregation and risk management
  2. In-scope activities and assets
  3. Use of third-party service providers
  4. Governance and conduct
  5. Cybersecurity
  6. Disclosures and customer protection
  7. Transition rules
  8. Other areas of concern

Legislative background

The consultation is the latest stage in a two-year effort by Brazilian lawmakers to bring digital assets under specific regulations enforced by the CBC.

In December 2022, the Brazilian government adopted the Legal Framework for Virtual Assets (Law No. 14,478), also known as the Crypto-Assets Act.

The Crypto-Assets Act, which entered into force in June 2023, places basic rules and definitions on the provision of virtual asset services by VASPs.

The act defines “virtual assets” as “digital representations of value that can be traded or transferred via electronic means and used for making payments or investments”.

The definition has four exceptions, namely for: national or foreign currencies; electronic money; loyalty tokens; and other financial assets that are already regulated, such as securities.

VASPs are defined as legal entities that issue virtual assets or who perform, on behalf of a third party, the exchange, transfer, sale or custody of virtual assets.

The act will also lead to new rules for the authorisation of virtual asset services and new criminal penalties for fraud and money laundering involving virtual assets.

The penalties will increase by one-third to two-thirds over regular fraud and money laundering, altthough this is yet to be defined.

A second law (Decree No. 11,563), adopted in June 2023, officially granted the CBC the authority to regulate and supervise the provision of virtual asset services.

This means that VASPs will be subject to the same general rules as other CBC-regulated entities, plus further rules that will be implemented when the regulatory framework is finalised.

There is no deadline for the CBC to finalise the framework, but it expects to do so between April and May this year.

High hopes for Brazil’s digital asset market

Coinbase, which launched in Brazil in 2021, submitted a 34-page consultation response, in which it referred to Brazil as an “emerging leader” in financial technology.

The success of Pix, Brazil’s instant payment, was given particular praise by Coinbase. In 2023, Coinbase integrated Pix into its deposit and withdrawal services as part of an ongoing expansion in Brazil, in addition to localising its customer support.

“We believe a well-designed and implemented virtual asset regulatory framework will put Brazil at the forefront of the digital finance revolution,” said Coinbase.

“Delivering legal and regulatory certainty to the market through an appropriately tailored regulatory framework will position Brazil to be a global leader in digital asset technology.”

Coinbase identifies 'key principles' for CBC policymakers

In response to the questionnaire, Coinbase identified five “key principles” for the CBC to consider in its design of the regulatory framework.

First, with reference to the FTX bankruptcy, Coinbase said that “virtual asset custody rules should promote customer protection”.

“We believe that customer assets should be held on a fully reserved, 1:1 basis,” said Coinbase.

“Such assets should not be staked, pledged, rehypothecated, or otherwise used except with the customer’s express, informed consent.”

To facilitate instant trading, VASPs should use omnibus customer accounts in the same way as traditional securities brokers and exchanges, Coinbase said.

This would mean that VASPs should have two ledgers, said Coinbase: one for omnibus customer accounts; and one for clients.

VASPs would use their own funds in the omnibus accounts to execute trades on behalf of customers, while customer funds would be custodied separately.

Jurisdictional flexibility for custodians

Another key question posed by the CBC is the extent to which VASPs should be able to base their services outside Brazil when serving Brazilian customers.

In relation to custody, Coinbase said it strongly favours VASPs being able to base their operations overseas while serving the Brazilian market.

“Virtual asset security is best served by a global infrastructure that requires coordinated action from geographically distributed actors to operate,” it said.

“Current security best practices include separating and storing private key materials across different locations, time zones and business functions.”

The crypto exchange argued that geographic separation of human capital and security infrastructure reduces the risk of a single point of failure when safeguarding assets, and minimises the potential damage of security breaches.

Instead of trying to “localise” all VASP services within Brazil, Coinbase suggested that the CBC work closely with regulators in other jurisdictions to promote high standards of customer asset protection.

Coinbase pushes for licence passporting

Similarly, Coinbase also argued strongly in favour of licence passporting rights for VASPs that intend to serve the Brazilian market.

“We encourage the CBC to prioritise the development of a passporting or equivalence regime for VASPs that are fully licensed and regulated in other jurisdictions to standards that are high enough to satisfy the CBC,” it said.

“We believe that measures like these will encourage more consistent regulation and deeper, more vibrant markets for virtual assets internationally.”

At present, there is no specific licence that VASPs must obtain to serve the Brazilian market, but this is something that the CBC intends to develop under the new framework.

However, VASPs currently must obtain licences if they offer other financial services that are regulated under a licensing regime.

Bitso, for example, Brazil’s largest crypto exchange, holds a Payments Institution licence and a Direct Credit Society (SCD) licence.

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