When it entered circulation in 2009, Bitcoin was an experiment that attracted the interest only of a narrow circle and was referred to simply as a currency. In the intervening period it became clear that the blockchain infrastructure that made Bitcoin possible offers a far wider range of applications; thousands of different cryptocurrencies emerged, foremost among them Ethereum, Binance Coin, Tether, Cardano, Solana and Polkadot. Today cryptocurrencies, Bitcoin among them, are treated as a kind of digital foreign exchange and generate trading volume as a widespread investment instrument. The natural consequence of this spread has been that the need for legal norms and enforcement mechanisms to regulate the field has come into sharp relief.
At the point now reached, Bitcoin has triggered transformations that may be regarded as fundamental across a great many headings, from the understanding of state sovereignty to the future of the banking sector. Cryptocurrencies and blockchain technology, however, are still at a developmental stage and fall within no country’s sphere of sovereignty, so their legal position has not been settled. Indeed, immediately after the Regulation was published, the departure abroad on 20.04.2021 of the founder of a cryptocurrency exchange, taking with him the cryptocurrencies held in the company account, kept the subject on the public agenda for a long time.
In this briefing note we assess how the technology works, the areas in which it is used, the regulatory approaches of different countries, the limited legislative framework in Turkish law and the risks to which the practice gives rise.
How Does Blockchain Technology Work?
Blockchain makes it possible to establish a distributed encrypted record system by removing the single-centre structure that is one of today’s fundamental security problems. Put in non-technical terms, the system rests on records and blocks. The concept of a record covers every kind of content data, from money transfers to customer information, varying according to the design. This data is processed and written into the blocks; the summary information of each block is attached to the block that follows it, and in this way a chain extending as far as the final block is formed.
Among the components on which the structure rests are the peer-to-peer network, the distributed ledger, the consensus mechanism and cryptography. It is the operation of these components together that gives the technology its immutable character.
Current and Expected Areas of Use of Crypto Assets
Economic systems have grown progressively more complex with globalisation. Blockchain technology promises greater transaction speed and lower cost in reducing the risks to which this complexity gives rise. Reliability rises and risks recede markedly, in particular thanks to the technique of cryptography.
The design of the technology is not uniform. In practice, two basic types of use are spoken of. In the public/permissionless model, participation in the network is open to all; a participant may monitor transactions and carry out transactions on their own account. Bitcoin and the altcoins are examples of this model. In the private/permissioned model, by contrast, control of the network lies with a single user and only those granted access may join the system; smart contracts may be given as an example of this second group.
Digital Currencies
The first manifestation of blockchain technology appeared in the currencies known by the name of Bitcoin. In this type of use the network is open to anyone wishing to transact, and the participants who join the network have the power to view every transaction on the blockchain. The transactions carried out by users are added to the chain by means of cryptography. Participants rely on the system’s consensus mechanism as to the accuracy of the transactions they have carried out or will carry out. The most characteristic feature here is the absence of any central authority that brings the currency into existence. Two basic functions have been designed for the creation of currency: confirming the transaction and keeping the record, and forming a block on a given network.
New digital currencies come onto the market by the day as the technology develops. As of 2021 the number of digital currencies stood at 6,737 and their market value had reached USD 2.5 trillion. Although these currencies rest on the same technology, they differ significantly from one another in terms of transaction times and consensus mechanisms. In the cryptocurrency market today, digital currencies such as Bitcoin, Ethereum, Ripple and BNB stand out with their heavy trading volume.
Smart Contracts
Smart contracts give rise to all the terms and consequences of an ordinary contract. They nevertheless have aspects that distinguish them from traditional contracts: they leave no need for intermediary institutions, every stage of them can be monitored over the network, and their risk and cost are low. They have the capacity to remove the risks that the method of payment by letter of credit may create in international trade. Constraints encountered with physical contracts, such as the possibility of the document being lost or the requirement that the parties come together in person, do not arise for these contracts. Since the whole process is cryptographically signed and recorded on the blockchain, the risk of forgery is also reduced. Many banks operating on an international scale have begun to use these contracts. Thanks to instantaneous data flow and ease of tracking, blockchain technology is spreading day by day across many sectors, foremost among them public services, manufacturing, industry, energy, chemicals and telecommunications.
The Use of Blockchain Technology in Financial Services
Money transfers within the country are effected through banks, while transfers between countries are effected with more than one intermediary institution becoming involved. The use of blockchain technology in this field is possible through the private permissioned network to which the user belongs. As a result, transaction speed increases, cost recedes and the risks associated with the transaction diminish.
By making use of the technique of cryptography that the technology offers, a digital identity may be created for each customer on a common network on which banks and state institutions would both be present. Even if a person has accounts or assets at more than one institution, they will have a single digital identity, that is to say a single signature, of their own, and identity verification procedures will therefore be completed in a very short time.
The Use of Blockchain Technology in the Public Sector
Among the countries in a pioneering position in this field are Dubai, Switzerland, England, Estonia, Singapore and Cyprus. The principal areas of application that stand out in the public sector may be summarised as follows:
- Notarial transactions: The purpose of carrying out a transaction before a notary is to obtain evidence and to keep a copy of the transaction with an impartial authority. Blockchain technology offers a structure that answers precisely this need.
- Tax monitoring and customs and border control: Digital identity may also be made use of in tax inspection and in customs and border control procedures, whose physical formalities are burdensome, which cause losses of time and cost, and in which unfair practices are from time to time encountered.
- Digital passports and identity management: Some countries, such as Dubai, are working on digital passport applications, and digital identity was first put into use in Austria. The application both makes daily life easier and provides a secure environment.
- Digital voting: The safeguard of democratic elections is strengthened by reducing the margin for error and ensuring uniqueness. Particularly in countries such as Türkiye where the counting of votes is a matter of controversy, voting over blockchain may contribute to results being obtained accurately.
Legal Regulation of Blockchain and Cryptocurrencies Around the World
The best-known manifestation of blockchain technology is cryptocurrencies. What makes cryptocurrencies valuable is that this technology has been used, their decentralised structure and the encryption method behind them. This structure removed from centralisation is, however, viewed with suspicion by state authorities.
Bitcoin came into being in 2009; cryptocurrencies existed before that date as well, but none of them had reached the maturity Bitcoin attained. The first purchase and sale transaction took place in 2010, and in the period that followed Bitcoin came to make up half of the existing market share on its own. Because the technology is relatively new, direct regulation in this field is almost non-existent. The existing rules concerning blockchain take shape for the most part around the headings of money laundering and know your customer, which give rise to risk for states. The application of those rules to the cryptocurrency system is possible only indirectly.
Approaches to the subject may be gathered under two headings: wait and see and regulatory. The European Union may be said to stand on the wait-and-see line. In a statement made by the European Securities and Markets Authority (“ESMA”) it was stated that blockchain technology has not yet reached a maturity requiring regulatory activity; the statement went on to set out expressly the view that at this stage it would be more appropriate to monitor developments. The European Commission has similarly stated that it is following current developments concerning the technology, that working groups on the subject have been set up and that pilot projects are being carried out.
There are, on the other hand, countries that have legislated directly despite the novelty of the technology. Malta constitutes a striking example in this respect. On 4 July 2018 the Maltese Parliament brought three separate statutes into force: the Malta Digital Innovation Authority Act (“MDIA”), by which the digital innovation authority was established; the Innovative Technology Arrangements and Services Act (“TAS”), by which distributed ledger technology was regulated; and the Virtual Financial Assets Act (“VC”), by which the issuance of digital currency was brought under rules.
States view cryptocurrencies differently from one another. This divergence becomes more visible when the regulations of different countries are examined in outline.
The strictest stance is seen in China; there both cryptocurrency and cryptocurrency mining have been expressly prohibited, and ICOs and token sales (STOs) have been brought within the scope of the same prohibition. Work specific to blockchain technology nevertheless continues.
Foremost among the countries that treat cryptocurrencies as legal tender is Japan. Japan supports blockchain technology and there are legal rules on the subject. However, after the country’s cryptocurrency trading platform Coincheck suffered a major attack on 26 January 2018, cryptocurrency trading was placed under the strict supervision of the authorities. In Switzerland too, cryptocurrencies are accepted as legal currency, are used as a means of payment in many fields including transport fares, and are made subject to money laundering regulation.
In Russia, although regulatory work on the subject is being carried out, cryptocurrencies have not been treated as legal tender and have been placed in the class of goods. The draft statutory text on digital financial assets prepared by the Ministry of Finance on 20 January 2018 was submitted to parliament on 20 March 2018.
There is also another group of countries that do not recognise the character of a means of payment. In Canada, although cryptocurrencies are not accepted as legal tender, they are widely used in commercial life; they are treated as a barter product, are traded on the exchange and function as a currency in purchases of goods and services over the internet. In South Africa, cryptocurrencies are not treated as legal currency on the ground that they have not been printed in physical form, and legal transactions carried out with them are not recognised; the Central Bank’s announcement has, on the other hand, signalled that they may be regarded as legal tender in the future. In India, the government has an inclination towards cryptocurrencies not being a means of payment; although there is no statutory regulation, court decisions point to the need for regulation.
In some countries the technology is supported but there is as yet no direct text. In France, blockchain technology is encouraged but there are no legal rules on the subject; in December 2017 the use of blockchain technology was permitted in respect of financial instruments of a wider scope. In Germany too there is no regulation in force; on the other hand, in the characterisation given by state bodies, cryptocurrencies are treated as financial instruments, and it is stated that cryptocurrency platforms must obtain authorisation and that commercial activity carried on with these currencies must be taxed.
In the United States of America, blockchain technology is supported and the technology and cryptocurrencies are widely used. Since state bodies define cryptocurrencies in different ways, their legal status varies from state to state. In Australia, cryptocurrencies are supported and legislative work is continuing; there are guidance notices published by the state authorities concerning taxation. In Iran, although blockchain technology is viewed positively, the stance on cryptocurrencies is not clear; the prohibition initially introduced on the grounds of use by terrorist organisations and money laundering was subsequently lifted, and it has even been stated recently that a national cryptocurrency backed by the rial will be issued with a view to circumventing the economic sanctions pursued by US President Trump.
On the European Union front, on 12 February 2018 the financial institutions published a warning addressed to citizens on account of the fact that virtual currencies have not been fully regulated and of their risky nature. Leaving aside what the Fourth Anti-Money Laundering Directive introduced, the European Banking Authority (“EBA”) emphasises the necessity of separate regulation in order to minimise the risks to which cryptocurrencies give rise. Together with the “FinTech Action Plan” prepared by the Council of Europe, it may be said that the member states of the union generally follow the approach taken in the “Hedqvist” judgment of the European Court of Justice of 22 October 2015, case no. C-264/14. In that judgment, which concerned whether VAT was to be levied on Bitcoin in Sweden, Bitcoin was characterised as a virtual currency and was exempted from VAT.
The Regulation on the Non-Use of Crypto Assets in Payments
Our first legal text on the subject is the Regulation on the Non-Use of Crypto Assets in Payments, published in the Official Gazette of 16.04.2021, no. 31456. The text contains certain provisions capable of giving direction, for the purposes of Turkish law, to the debate on the legal character of cryptocurrencies; crypto assets were defined for the first time in this Regulation.
Regulation on the Non-Use of Crypto Assets in Payments, Art. 3(1)
“For the purposes of this Regulation, a crypto asset means intangible assets which are created virtually using distributed ledger technology or a similar technology and distributed over digital networks, but which are not characterised as fiat currency, scriptural money, electronic money, a payment instrument, a security or any other capital market instrument”
The principal aim of the Regulation is to prevent transactions carried out with cryptocurrencies from being conducted through payment and electronic money institutions. The text therefore does not have the character of a general and comprehensive regulation of cryptocurrencies.
Apart from the Regulation, there are statements made by the CBRT, the BRSA and the CMB, particularly with regard to ICOs. Those statements, however, go no further than recalling that Bitcoin is not treated as electronic money and pointing out the risks it may give rise to. They consist of a number of warnings to the effect that the greater part of the applications known as “cryptocurrency sales”, which are aimed at raising funds by means of blockchain technology, fall outside the supervision and oversight of the CMB and are speculative investments in character.
In Turkish doctrine, it has been debated whether cryptocurrencies are to be treated as money in terms of their legal character, and a consensus has been reached that they do not have the character of money. Recently, the question whether income derived from cryptocurrencies may be taxed has also begun to come onto the agenda.
Legal Rules on Digital Identity
Blockchain technology makes it possible for data to be transferred to the digital environment. This in turn makes it possible for data to be processed and protected in a more systematic and reliable manner.
Looking at the position in Türkiye, it may be said that legislative work on digital ID is continuing and that developments around the world are being followed closely. In our country, digital identity applications were placed on a legal footing by the Regulation on the Identity Card of the Republic of Türkiye of 3 December 2019, no. 30967.
Regulation on the Identity Card of the Republic of Türkiye, Art. 4(ç)
“Biometric data: data specific to the person which is taken with a view to enabling identification and identity verification procedures to be carried out by means of electronic systems,”
Pursuant to this provision, it should be stated that the new citizenship identity cards produced in Türkiye have the quality of a digital identity and that this quality rests on a legal text.
Legal Rules on Smart Contracts
The principal features distinguishing smart contracts from traditional contracts are that every stage of the contractual process is automated and that there is no longer any need for the parties to come together. It is nevertheless likely to be accepted that these contracts too give rise to all the terms and consequences of a traditional contract.
The use of smart contracts is spreading worldwide. Nestlé and Walmart are among the companies that have begun to use these contracts, and at the Port of Rotterdam smart contracts have been incorporated into maritime logistics processes.
There are no legal rules, either worldwide or in Türkiye, on how smart contracts are to be formed and in what manner they are to give rise to their terms and consequences. The general tendency is to interpret these contracts through the statutory order in force.
The United States Commodity Futures Trading Commission (CFTC) has published a report on the subject. The report states that, according to the procedures and principles of their use, smart contracts may be subject to the regulations in force, including banking and money laundering legislation.
Risks to Which the Use of Blockchain and Bitcoin May Give Rise
First of all, the risk of Bitcoin turning into an instrument of money laundering and tax evasion is on the agenda. There is, on the other hand, no statutory provision prohibiting the purchase and sale of Bitcoin.
In the Suspicious Transaction Reporting Guide prepared by MASAK, “the transfer of funds from customer accounts to intermediary institutions selling Bitcoin for the purpose of purchasing Bitcoin” is counted among the “types of suspicious transaction”. Intermediary banks are therefore under an obligation to report such transactions to MASAK. The subject is also closely connected with the debates falling under the heading of internet offences and their penalties.
The risks are not limited to this. The impossibility of knowing who carried out a transaction is a problem area in itself; connected with this, the question in whose name and on what basis tax is to be levied also awaits an answer. The existence of virtual currency may increase the number of offences committed by producing an effect that facilitates their commission; the possibility that products whose purchase and sale is prohibited may change hands through virtual currency also falls within this scope. Although the transparency of the system is regarded as an important advantage, it gives rise to serious concerns as to the security of trade secrets and personal data. Another contentious heading is which state will have jurisdiction over transactions carried out on the blockchain. Finally, it remains uncertain what result will follow, in the face of the immutable structure of the technology, where a stay of execution is ordered in respect of a transaction carried out on the blockchain.
Independent Legal Assessment
The picture in Turkish law as regards crypto assets consists, in place of comprehensive regulation, of a single regulation with a narrow purpose together with statements in the nature of warnings from the supervisory authorities. For ventures that build their commercial activity on crypto assets or blockchain infrastructure, this picture means both flexibility and unpredictability. So long as the problem of characterisation remains unresolved, an increase in disputes under headings such as taxation, security, enforcement and bankruptcy is to be expected.
In work carried out in this field in practice, it is important that the following matters be assessed in advance:
- Clarifying whether the crypto asset is positioned in the transaction concerned as a means of payment or as a value that is the subject of investment or of security
- Ensuring that no arrangement falling within the scope of the payment prohibition in the Regulation is inadvertently written into the text of the contract
- Reflecting MASAK reporting obligations and know-your-customer processes in the operating procedures in written form
- Expressly agreeing in the contract, in work where smart contracts are used, the law to be applied and the competent authority in the event of a dispute
- Examining before the transaction, in cross-border dealings, the approach of the counterpart country to crypto assets
- Determining a method as to how personal data and trade secrets are to be protected in the face of the immutable structure of the blockchain
Independent Legal provides advisory services in this field at the intersection of information technology law and commercial law, from the structuring of contracts to the management of disputes.