Pakistan's Crypto Crossroads: A Phased Approach to Responsible Innovation

Borderless, open-sourced, volatile and decentralised — crypto is fast-paced and constantly evolving.

Cryptocurrencies have become an increasingly hot topic in recent times, with new use cases and applications being discovered almost daily. This rapid evolution of blockchain-based technologies and cryptocurrency use cases is placing an immense strain on the existing legal and regulatory frameworks, which are struggling to keep pace with these innovations.

Each new cryptocurrency use case or application, from DeFi to Web3, brings with it a unique set of legal uncertainties and potential risks that must be assessed and managed. Moreover, the cross-cutting nature of crypto regulation spans multiple regulatory regimes, including banking, securities, commodities futures, data protection, and anti-money laundering. These regulatory domains are often governed by different institutions with varying priorities, further complicating the regulatory landscape.

For a country like Pakistan, which is still in the process of integrating this emerging sector, the task is even more pronounced. Pakistan must strike a careful balance between establishing legal certainty and navigating its own economic priorities and institutional capacities. It is also crucial for Pakistan to factor in its specific macroeconomic context and align its regulatory strategy accordingly.

However, the urgency to bring this emerging sector under the umbrella of a comprehensive regulatory framework is undeniable. As the world becomes increasingly interconnected, Pakistan cannot afford to be an outlier in setting up a global-standard framework for crypto regulation.

The goal is to foster responsible innovation in a way that protects consumers and investors in this borderless digital economy, while also enabling the country to participate fully in the global crypto market and benefit from its potential for financial inclusion and economic growth.

A phased approach may be useful to manage the complexity of crypto regulation in Pakistan.

The first phase could focus on laying the foundation for crypto regulation in Pakistan. This would involve several key steps:

1. Central Oversight Authority: Establish a dedicated cryptocurrency regulatory body with a clear mandate for licensing, compliance, coordination with relevant institutions, and ongoing policy development. This body could report to the finance minister and be advised by the Pakistan Crypto Council.

2. AML/CFT Standards: Align Pakistan’s anti-money laundering, counter-terrorism financing (AML/CFT) standards with the Financial Action Task Force (FATF) guidelines. Develop a cryptocurrency-specific AML/CFT framework with robust ‘know-your-customer’ (KYC) norms, transaction monitoring, and efficient enforcement mechanisms.

3. Legal Definitions and Guidelines: Clarify the legal definitions of cryptocurrency assets, Virtual Asset Service Providers (VASPs), and blockchain applications to eliminate ambiguity. Set forth clear regulatory guidelines for capital requirements, risk management practices, and investor protection measures.

4. Licensing VASPs: Institute a robust registration and licensing regime for Virtual Asset Service Providers (VASPs), including cryptocurrency exchanges, wallets, and custodians. This step is essential to ensure consumer protection, market integrity, and regulatory compliance.

The second phase could focus on controlled innovation.

1. Dual-Tier Licensing Model: Adopting a dual-tier licensing model, similar to those in Singapore and Japan, would allow for lighter regulation of smaller, less risky crypto firms, while requiring stricter compliance from larger, more significant players. This approach balances the need for flexibility in fostering innovation with the systemic safety concerns posed by large-scale crypto firms.

2. Expanding Regulatory Sandboxes and Pilot Programs: Facilitate controlled testing environments where new crypto technologies, products, or services can be deployed and monitored in a limited capacity. Such regulatory sandboxes, like the one being established by the Securities and Exchange Commission of Pakistan (SECP), should be expanded and focused on emerging sectors like blockchain, digital payments, and tokenised assets.

3. Legal Framework for Blockchain Use: Beyond cryptocurrencies, blockchain can streamline government services, logistics, and recordkeeping. Develop a national blockchain strategy, complete with the necessary legal and regulatory clarity, to integrate blockchain technology for improving public sector efficiency and public trust in institutions.

The third phase could focus on protection, resolution and value creation.

1. Consumer Protection Standards: Introduce strong standards for transparency in crypto advertisements, mandatory secure custody protocols for user assets, and clear disclosures to protect consumers and build trust in the market.

2. Data Protection Laws: Integrate strong data protection laws that mandate encryption, secure handling of personal and financial data, and best practices in data storage and transfer across all crypto platforms to prevent misuse and ensure privacy.

3. Fast-Track Dispute Resolution: Facilitate the speedy resolution of crypto- and blockchain-related conflicts through efficient arbitration and mediation frameworks.

The last phase could focus on strategic integration.

1. Regulating and Incentivising Bitcoin Mining: Given the potential for surplus electricity in certain regions of Pakistan and the rising global demand for Bitcoin, consider a strategy for the legal and controlled integration of Bitcoin mining in a way that is economically beneficial to Pakistan and aligns with its environmental goals. This could involve offering tax incentives for clean energy solutions used in crypto mining.

2. Cryptocurrency Taxation Policy: Develop a clear and consistent cryptocurrency taxation policy that aligns with the broader tax system in Pakistan. Define the tax implications of capital gains and income