Introduction
Estonia, a Baltic nation renowned for its innovative digital infrastructure and progressive policies, has emerged as a leader in the global technology landscape. With its capital, Tallinn, gaining recognition as a vibrant hub for tech startups and digital entrepreneurs, Estonia provides an ideal environment for fintech innovation and blockchain development. The country's commitment to fostering a supportive ecosystem for emerging technologies has positioned it as a prime destination for businesses seeking to capitalize on the opportunities presented by the digital revolution.
In Estonia, virtual currency services are not considered financial services (although they are equated to financial services in terms of AML/CTF requirements). Estonia has been at the forefront of implementing stringent anti-money laundering (AML) and counter-terrorist financing (CTF) measures to mitigate the risks associated with virtual currencies while fostering innovation and growth in the sector. The oversight of anti-money laundering regulations falls under the purview of the Financial Intelligence Unit (FIU), the designated authority responsible for combating financial crimes and ensuring compliance with AML/CFT regulations.
Since the enactment of a groundbreaking law on November 27, 2017 (later amended and entered into force in Estonia on March 15, 2022), Estonian entrepreneurs have been afforded the opportunity to obtain licenses for two distinct avenues:
- the exchange of virtual currency to fiat (traditional) currency,
- and the provision of virtual currency wallet services.
As Estonia continues to uphold its reputation as a forward-thinking jurisdiction for digital assets innovation, collaboration between regulatory bodies and industry stakeholders remains paramount in fostering a secure and transparent environment for cryptocurrency operations.
The Act on the Prevention of Money Laundering and Financing of Terrorism
In light of the evolving landscape of virtual currencies, in March 15, 20222, Estonia has introduced updated legislation with the primary aim of mitigating the risks associated with money laundering, terrorism financing, and the proliferation of weapons of mass destruction within the realm of virtual assets. The Act on the Prevention of Money Laundering and Financing of Terrorism specifically targets virtual asset providers (VASPs) and seeks to bolster supervision in this sector.
The key changes outlined within this legislative update include:
- Stringent Capital Requirements: VASPs are now required to maintain substantial authorized capital, with specific thresholds depending on the nature of the services provided. For instance, providers offering virtual currency exchange services must have a minimum authorized capital of €100,000, while those offering virtual currency transfer services must have at least €250,000.
- Enhanced Customer Identification Preconditions: VASPs must employ technology with a high level of reliability to accurately identify and verify customer identities. This includes the use of digital authentication documents or other electronic identification systems meeting stringent reliability criteria established by Estonian law.
- Mandatory Business Plan Presentation: VASPs are mandated to present a comprehensive business plan spanning at least two years, outlining their operational strategies and compliance measures.
- Own Funds Requirements: VASPs must maintain their own funds equal to a certain percentage of their transaction volume, ensuring financial stability and liquidity. The calculation of own funds is intricately detailed, with specific percentages corresponding to different transaction volume tiers.
- Annual Audit Requirement: VASPs are obligated to undergo annual audits of their financial reports by certified auditors. This requirement aims to enhance transparency and accountability within the sector.
- Qualifications for Board Members: Members of the board of VASPs are required to possess higher education and a minimum of two years of professional experience. Additionally, a board member may not hold positions on the board of more than two VASPs simultaneously.
- Increased State Fee: The state fee for applying for a cryptocurrency license has been significantly increased from €3,300 to €10,000, reflecting the government's commitment to ensuring the integrity of the licensing process and strengthening regulatory oversight.
As these regulatory changes come into effect, businesses seeking to engage in cryptocurrency activities in Estonia must adhere to these stringent requirements to obtain and retain their licenses.
Obligations Imposed on Crypto Companies:
To obtain specialized authorization from the relevant regulatory authorities in Estonia, such as the Financial Intelligence Unit (FIU), for engaging in cryptocurrency exchange and storage services, applicant companies must adhere to a set of stringent obligations, including:
- Development of Criteria for Evaluating Customer and Individual Transaction Risks:
- Establishing comprehensive criteria for assessing the risks associated with both customers and individual transactions conducted on the platform.
- Implementation of KYC/AML Documentation:
- Overview of high-risk transactions, detailing protocols for monitoring client communication and transaction locations.
- Overview of lower-risk operations, specifying procedures for conducting such transactions in compliance with regulatory standards.
- Guidelines for securely storing transaction and customer data, ensuring compliance with data protection regulations.
- Protocols for reporting suspicious transactions or activities to the regulatory body, as mandated by law.
- Establishment of Procedural Guidelines:
- Risk classification methodologies to assess and categorize different types of risks.
- Evaluation of risks associated with fund and transaction origins to prevent illicit activities.
- Implementation of due diligence measures to verify the legitimacy of transactions and counteract potential money laundering activities.
- Internal auditing processes to regularly review and assess compliance with regulatory requirements.
- Adherence to obligations for promptly reporting any suspicious transactions to the relevant regulatory authorities, such as the FIU.
By fulfilling these obligations, cryptocurrency companies in Estonia demonstrate their commitment to upholding the highest standards of compliance, security, and transparency in the burgeoning digital asset industry.
Innovation and Support
Estonia's commitment to fostering innovation in the fintech and blockchain sectors is evident in initiatives such as the e-Residency program and the establishment of the Finantsinspektsioon Innovation Hub.
The e-Residency program allows entrepreneurs from around the world to establish and manage their businesses online, leveraging Estonia's digital infrastructure and access to the European Union market.
The Finantsinspektsioon Innovation Hub serves as a pivotal resource for fostering financial technology (FinTech) innovation within the country's financial sector. Established with the strategic goal of ensuring a stable, reliable and innovation-friendly financial market, the Innovation Hub facilitates communication between the Finantsinspektsioon and companies seeking guidance on integrating innovative solutions into their operations.
Through this initiative, companies involved in FinTech, as well as those planning to introduce novel solutions into their activities, can engage directly with the Finantsinspektsioon to seek advice, obtain information on financial supervisory positions, and navigate the regulatory landscape.
The hub aims to streamline the process for innovative companies to enter the market by providing support in understanding regulatory requirements, qualifying services, and guiding businesses through the authorization process when necessary.
Additionally, the Innovation Hub offers assistance to companies creating innovative supervisory solutions, further contributing to the development of a robust and forward-thinking financial ecosystem in Estonia. To avail of the services provided by the Innovation Hub, companies must meet specific criteria and complete the application process outlined by the Finantsinspektsioon. This proactive approach to fostering innovation underscores Estonia's commitment to maintaining its position as a global leader in FinTech and blockchain technology.
Taxation
Estonia's tax regime for cryptocurrency transactions is characterized by its simplicity and transparency, offering favorable conditions for businesses and investors alike. Key aspects of Estonia's crypto taxation system include:
- Corporate Income Tax (CIT): Crypto companies are subject to a flat rate of corporate income tax on their profits, with dividends distributed to resident shareholders exempt from taxation. The rate varies between 0%-20%.
- Value Added Tax (VAT): VAT is not levied on the purchase or sale of cryptocurrencies, nor on the provision of crypto-related services, providing clarity and certainty for businesses operating in the sector. The rate is 20%.
- Withholding Tax (WHT): Estonia does not impose withholding tax on dividends, interest, or royalties paid to non-residents, further enhancing the attractiveness of the country as a jurisdiction for crypto investments and transactions. The rate varies between 7%-20%.
- Social Tax (ST): Is a mandatory contribution imposed on employers in Estonia to fund social security programs. This tax is calculated based on the gross wages paid by the employer to their employees and is intended to cover various social security benefits, including health insurance, unemployment benefits, pension contributions and other social welfare programs. The rate is 33%.
Next Steps
In 2021, the Ministry of Finance introduced a draft version of national legislation designed to regulate crowdfunding services, including those not currently governed by EU regulations, as well as virtual currency services. If passed, this legislation would classify virtual currency services as financial services, subjecting them to oversight by the Estonian Financial Supervision and Resolution Authority (EFSRA). However, the implementation of this national law has not occurred and its future is poised for a shift with the impending enactment of MiCA. Once MiCA comes into effect, it is expected to influence the direction and scope of the national regulation concerning virtual currency services.
Conclusion
Estonia's progressive approach to cryptocurrency regulation, combined with its robust digital infrastructure and supportive ecosystem, positions the country as a leading destination for blockchain innovation and investment. With a clear legal framework, favorable tax regime, and government support for fintech development, Estonia offers a compelling proposition for businesses seeking to capitalize on the opportunities presented by the digital economy.
Note: This text is the sole work of the author and does not bind BlockReg Advisors Ltd. nor does it constitute legal advice. All rights reserved.
