Regulation of cryptocurrencies in the UK

BCL Solicitor Hannah Raphael and Employed Barrister Jonathan Flynn take a closer look at the changing landscape of cryptocurrency regulation in UK.

Introduction

There are currently in the region of 1500 cryptocurrencies in existence across the world and although valuations vary wildly, the cryptocurrency market is estimated to be worth in the hundreds of billions of dollars. With crypto-exchanges now advertising on the London Underground and Mastercard’s new patent for a credit card which (if brought to market) will allow customers to instantly pay for items on their credit card using digital currency, it is safe to say that cryptocurrencies are well on their way to becoming mainstream.

They are not there yet though. It still takes around 10 working days to process a payment in cryptocurrency which means they are not regularly used as a means of payment, a fact which has led many, including the UK government to question whether cryptocurrency is even a fitting term. They have opted for the term “crypto-assets” instead to reflect the fact that currently cryptocurrency more closely resembles a store of value than a medium of exchange.

Cryptocurrencies have lost roughly 70% of their value since the heady days of 2017 when, at its peak, the price of one Bitcoin reached around £15,000. Both the fact that they are not widely used as a medium of exchange and the dramatic price drop will no doubt have contributed to the conclusions reached by the Bank of England’s Financial Policy Committee in its report, published in March 2018, that “existing crypto-assets [do] not currently pose a material risk to UK financial stability”.

Cryptocurrency Crime

Cryptocurrencies may not presently pose a risk to the City of London but they pose a huge risk for investors as they are notoriously popular with criminals. This is due in large part to the anonymous and borderless nature of the transactions, provided via the blockchain technology upon which they are founded. It is also due though to the abundant easy prey available in the form of non-professional investors, dazzled by the possibility of huge returns.

Cryptocurrency related crimes are no longer limited to tales of anonymous purchases of illicit goods from the Dark Web. The Director of Europol estimates that in 2017 criminals in Europe laundered $5.5 billion worth of undeclared cash via cryptocurrencies. Many cryptocurrency exchanges are willing to accept customers without carrying out proper due diligence.

Some currencies offer anonymity as an intrinsic feature and applications such as Bitcoin Blender promise to make transactions 100% anonymous.

The City of London Police received over 200 reports of cryptocurrency fraud over the course of just two months earlier this year. These reports related to scams by fraudsters obtaining credit card details following promotions of fake investments in cryptocurrencies.

There have also been complaints of fraudulent Initial Coin Offerings (‘ICOs’). ICOS are a digital means of raising funds from the public. Typically a token is offered in exchange for cryptocurrency. The token is promoted as something that will grow in value. Frequently investors discover down the line that the token does not exist or that it is worthless as the business they invested in at best quickly went bust or at worst never existed.

Cryptocurrency is also highly susceptible to theft. It was reported recently that $1.1 billion in cryptocurrency was stolen (globally) in the first half of 2018. Cryptocurrency is frighteningly easy for hackers to steal from those with inadequate levels of cyber security. This applies to both those who hold their currency in personal cloud wallets as well as with established exchanges. Cryptocurrency is frequently stolen with the assistance of ransomware. Previously a tool associated mostly with organised crime gangs, ransomware is becoming increasingly easy to buy and purchase online.

Finally, there is growing concern surrounding a yet further category of cryptocurrency crime. A recent study demonstrates persuasively that the dramatic volatility in cryptocurrency prices experienced last year was caused by market manipulation.

Notwithstanding this proliferation of criminal activity, to date these crimes have not been actively investigated or prosecuted in the UK.

The current position

The lack of regulation in the UK coupled with under-resourced and under-trained law enforcement officers has (at least in the recent past) contributed to an apparent lack of interest or appetite for pursuing the perpetrators of cryptocurrency related crimes. There are clear signs that the position is beginning to change however.

The UK government and financial regulators have grappled with the question of whether, and if so to what extent, it is necessary to regulate cryptocurrencies. Prior to this year the UK government had opted for take a wait-and-see approach, preferring instead to observe the effects of regulation in other countries, in particular the United States. This strategy has been driven in no small part by the fear that over-regulation would deter potential investors and innovators thereby thwarting the government’s desire for the UK to be a global hub for Fintech such as blockchain.

There are several signs that clearly demonstrate that the UK government is starting to take a more active role. To assist with these issues (and others) earlier this year the UK government established a ‘Cryptoassets Taskforce’ comprising of senior leaders from government and representatives from HM Treasury, the FCA and the Bank of England.

The Taskforce met in May and July of this year and are expected to report on their findings imminently. Meanwhile in September the UK Parliament Treasury Committee reported the findings from their inquiry into digital currencies and distributed ledger technology. They concluded that regulation of cryptocurrencies is required for anti-money laundering purposes and consumer protection.

Cryptocurrencies have been on the agenda at the FCA for some time but they have been reluctant to accept responsibility for their regulation. This position has been defended by reference to the fact that cryptocurrency activities are not currently listed as a regulated activity in the Financial Services and Markets Act 2000 (Regulated Activities) Order (‘the RAO’). So far the FCA has accepted that cryptocurrencies are subject to regulation only to the extent that they form part of other regulated services or products, for example cryptocurrency derivatives.

In May it confirmed that it was investigating 24 unauthorised cryptocurrency businesses operating in the UK to determine whether they might be carrying on regulated activities that require FCA authorisation, suggesting that it is confident and content to accept responsibility for the regulation of cryptocurrency but only on this extremely limited basis.

Guidance issued on the FCA website sets out the risks associated with investing in ICOs. As matters stand however the FCA has not accepted that ICOs fall within its purview as it considers itself to have jurisdiction only over those ICOs that offer tokens that could be classed as securities.

Implementation of the 5th Anti-Money Laundering Directive

Further regulation is on its way. In July of this year the UK government announced that the UK will adopt the 5th Anti-Money Laundering Directive (aimed at preventing terrorist financing and money laundering) in time for the EU imposed deadline of January 2020. This means that from January 2020 all cryptocurrency exchanges (which trade fiat currency for cryptocurrency) will be required to register with the FCA. They will also be obliged to perform customer due diligence and submit suspicious activity reports.

Although important and undoubtedly helpful, the success of these measures in the deterrence of money laundering will be dependent upon the implementation of similar measures across the globe, without which criminals will simply seek out exchanges in unregulated jurisdictions.

Moreover further regulation of exchanges will be necessary to prevent cryptocurrency theft. Without the addition of a specific requirement for exchanges who also operate as wallet providers to demonstrate a high level of cyber security adequate to protect against hackers, investors remain at risk of losing their entire investment.

Is further regulation required?

Cryptocurrencies may not present a threat to the financial status quo at this point in time but as stated by the Treasury Committee, “Crypto-assets have been embedded in certain pockets of society and industry, and it is highly likely that they are here to stay”.

The Committee concluded that regulation was urgently required and that at a minimum it should be introduced to address consumer protection as well as money laundering. Further, the 5th Anti-Money Laundering Directive should be adopted as quickly as possible and that via an extension of the RAO, the FCA should regulate both the provision of crypto exchange services and the issuance of ICOs.

It remains to be seen when and even whether these recommendations will be acted upon. What is clear is that cryptocurrency related crime is now being treated seriously by the UK government and regulators alike and an increase in the active investigation and prosecution of those crimes will surely follow.

 

Authors:

Hannah Raphael is a solicitor at BCL specialising in all areas of business and general crime. She has defended clients in proceedings instituted by the SFO, the FCA, HMRC, the Information Commissioner’s office and the CPS. Hannah has acted for high profile clients in relation to allegations of conspiracy to defraud, insider dealing, money laundering, breaches of data protection, and computer misuse.

Jonathan Flynn is an employed barrister at BCL specialising in criminal and regulatory law. He has particular expertise in fraud, bribery and corruption, restraint and confiscation proceedings, and general crime. Jonathan has acted in a number of high-profile, complex and multi-jurisdictional cases, including investigations / prosecutions by the Crown Prosecution Service, Financial Conduct Authority, HM Revenue & Customs, Serious Fraud Office and National Crime Agency.