Hannah Raphael discusses the UK’s policy and regulatory approach to cryptoassets.
2018 was a bad year for cryptocurrency. Bitcoin fell from its heady highs of $20,000 per coin at the end of 2017 to less than $4,000 by the end of 2018. An estimated $3-$4 billion worth of cryptocurrency was laundered across Europe, and an estimated $2 billion’s worth was stolen worldwide, mostly from cryptocurrency exchanges. In the UK roughly 50% of Initial Coin Offerings (‘ICOs’) failed and 25% of them are thought to have been fraudulent. By autumn the mainstream media was awash with declarations that the Bitcoin bubble had burst. It is hardly surprising therefore to hear that as we enter 2019 crypto-trading is at an all-time low.
2019 may well be a brighter year for the crypto industry however. Technological innovation continues apace across the sector, from enhanced security for exchanges and wallet holders to the development of more efficient, less volatile and more transparent ‘coins’. In addition a secondary market is evolving in goods and services that relate to cryptocurrencies, such as the purchase of cryptocurrencies by credit card and the trading of crypto-derivatives.
Moreover the UK is finally starting to take steps towards regulating cryptoassets. The authorities in the UK have spent some considerable time over the question of how to and indeed whether they even need to regulate this fast-changing industry. The goal is to regulate in a way that encourages innovation and investment in the sector whilst at the same time protecting the customer and the integrity of the market. If that balance can be achieved, or so the thinking goes, institutional investors will be encouraged to enter the market and the industry will thrive.
In October 2018, the UK ‘Cryptoassets Taskforce’ (‘the Taskforce’), which consists of HM Treasury, the Financial Conduct Authority (FCA) and the Bank of England, published its final report on the UK’s policy and regulatory approach to cryptoassets and distributed ledger technology (‘DLT’).
In its report the Taskforce recommends the implementation of legislation that will exceed the requirements set out in the EU 5th Anti Money Laundering Directive (‘5MLD’). Fiat to cryptoasset exchange firms and custodian wallet providers will be brought within the scope of anti-money laundering/counter terrorist financing (‘AML/CTF’) regulation, as required by 5MLD, but consultation is underway as to whether UK legislation should also extend to:
- crypto to crypto exchanges, (in order to prevent the anonymous layering of funds),
- peer to peer exchange platforms,
- cryptoasset ATMS, (which could be used anonymously to purchase cryptoassets),
- non-custodian wallet providers; and
- firms based outside the UK, when providing services to UK customers (to avoid the ability for those based in the UK to bypass UK regulation by dealing with firms based abroad).
The government has asked the FCA to consider taking on the role of supervising firms in fulfilling their AML/CTF obligations.
The Taskforce report states that the government will consult on its proposed actions in early 2019, and will legislate later this year to give effect to this response.
The UK is also actively engaging in discussions with a number of international bodies, including the Financial Action Task Force, G7 and G20, and the International Organization of Securities Commissions, to help ensure that there is a global response to the risks posed by cryptoassets.
On 23 January 2019 the FCA published its draft “Guidance on Cryptoassets” (‘the draft guidance’). Whilst recognising that the regulatory perimeter was not specifically designed to cater for cryptoassets and that there is a strong case for reassessing its definition and scope, the draft guidance provides clarification around which cryptoasset activities currently fall within the FCA’s regulatory perimeter. It achieves this by dividing cryptoassets into three categories of ‘token’: exchange, security and utility. Broadly speaking, an exchange token refers to a cryptocurrency, like Bitcoin, a security token refers to a token which amounts to a ‘Specified Investment’ under the Regulated Activities Order (‘RAO’), and a utility token refers to a token which can be redeemed for access to a specific product or service that is typically provided using a DLT platform.
The draft guidance states that currently only security tokens fall within the FCA’s regulatory perimeter but recognises that the distinction between utility token and security token is not always clear and that some tokens may exhibit hallmarks of more than one token.
The draft guidance examines ICOs in some detail concluding that only ICOs that issue ‘security tokens’ fall within the perimeter. It calls these Security Token Offerings, or STOs. Recognising that ICOs have the potential to provide an important means of fundraising for new business ventures in the future, and that this can only happen if they are properly regulated, HM Treasury is considering extending the FCA’s regulatory perimeter to cover all ICOs.
Finally, by way of consumer protection, the draft guidance raises the possibility of a ban on the sale of crypto-derivatives to retail customers given the inherent risks involved. A derivative is by nature extremely volatile, but when it is referenced to something as volatile as cryptocurrency, that volatility increases exponentially.
There has been a notable lack of FCA enforcement in the crypto sector to date. This is presumably in no small part due to the evolving and somewhat muddy nature of the regulatory framework. Given that some clarity will be provided once the guidance is finalised and the Taskforce consultations are complete, this may well be the year that the FCA begins to take a more active role in enforcement. That being said, it is likely that, for the time being at least, there will be leniency for cases involving legitimate perimeter issues. Should the FCA accept regulatory responsibility for ICOs we may start to see formal investigations opened into fraudulent ICOs.
2019 will therefore likely be a year of transition as we wait to learn of the reach of AML/CTF regulation for cryptoassets in the UK and whether, and if so to what extent, the FCA perimeter is extended. Only time will tell whether these forays into regulation will succeed, either in preventing illicit activity, or in helping to resuscitate crypto’s tarnished reputation.
This is an updated version of an article examining the regulations of Cryptoassets in 2018, which you can find here.
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.