The regulation of cryptoassets in the UK

20.10.23

A brief overview of the current state of play regarding the regulation of cryptoassets and stablecoins in the UK.

Peter Howitt

Managing Director

Summary (or TL;DR)

Regulatory Strategy – in the absence of an authorisation regime for cryptoasset businesses (VASPs), the FCA has used a two-pronged attack to seek to regulate the market:
- VASPs doing business from the UK are required to register for AML purposes.
- financial promotions for cryptoassets to consumers can only be made using lawful routes such as by authorised persons or AML-registered VASPs.

Property – Cryptoassets are not usually considered to be currency or money, but rather a type of property.

Regulated Activity – however, where a token represents a financial interest, a unit in a collective investment scheme, a deposit or another form of regulated liability (such as e-money) then it does fall within existing regulated activities.
Specified Investment – In addition, many cryptoassets now fall within the UK financial services promotion regime. See UK Cryptoasset Financial Promotion Regime
Stablecoins – these require special attention as they are considered to have the potential to be a widespread form of payment and may also be used as programmable money: for example as collateral within smart contracts for the sale of goods or services, escrow arrangements and complex derivative transactions. The FCA and UK Govt believe they could pose heightened risks to consumers and the financial stability of the UK.

UK: Calls for Evidence Cryptoassets & Stablecoins

The EU has already legislated for specific treatment of single currency and multi-asset stablecoins as part of its comprehensive Markets in Crypto Assets Regime (MiCA). Introduction to MiCA

The UK is taking a different, more piecemeal, approach that may ultimately prove more effective.

Current state of play in the UK

There are many different types of cryptoassets, including Bitcoin, Ethereum, and tethered stablecoins (such as UDSC and USDT). Cryptoassets can be used for a variety of purposes, including payments, investments, and speculation.

Cryptoassets are now within the definition of specified investments under UK law. In addition, some stablecoins already meet the definition of electronic money under EU, UK and Gibraltar law definitions (which definitions are the same). The UK intends to bring all stablecoins within the payments regulatory perimeter – this will involve changes to UK law for e-money and payment services.

The new Financial Services and Markets Act 2023 (FSMA 2023 – see further below) came into force on 29 June 2023 (with some aspects coming into force by 01 January 2024). It enables the UK to bring in secondary legislation or specific regulatory requirements by the FCA or HM Treasury to properly regulate cryptoassets and stablecoins. Any secondary legislation or amendments to existing rules will follow consultation with relevant industry bodies for payments, investment and wholesale use purposes.

The UK as a global hub for cryptoasset technology and innovation

The UK government has announced a series of measures to make the UK a global hub for cryptoasset technology and investment:

Stablecoins: The government plans to bring stablecoins more clearly within financial services regulation depending on their structure and use cases.
Financial Market Infrastructure & Digital Securities Sandbox: Sandboxes have been introduced to enable regulated firms to experiment and innovate with cryptocurrencies, stablecoins and blockchain technologies.

Click to access Consultation_on_Digital_Securities_Sandbox.pdf

Consultation on the Digital Securities Sandbox

Cryptoasset Engagement Group: a new group was established to work more closely with the various industries impacted by cryptasset technologies.
Tax System: the UK is considering enhancing the competitiveness of the UK tax system to encourage further development of the cryptoasset market.
Non-Fungible Token (NFT): The Royal Mint is working on an NFT for Great Britain as a symbol and token of the forward-looking approach of the UK.

Rishi Sunak, the current Prime Minister of the UK, has stated that it is his ambition to make the UK:

“ a global hub for crypto asset technology, and the measures we’ve outlined today will help to ensure firms can invest, innovate and scale up in this country”
UK Parliament – Regulating Crypto

Current UK Law

Unlike the EU, the UK government has taken a more cautious approach to the regulation of cryptoassets, preferring to wait for the market to mature before introducing comprehensive legislation and authorisation requirements for different aspects of the sector and technologies.

As mentioned above, the UK does not currently have a cryptoasset authorisation regime. The first major laws to be enacted for the sector have been for financial promotions of cryptoassets under financial promotions rules and anti-money laundering regulations:

The Financial Services and Markets Act 2000 (FSMA 2000): This act regulates financial services in the UK and the new financial promotion regime for cryptoassets is within this framework.

The Money Laundering, Terrorist Financing and Transfer of Funds (Information on the Payer) Regulations 2017 (MLRs):
- These regulations require UK cryptoasset firms to register with the Financial Conduct Authority (FCA) and to implement anti-money laundering (AML) and counter-terrorist financing (CTF) measures.
- From 1 September 2023, cryptoasset businesses in the UK are required to collect, verify, and share information about cryptoasset transfers under the Travel Rule. This rule mirrors the requirements for fiat transactions in the banking and payments sector. However, it has proven difficult for the industry to implement a widely agreed information layer for compliance purposes.

The Proceeds of Crime Act 2002 (POCA): This act can be used to prosecute individuals who use cryptoassets to launder money or finance terrorism.

The Financial Services and Markets Act 2023 (FSMA 2023): This introduces wide-ranging changes to the UK regulatory framework and further separates the UK from the EU financial services regime that it retained in the immediate aftermath of Brexit.

FSMA 2023 also permits a new Designated Activities Regime (DAR):
- Giving new rule-making powers to the FCA and also, novelly, to HM Treasury.
- The DAR allows for existing financial services regulation to be modified to accommodate new designated activities that are not considered to fit within FSMA 2000 and the UK Regulated Activities Order.
- The DAR will initially cover activities relating to financial markets exchanges, instruments, products and investments currently provided for in retained EU law.
- DAR is likely to be used for cryptoasset activities that cannot be put within existing (or suitably modified) financial promotion, payments, e-money, investment and other regulated activities.

Proposed UK Authorisation Regime for Cryptoasset Service Providers

The UK government is currently considering several proposals to strengthen the regulation of cryptoassets, including:

A licensing regime for cryptoasset firms: This would require all cryptoasset firms to obtain a license from the FCA:

“An amendment to the RAO power, Section 22(4) of FSMA, made through the FS&M Bill affirms the use of the RAO power for the financial services regulation of cryptoassets. This clarifies that persons (natural or legal) who are carrying out certain activities involving cryptoassets “by way of business” would be performing regulated activities and therefore require authorisation under Part 4A of FSMA. It would also mean that the FCA’s general rule making powers would be available, allowing the FCA to design regulatory regimes for newly added activities.”
UK: Calls for Evidence Cryptoassets & Stablecoins

(See Summary below)

The current intention is not to include all cryptoassets within the definition of ‘financial instruments’ for MiFID purposes (although they are treated as specified investments for financial promotion purposes). Instead, HM Treasury is expected to use the new DAR regime powers to regulate (or prohibit) certain cryptoasset activities where they do not fall within the existing financial services regulatory perimeter.

The FCA’s Perimeter Guidance for Cryptoassets (PS 19/22) sets out more detail on the different types of cryptoassets and their interactions with the existing financial services regulatory perimeter.

In a separate article, we will summarise the current state of play for the proposed Digital Pound by the Bank of England.

Summary following the UK Cryptoasset Consultation

Principles for Regulations

The new regulatory regime for cryptoassets will be based on the following principles:

Clarity: clear and easy to understand for both businesses and consumers.
Proportionality: proportionate to the risks posed by different types of cryptoassets.
Innovation friendly: it should be designed to support innovation in the cryptoasset sector.
Consumer protection: it should protect consumers from fraud and other risks.

The regulation of cryptoasset issuers

Cryptoasset issuers should be required to hold sufficient reserves to back their tokens.
Cryptoasset exchanges and service providers should be required to put in place appropriate systems and controls to mitigate the various risks.

The future of cryptoassets

The government believes that cryptoassets have the potential to offer several benefits, including:

Fast and cheap payments
Increased financial inclusion
Innovation in the financial sector

The government also recognises that there are risks associated with cryptoassets, including:

Fraud and scams
Price volatility
Lack of regulation

The role of the FCA

The Financial Conduct Authority (FCA) is the UK’s financial services regulator. The FCA is responsible for protecting consumers and promoting market integrity in the financial system.

The FCA has a number of powers to regulate cryptoassets, including:

Authorising cryptoasset exchanges and service providers as financial firms
Regulating cryptoasset service providers for AML and CTF purposes
Regulating the promotion of cryptoassets to consumers

The FCA, and HM Treasury with its new DAR powers, will therefore be in the driving seat for the UK as it seeks to regulate cryptoassets without stifling innovation. It will be interesting to see how HM Treasury use its new powers under DAR, and how it interacts with the FCA in the regulation of cyrptoassets.