11 Aug 2022

Cryptoassets and the campaign of UK regulators

Although it may not have arrived with any fanfare, UK regulation of the cryptoasset industry began some time ago. In January 2020 UK cryptoasset businesses became obliged to register with the FCA for the purposes of the Money Laundering Regulations, thus putting them on the path to a level playing field with banks and other financial services institutions with regard to AML obligations.

FCA moves towards active policing

However, it is only since 1 April 2022, on expiry of the Temporary Registration Regime, that the FCA will be expected to start actively policing AML compliance amongst UK cryptoasset businesses. This may come as a relief to UK banks and other financial services providers, who until now have been the main line of defence against cryptoassets being used to launder money within the UK.

Similarly, the proposed expansion of the promotions regime to include cryptoassets will see the FCA moving away from simply warning consumers that investments directly into cryptocurrency are not regulated or protected, to actively policing whether cryptoasset promotions are authorised (or approved by an authorised person), and ensuring that those promotions are fair, clear and not misleading. All of this is likely to result in a fairly immediate (i.e. within the next 12 months) uptick in FCA action on cryptoasset AML and promotions enforcement. If not, the FCA will be expected to explain why.

The Bank of England Financial Policy Committee position (as published on 24 March 2022) is that, whilst cryptoassets and Decentralised Finance (De-Fi) do not currently pose a major threat to UK financial stability, that may change if they continue to develop at the pace we have seen over the last 10 years. As such, new regulatory and law enforcement (including and especially financial crime) frameworks will be needed. The Financial Policy Committee takes the view that, where cryptoassets serve the same economic function as other assets, they should be brought within the same existing legal frameworks. In other words, whilst crypto may be an entirely new asset class, it does not require an entirely new approach to regulation or financial crime prevention – and indeed such a segregated approach would probably be undesirable, if not unworkable.

Global hub for cryptoassets

The subsequent declaration by the Chancellor, Rishi Sunak that he wants the UK to become a ‘global hub’ for cryptoassets, and that the Treasury plans to regulate stablecoins (i.e. those pegged to and backed by a fiat currency or other external asset) in the near future gives some indication of how the UK authorities plan to address the challenge.

As well as creating economic opportunities within the UK, these plans indicate an intent to encourage a regulated form of cryptocurrency investment over which much greater control can be exercised than the current global crypto market. The hope will be to steer UK investors away from those assets and service providers which pose a financial crime risk, whether through fraud and theft or through money-laundering and circumventing sanctions, and towards those that can be more closely supervised and monitored.

Regulators and Governments across the world grappling with cryptocurrency regulation are facing a quandary akin to drug policy in the 20th century. Having conceded that the problem is not going away, the spectrum of possible responses runs from absolute prohibition (as is currently China’s approach to crypto) to absolute permission (as is the de facto position in many jurisdictions, although unlikely for much longer), to compromise strategies like those being tabled in the UK.

Such compromise strategies aim to minimise harm to both investors and society (whether through economic instability or financial crime risk) by creating a regulated ‘safe space’ in which the demand can be satisfied, and by doing so freezing out (or at least minimising the influence of) those outside that perimeter, whilst also ensuring some of the economic growth and tax benefit flow towards state coffers.

Incidentally, Mr Sunak’s choice of words in promising a ‘global hub’ for cryptocurrency in the UK is an interesting one. It was only in February 2022 that Transparency International used exactly the same term to describe the UK’s role as a centre for international money laundering, particularly for suspect Russian wealth.

A line in the sand

What is likely to happen, or so the UK authorities hope, is that the proposed changes draw a prominent line in the sand between cryptoassets services providers who are and who are not regulated in the UK.

As well as encouraging financial crime compliance overall, the intent will be to steer consumers and investors towards those cryptoassets regarded as less risky to the UK’s financial systems and of greater economic benefit (i.e. asset-backed stablecoins, which are much less volatile and much more suited to being used as means of payment) and away from those cryptoassets regarded as more risky and volatile (i.e. ‘freestanding’ cryptocurrencies such as Bitcoin and Ethereum), which are used more as investment assets than means of payment and (most critically) are likely to result in speculation bubbles.

UK regulation will always be limited by its jurisdictional reach and so, short of state intervention to block offending internet traffic, offshore cryptoasset businesses will still be able to reach UK investors. However, the challenges facing them under the proposed new regime will be several.

Firstly, their clients will find it increasingly difficult to negotiate the ‘on and off ramps’ of UK financial institutions who will still act as the gatekeepers between crypto and the mainstream economy. In particular, once there is a regulated UK framework for cryptoassets, financial institutions (and the agencies to which they submit Suspicious Activity Reports) are likely to have a heightened suspicion towards those seeking to use unregulated offshore service providers to deal in unregulated assets, when there are regulated UK alternatives available (notwithstanding that not all cryptoassets are created equal or used for the same purpose, particularly when comparing stablecoins with ‘freestanding’ cryptocurrencies).

Similarly, those offshore providers will have very limited channels through which they can promote their services to UK clients, whilst those within the UK promotions regime will have access to a much wider market, and the ability to market their offering as a mainstream product in a way that crypto has not yet been able to achieve. As such, the picture for financial crime and regulatory enforcement in the UK is that, for those who are willing to play the game on the same terms as the established financial services industry, there is a cautious welcome and opportunities on offer. However, for those unwilling or unable to join, life is likely to become a lot more difficult, at least with regard to UK investors.

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