The Bank of England made several proclamations on the UK’s fast-growing cryptocurrency market this week.
“It probably isn't a financial stability risk today but it has all the makings of something that could become one,” said Bank of England governor Andrew Bailey, adding that banks should be “especially cautious” about holding crypto assets while they remain unregulated.
With around 2.3 million people in the UK now owning cryptocurrencies, accounting for 0.1% of household wealth, deputy bank governor Sir Jon Cunliffe said it was time for institutions to “roll our sleeves up” to develop a regulatory framework to bring what is sometimes seen as a wild west market under control.
What is such a regulatory framework likely to involve?
Since the start of 2020, the Financial Conduct Authority (FCA) has been supervising crypto-asset businesses for anti-money laundering purposes.
Earlier this year, the UK tax office published a crypto assets manual for individuals and businesses providing more clarity for honest players (individuals are taxed on the profits made from the sale of crypto assets under Capital Gains Tax).
It also set out definitions of cryptocurrencies, which it does not categorise as money. It put them into four categories:
Exchange tokens (Used as a means of payment)
Utility tokens (Used to pay for goods or services on a specific platform)
Security tokens (Showing rights over a business or venture)
Stablecoins (Cryptocurrencies that are less volatile as they are pegged to assets such as fiat currencies or gold)
These definitions are likely to be key to any future regulatory framework in the UK.
Regulatory involvement in the crypto sphere has also targeted the sale of derivatives and exchange-traded notes (EFTs) for crypto assets, which were banned in January 2021.
Meanwhile, the FCA has required companies to put disclaimer banners on their websites and advertisements and has repeatedly called for a crackdown on advertising around crypto assets, both by regulators and by the social media and other internet platforms that often host them.
The Advertising Standards Authority (ASA) this week banned several such ads for “irresponsibly taking advantage of consumers’ inexperience and for failing to illustrate the risk of the investment”.
These regulations are likely to be strengthened in the near future – the ASA has more ads and companies under investigation and says it is working to publish detailed guidance on standards, which will also cover non-fungible tokens or NFTs.
The FCA has further said it expects to get more powers to oversee crypto promotions, potentially before the end of the year. This may include adverts needing to be approved by an authorised firm and the potential to dish out fines for breaches of standards, as other financial products governed by the FCA are normally subject to.
Not your normal companies
One issue with regulating the crypto market lies in the structure of some of the biggest players.
“The main challenge for regulators when dealing with cryptocurrency companies has to do with their lack of traditional reliance on physical locations, centrally located executive teams, and fully present workforces,” John Sarson, chief executive of Sarson Funds, told Capital.com.
“We all understand the challenge facing regulators when they want to send a legal communiqué to a crypto company that lacks a physical mailing address.
“What’s maybe less obvious is that it is nearly impossible to identify potential ethical conflicts and to monitor for inappropriate employee behaviour when a company’s beneficial owners are undisclosed and its workforce is scattered across the globe with only their Ethereum wallets as the durable identifier that alleged employment may or may not have taken place,” he added.
The UK has already come up against this.
Earlier this year the FCA said that although Binance, the world’s biggest cryptocurrency exchange, had complied with requirements such as displaying warning messages on its website, it was “not capable of being effectively supervised” because of opacity around how its business and group are organised and the routes for UK companies to purchase products.
That was after Binance announced in July that it wanted to place a greater focus on compliance, collaborate with regulators and law enforcement, and also set its own standards on areas like insider trading, consumer education and protection of user assets.
The news led to a growing number of crypto asset firms abandoning attempts to register with the FCA at all – a deadlock still without a solution.
In January, the government launched a review into whether stablecoins, which are pegged to an asset such as the dollar to keep their price steady, should be brought into the UK regulatory perimeter while crypto assets that are primarily used for speculative investing remain outside of it for now.
It said it believes stablecoins could allow for faster, cheaper payments and make it easier for people to store money without the volatility of other crypto assets.
According to a report from London law firm Shearman & Sterling, regulation, in this case, could require firms involved in stable token issuance, transactions, administration and more to be authorised and submit to requirements to protect consumers and ensure financial stability in the event of insolvency or other failures.
This would be overseen by the Payment Systems Regulator (PSR) until it reached a “systemic scale”, at which point the Bank would take over.
But challenges remain here too.
As the Shearman & Sterling report points out, “A key aspect is the consideration of location requirements for firms engaged in the marketing of stable tokens in the UK. Any location requirement would be a departure from the current regulatory approach and could possibly be detrimental to the UK’s open and agile markets policy.”
Many countries are grappling with how to balance regulation and consumer protection with fostering innovation and the potentially lucrative benefits crypto firms could bring.
The current landscape is different the world over, but according to John Sarson, “to date, no G20 country has figured out how to effectively tame cryptocurrency”.
The US is having many similar discussions with the UK, with regulators frequently speaking on the need to create a stronger framework around crypto (a review is also being conducted into stablecoins).
The EU has proposed and is weighing up creating a specially dedicated regime for crypto companies that would allow only licensed providers to operate crypto exchanges and offer cryptocurrencies within the bloc.
A recent inquiry in Australia called for numerous reforms to a regulatory framework it said was “not fit for purpose.”
These included establishing a market licensing regime for digital currency exchanges; establishing a custody or depository regime for digital assets; updating and recognising Decentralised Autonomous Organisation (DAO) company structures, organisations that make decisions based on automation and smart contracts and which are common in the decentralised finance world. Many of the measures will be consulted on next year.
Then there are countries like China and Egypt which have taken the extreme step of outlawing all cryptocurrency mining and cryptocurrency transactions.
While there are evidently some conflicts of interest at play between crypto businesses and regulators, many also say they welcome regulatory clarity, if it doesn’t stifle innovation and growth in their eyes (and that’s a big ‘if’).
“Regulation is a vote of confidence that this is a respected asset class that can be an important contribution to global financial markets,” said Sukhi Jutla, co-founder and chief operating officer at blockchain-based online marketplace MarketOrders.
“It would be welcomed by many players in the crypto world because this will give more confidence to people to invest in companies building crypto startups and for people who want to invest in crypto assets. At the moment there are still so many scammers in this field which is what deters investors from entering this market coupled with the volatility.”
John Sarson agreed.
“We and many other firms in the cryptocurrency space embrace thoughtful regulation and the consumer protections that come along with it... with an emphasis on thoughtful regulation,” he said.
“Until lawmakers understand what’s happening in cryptocurrency, they will not able to regulate it effectively.”