Back in 2013, Erik Voorhees, one of the foremost Bitcoin entrepreneurs, said in an interview that Bitcoin is "the Wild West of finance". The UK Treasury Committee would appear to agree, given the recommendations it has made in its report on 'Crypto-assets', which follows its inquiry into Digital Currencies and distributed ledger technology in the UK earlier this year.
In the Report, the Treasury Committee advises on the need for the introduction of regulation in the "Wild West" of crypto-assets. It believes that if the UK "develops an appropriate and proportionate regulatory environment for crypto-assets and if future innovations in crypto-assets proved themselves as beneficial to society and industry, the UK could be well placed to become a global centre for this activity…"
The Report focuses on the need for implementing regulation to address, at a minimum, two key areas: consumer protection and anti-money laundering.
Implementation of regulation
Over the past year, we have witnessed a trend towards regulatory and legislative engagement. Following a significant drop of the price of Bitcoin, the European Securities and Markets Authority, in conjunction with the European Banking Authority and the European Insurance and Occupational Pensions Authority, published a pan European warning on the risks of purchasing virtual currencies. Following this warning, regulation has started to gather pace, albeit slowly. In Gibraltar, for example, the Gibraltar Financial Services Commission (GFSC) established a Distributed Ledger Technology Regulatory Framework (DLT framework). The GFSC has designed regulatory principles for DLT businesses in its DLT framework, including (among others):
- Conducting business with honesty and integrity;
- Ensuring that all systems and security access protocols are maintained to appropriate high standards; and
- Having systems in place to prevent, detect and disclose financial crime risks such as money laundering and terrorist financing.
The Report stresses that the UK should "learn from those experiences of countries that have implemented regulation". To address the UK's lack of regulation quickly, rather than create a new regulatory framework bespoke to crypto assets, the Treasury Committee recommends doing this by extending the Regulated Activities Order (RAO) which would extend the scope of regulated activities for which the scope of FCA authorisation is required. It believes that this approach would quickly provide the Financial Conduct Authority (FCA) with the "necessary legal powers to execute its duties of protecting consumers and maintaining market integrity". This broadly follows the approach of CryptoUK, the first self-regulatory trade association for the UK cryptocurrency industry, which argued in written evidence to the Treasury Committee that "incorporating crypto-asset activity into the existing RAO was the “simplest” option for imposing regulation on crypto-assets".
What the Report does not detail, however, is how the RAO would be amended.
The main concern here is the FCA's inability to regulate misleading advertisements aimed at consumers (e.g. retail users and investors) for crypto-asset investing. As crypto-asset activities fall outside the FCA's regulatory perimeter, it is restricted in the actions it can take. The Treasury Committee hopes that by giving the FCA more power to control how the crypto industry (in particular, "crypto-exchanges and ICO issuers") markets its services, it could also help to protect investors more widely from issues such as fraud and hacking.
The Report suggests that there is an increasing risk of the use of crypto assets for money laundering and terrorist financing activities. As noted in our recent article on crypto-collectibles, in June 2018, the Fifth Anti-Money Laundering Directive (MLD5) was published. One of the aims of MLD5 is to increase transparency in newly developed payment methods, and thereby bring virtual currencies into the scope of European anti-money laundering regulation. The Treasury Committee emphasises the need for the UK Government to implement MLD5 in UK law "as quickly as possible", regardless of Brexit, and suggests that the FCA be the regulator to supervise anti-money laundering.
Crypto-asset exchanges and custodian wallet providers should consider the cost and time involved in the implementation of new regulation. We wait to receive further guidance to determine the extent of compliance changes.
What else does the Report cover?
The Report is broad and comprehensive and explores the advantages and limitations of blockchain and crypto-assets, the risk of crypto-assets in terms of areas such as price volatility, susceptibility to hacking, ICOs, money laundering. and risk to financial stability. The Treasury Committee states that in deciding the regulatory approach the UK Government and regulators should first "evaluate the risks of crypto-assets, and assess whether their growth in the UK should be encouraged". Next, if the UK Government decides that growth is to be encouraged, the Treasury Committee "believes that the introduction of regulation could lead to positive outcomes for the crypto-asset market".
What can we expect next?
As the Report notes, the "global regulatory response to crypto-assets is in its infancy". Over the next few months we may well see regulatory and legislative engagement transition from high-level statements and knowledge gathering, to concrete proposals, and most likely an increase in enforcement in this developing space.
If you have any queries or seek to find out whether or not your crypto-asset is regulated, contact a member of our crypto-currencies and blockchain team.
For the latest reported cases, regulatory announcements and corporate developments in the cryptocurrency sector, view our cryptocurrency case tracker.