The Future of UK Crypto Regulation – The FCA’s Cryptoasset Taskforce and recent events

With the enduring turmoil in crypto markets you could be forgiven to overlook important developments on the regulatory side of things. In whatever way the current turbulence evolves, chances are that Bitcoin nor the rest of the crypto industry is coming to an end. So, there is merit in keeping a cool head and follow what’s going on especially since these events combined with the market downturn will heavily influence the picture of the foreseeable future. The report of the FCA’s Taskforce that also looks at Cryptoasset regulation is one such event, but there is more happening and the tremendous losses in crypto value will also have a major impact, as we will see.

Bitcoin has dropped to $4,200, shedding almost 80% from its all time high close to $20k in December last year. Elsewhere,the situation for other cryptocurrencies is even more dramatic: A report by EY published recently concluded that almost 9 out of 10 the top ICOs of 2017 was below their listing price with 30% loosing practically all their value. And that doesn’t include all the other ICOs, fraudsters included, that left their investors empty handed. Meanwhile Bitcoin Cash, the most prominent of Bitcoin offspring that resulted from a fork in August 2017, finds itself in a battle of survival following the split last week into two cryptocurrencies, initially called “Bitcoin Cash ABC” and “Bitcoin Cash SV”, that caused it to loose two thirds of its value in the last two weeks alone. Dire times for the crypto community.

Still, Bitcoin and Cryptocurrencies are unlikely to disappear altogether. While it might be difficult to focus in such turbulent times, it is still important not to loose track of what’s going on elsewhere in the blockchain world and in particular in relation to the regulatory side of things.

For instance, the UK’s Financial Conduct Authority (FCA) recently published the findings of the Cryptoasset Taskforce, a working group established in March 2018 and led by HM Treasury and consisting as well of the Financial Conduct Authority and the Bank of England. In its paper “UK Digital Strategy”, the government has set out its ambition for the UK to be the world’s most innovative economy, and to maintain its position as one of the leading financial centres globally. No small feast to achieve and blockchain is part of this ambition. The taskforce therefore produced an overview of cryptoassets (which is used synonymously for cryptocurrencies like Bitcoin in the report) and the underlying technology. The report assessed the associated risks and potential benefits, and sets out the path forward with respect to regulation in the UK.

The report came to the conclusion that while cryptoassets are not widely used in the UK, they pose a range of risks, notably to consumers (who may face large losses), market integrity (due to manipulation and other market-abuse style strategies) and financial crime. While cryptoassets currently pose no material risks to financial stability, this may change in the future, a view also taken by a report on the same topic by the Financial Stability Board. As a result, the three authorities will launch a consultation early next year to address these risks appropriately. The consultation will focus on the following aspects:

  • implementing one of the most comprehensive responses globally to the use of cryptoassets for illicit activity
  • a potential prohibition of the sale to retail consumers of derivatives referencing certain types of cryptoassets (for example, exchange tokens)1, including CFDs, options, futures and transferable securities
  • guidance clarifying how certain cryptoassets already fall within the existing regulatory perimeter
  • whether the regulatory perimeter requires extension in relation to cryptoassets that have comparable features to specified investments but that fall outside the perimeter

With regard to the fight of financial crime and use of cryptoassets for illicit activity, the regulators can build on the existing framework and its upcoming amendments introduced by the Fifth EU AML Directive (5MLD) that will bring various aspects of the crypto industry within the scope of the wider system of financial regulation.

Early this week, the FCA’s Christopher Woolard, Executive Director of Strategy and Competition, touched on the potential prohibition of crypto derivatives during a speechat The Regulation of Cryptocurrencies event in London. Woolard said that the FCA was “concerned that retail consumers are being sold complex, volatile and often leveraged derivatives products based on exchange tokens with underlying market integrity issues. Given this, the FCA will also consult on a prohibition of the sale to retail consumers of derivatives referencing certain types of cryptoassets (for example, exchange tokens), including contracts-for-difference(CFDs), options, futures and transferable securities.” This references previous FCA action in line with a wider crackdown on CFDs like ESMA’s restrictions on the sale to retail consumers of CFDs referencing cryptoassets. This measure took effect on 1 August 2018 and was renewed on 1 November 2018. While this intervention is temporary and subject to renewal, European regulators are unlikely to open the gates again any time soon.

And this is where the current market downturn is particularly relevant: with many investors suffering losses either through cryptoassets directly or derivatives, the pressure mounts on the authorities to take action. This could come in the form of regulatory measures regarding crypto derivatives, a stronger crackdown on ICOs as well as the different players in the market like wallet providers and exchanges. It will most certainly move the crypto sector closer to the rest of the financial industry as many of these developments simply mirror aspect other parts of the world of finance.

The taskforce report promises also guidance clarifying how certain cryptoassets already fall within the existing regulatory perimeter including the consultation on how regulations can be extended to ICOs. This means that the FCA is likely to issue ICO specific regulations, which will channel the fundraising model into a specific structure. However, this could also increase the attractiveness of the FCA’s model for ICO fundraising in the UK similar to the jurisdiction’s success with different crowdfunding models and related regulations.

Most importantly, the authorities appreciate though that while the UK’s objective to be the world’s most innovative economy means to put itself in competition with other financial centres, the success of any regulatory measure for the crypto sector needs the collaboration between authorities and lawmakers around the globe and that a comprehensive response can only be achieved through engagement with international bodies and industry stakeholders alike.