The UK Treasury today launched a consultation into cryptocurrency regulation that could prove highly influential for the burgeoning industry.
Coming off the back of a disastrous year for the crypto markets, crypto regulation has become even more of a hot-button topic than ever.
Trillions of dollars were wiped from the markets in 2022, leading to large-scale bankruptcies and mass firings, yet the debate still rages as to how to regulate the market. Or if it even can be in the first place.
So what does the UK government propose? Let’s dive in.
The question of securities
Within the call for evidence, the UK government weighed in on the debate surrounding how and when securities law should be applied to cryptocurrencies.
“Within traditional financial services the closest parallel to the creation, issuance and distribution of cryptoassets probably exists in the securities markets,” said the report.
It continued: “For cryptoasset issuance and disclosures, the government proposes to follow a similar approach to that for securities and apply regulation when the asset is admitted to trading on a regulated cryptoasset trading venue.”
Canonisation of this viewpoint would have huge implications for the issuance of cryptocurrencies, since per UK law, issuing securities without an approved prospectus is a criminal offence under the Companies Act 2006.
Gone would be the days of issuing tokens to the public without adhering to burdensome disclosure requirements to prospective investors.
While that would help to restrict fraudulent activity from bad-faith actors seeking quick profits through ‘pump and dump’ and other scam-like actions, it could also provide a significant cost hurdle for genuine start-up cryptocurrency ventures.
Comments from economic secretary to the treasury Andrew Griffith alluded to this dichotomy: “We remain steadfast in our commitment to grow the economy and enable technological change and innovation – and this includes cryptoasset technology.
“But we must also protect consumers who are embracing this new technology – ensuring robust, transparent, and fair standards.”
Who gets the better end of the bargain will be determined over the course of the consultation, which is open until April 30, 2023.
A compensation blind spot
Investor protections and compensation practically do not exist in the crypto markets, and it could potentially stay that way given certain statements.
Per the report: “Regarding investor protections, whilst it is not the government’s intention for Financial Services Compensation Scheme (FSCS) protections to apply to investor losses arising from cryptoasset exposures, it is the responsibility of the Prudential Regulation Authority and Financial Conduct Authority as the UK’s independent financial regulators to set the limits of FSCS protection in respect of regulated activities carried out by authorised firms.”
In short, financial compensation when a crypto bank or exchange goes belly up, as was commonplace throughout 2022, is unlikely to come any time soon.
The DeFi issue
The UK government appears to be cognizant of the issues it will face in regulating the decentralised finance (DeFi) market due to the lack of any real form of centralised intermediary throughout the DeFi value chain.
Since DeFi protocols are open sourced and borderless by their very nature, “typical systems of financial services regulation – which usually rely on the authorisation and supervision of individuals and firms undertaking specified activities – may be difficult to apply,” said the consultation.
“Some parts of the value chain may not be practical to regulate, for example, the underlying protocol if that has become truly open sourced and decentralised over time,” it added.
The consultation suggested an international approach to DeFi regulation without delving into greater detail.
Proposals have been put forward to bring stablecoins, or what the government calls ‘digital settlement assets (DSAs)’ into the “regulatory perimeter for systemic payment systems and service providers”. This would bring stablecoins such as Tether and USD Coin under the remit of the Bank of England.
The Financial Conduct Authority regime would also apply to fiat-backed stablecoins, which is to be defined in the statutory instrument expected to be laid in the first half of 2023.
“Ultimately, only time will tell whether the measures balance the drive for innovation and the oft-trumpeted growth agenda against the clear need to mitigate risks of consumer harm and financial stability, stated Albert Weatherill, financial services partner at Norton Rose Fulbright.
Weatherill also pointed out that the UK’s approach appears to be using an existing legal frame whereas across the channel in the European Union, lawmakers are poised to vote on an entirely bespoke regulatory regime under the Markets in Crypto-assets Act.
According to Nigel Green chief executive of financial consultancy deVere Group: “A strong regulatory framework will help protect investors, tackle criminality, and reduce the potential possibility of disrupting financial stability” while also offering a “potential long-term economic boost to the UK as digital is the inevitable future of finance”.
deVere Group recently released a study showing that 82% of high-net-worth clients with between £1mln and £5mln of investable assets sought investment advice on cryptocurrencies.
“Wealthy investors, a typically conservative cohort, also understand that digital currencies are the future of money, and they don’t want to be left in the past,” Green said.
Stricter regulation was inevitable in the wake of the FTX scandal, said Laith Khalaf, head of investment analysis at AJ Bell.
Khalaf warned that “the proposed regulations are not a silver bullet that will guarantee absolutely no consumer harm stems from the crypto industry”, though he did agree that they would provide a “more robust regulatory framework that is several steps closer to that applied to more mainstream financial activities”.
“It’s notable that the government is not by any means shutting the door to crypto, and is keen to encourage technological innovation, but within prescribed regulatory boundaries,” Khalaf added.