Global regulators ramp up the rhetoric on cryptocurrency regulation
By Stephen Elam and Shelley Drenth
With the price of Bitcoin reaching record highs of over US$40,000 in early January, the profile of – and investor interest in – cryptoassets continues to increase. With this, the global regulatory landscape is swiftly evolving with recent calls for cryptocurrency to be subject to tightened rules and HM Treasury releasing an important new consultation.
There has been a flurry of political and regulatory engagement with cryptoassets in recent weeks. On 13 January, the European Central Bank President Christine Lagarde labelled Bitcoin as a “highly speculative asset”, which has been responsible for “totally reprehensible money laundering”, and called for regulation to be applied and agreed upon “at a global level”.  Across the pond, the SEC flexed its muscles in December by launching enforcement action against the blockchain payments company Ripple for raising capital of US$1.3 billion from offering allegedly unregulated securities, and the U.S. Treasury Department’s Financial Crimes Enforcement Network (“FinCEN”) floated a controversial regulation introducing data collection and reporting requirements for cryptocurrency exchanges – if enacted it would cut across some of the anonymity associated with cryptocurrency.
UK regulators have not stayed silent. On 11 January, the FCA issued a warning to consumers that they “should be prepared to lose all their money” if they invest in cryptoassets and will be left without redress if something goes wrong given the unregulated nature of many cryptoasset related activities. The FCA, whose statutory objectives include securing an appropriate degree of protection for consumers, is no doubt concerned about the increasing number of UK consumers who now purchase cryptocurrency, with 5.35% of consumers holding cryptocurrencies in 2019 compared to 3% in 2018 (described by the FCA as a “statistically significant” increase). It will no doubt be higher again in 2020. Despite the current bull run, cryptoassets are notoriously volatile, and consumers can quickly suffer losses as easily as they achieve gains. The FCA will be conscious of pressure to ensure that everyday consumers are adequately protected by regulation – particularly if market events result in significant losses for crypto investors.
The FCA has to date taken a relatively non-interventionist approach to cryptocurrency regulation, releasing guidance in July 2019 (PS19/22) that confirmed “exchange tokens” (e.g. Bitcoin) should be unregulated and fell outside of the ‘regulatory perimeter’; just like fine wine and art, the mere fact that some consumers might purchase cryptoassets speculatively with a view to realising profits did not mean that they were or should be regulated. The FCA opined that cryptoassets would only fall within the regulatory perimeter if they bestowed rights akin to the ‘specified investments’ already set out in the Regulated Activities Order (e.g. shares or debt instruments).
However, the impact of regulation on (unregulated) exchange tokens has been gradually increasing over time. The FCA’s recent warning coincided with two new significant regulations coming into force:
- The UK has now implemented the Fifth Anti-Money Laundering Directive, meaning that since 10 January 2021, firms carrying on certain “cryptoasset activities” (e.g. exchange providers) must – where they are operating such a business in the UK – be registered with the FCA under the AML/CTF regulations. Any firms operating past this date without a registration are potentially committing a criminal offence.
- On 6 January 2021, the FCA’s new rules came into force banning the sale, marketing and distribution to retail consumers of all crypto-derivatives. The FCA took this step on the basis that “retail consumers can’t reliably assess the value and risks” of these products, and that banning them would prevent up to £101 million worth of harm to retail investors per year.
With momentum building, HM Treasury published a consultation paper on 7 January 2021 that outlines further steps the Government proposes to take to further mitigate risks to consumers. The focus for now appears to be on “stablecoins”, a type of cryptocurrency whose value is pegged to other assets (often conventional assets: e.g. the US dollar or gold) in order to stabilise price volatility. HM Treasury has proposed the creation of a regulatory regime for stablecoins that are to be used as a means of payment, which will cover firms issuing stablecoins and/or providing services in relation to such coins.
For now, exchange tokens such as Bitcoin and Ethereum “could initially” remain unregulated for conduct and prudential purposes, with HM Treasury noting that although the retail investment use of these tokens raises potential issues, the public’s understanding of the risks involved in investing in this space is improving. Nevertheless, these otherwise “unregulated” tokens have increasingly being ‘touched’ by more stringent regulation under AML regimes and with the ban on cryptoasset derivative sales to retail clients. The Government has warned that it will take further action and bring new activities within the regulatory perimeter if necessary.
We expect 2021 to be a critical year for cryptocurrency as the sector inches closer to mainstream commerce and regulators continue to grapple with these issues.