Back in February, the House of Commons Treasury Committee (the “Committee”) opened an inquiry into crypto-assets that involved over fifty written submissions, three oral evidence sessions, and months of research. In the report, released in September, the Committee gave a sense of urgency to the need for regulation in the crypto-asset industry.
The report was titled ‘Crypto-Assets’, and it was a very deliberate choice by the Committee to depart from terms used in the past like ‘digital currencies’, ‘virtual currencies’ or ‘cryptocurrencies’ and refer to crypto-assets throughout the document. It took the view, based on the evidence it gathered, that no ‘cryptocurrencies’ currently fulfil all of the functions that define ‘currency’, namely, to serve as a store of value, a medium of exchange, and a unit of account. Rather, crypto-assets are currently held as a vehicle for speculation and making gains or losses on investment, putting them squarely in the ‘asset’ category. Referring to cryptocurrencies as crypto-assets seems to be gathering consensus with regulatory authorities in 2018, with the Bank of England making reference to the term in its submission to the Committee back in May, the FCA using the term in its June Dear CEO letter on ‘Cryptoassets and Financial Crime’, and the European Commission adopting it in its Fintech Action Plan released in March.
Aside from reviewing the role of crypto-assets, the Committee more broadly studied the potential for blockchain as a technology. As an alternative payments system, the Committee was sceptical as to blockchain’s capacity to handle the volumes of transactions necessary for it to become widely used. While supportive of efforts to explore blockchain’s applications in financial services and supply-chain management, it was careful to underline that blockchain was not a panacea to challenges in these industries, and “should not be pursued for its own sake.”
The bulk of the report, however, was reserved for the “particularly problematic” regulatory vacuum for crypto-assets. The Committee considered that the lack of inherent value in crypto-assets, the vulnerability of crypto-assets exchanges to hacks without appropriate systems to compensate investors in the case of losses, and the fact that ordinary investors erroneously invest in initial coin offerings (“ICOs”) expecting financial returns when they are only being promised future access to a service or utility, all underscore the extreme risk in dealing with crypto-assets and ICOs. Their lack of regulation exacerbates that risk, as otherwise illegal market manipulation can take place, and “clearly misleading” advertisements can be directed at ordinary investors. Because crypto-asset activities mainly fall outside its regulatory perimeter, the FCA has been limited to issuing consumer warnings on the topic, which the Committee has considered “a feeble corrective”. Aside from the consumer risks, the Committee also stressed the potential for money laundering and terrorist financing that comes with the anonymity and regulatory vacuum in crypto-asset exchanges.
In light of the risk that crypto-assets pose to consumers, the Committee concluded that the current response from regulators and the government, which is one of ambiguity, “is clearly not sustainable.” In its stead, the Committee advocated for making crypto-asset firms play by the same rules as everyone else in the financial industry. In practical terms, this means regulating crypto-assets as ‘specified investments’ under the FSMA Regulated Activities Order 2001 as amended (the “RAO”). As such, the Committee recommended that HM Government consider what crypto-asset related activity should fall under the RAO, but explicitly requested that this “include at a minimum the issuance of ICOs and the provision of crypto exchange services.” Regarding the money laundering and terrorist financing risks, the EU’s Fifth Money Laundering Directive will bring crypto-asset exchanges within the purview of AML/CTF obligations, but the United Kingdom currently faces the prospect of leaving the EU without a transition period in March 2019. If that were to come to pass, however, the Committee would still expect the government to transpose the relevant provisions of the Directive in UK law “as quickly as possible.”
Stakeholders should view this report and its forceful call for regulation of crypto-assets as a potential bellwether of the UK’s regulatory approach as a whole. As stated in its business plan for 2018/19, the FCA intends to publish a review of crypto-assets in collaboration with HM Treasury and the Bank of England very soon, in which it is expected to respond to the Committee’s recommendation that the activities performed by crypto-asset exchanges and ICO issuers be brought within its regulatory perimeter. If the FCA, HM Treasury and the Bank of England agree with the Committee’s report, the regulatory treatment of crypto-assets and related activities in the UK will potentially see monumental change in 2019. Crypto-asset exchanges, ICO issuers, custodian wallet providers, and other firms —whether authorised or not— that are offering services related to crypto-assets or to clients in the crypto industry should pay attention to the changing regulatory and legal landscape in the UK and around the world on this topic.