Squire Patton Boggs | Paul Anderson

Introduction

In response to the question ‘What are cryptoassets?’, the principal UK regulator in the area, the Financial Conduct Authority (FCA) tells us that ‘Cryptoasset is a broad term and covers many different types of products. The most popular forms of cryptoassets include tokens like Bitcoin, Ether and Litecoin’. The Financial Services and Markets Act 2023 (27 June)1 includes this definition:

‘cryptoasset’ means any cryptographically secured digital representation of value or contractual rights that—(a) can be transferred, stored or traded electronically, and(b) that uses technology supporting the recording or storage of data (which may include distributed ledger technology).

It makes sense to start with what is in front of us; that is, the existing relevant law and regulation and then examining what is in front of us with major new proposals afoot in the UK. At the time of writing, since the enactment of the Financial Services and Markets 2023, the FCA, the Prudential Regulation Authority (PRA) and the Bank of England (BoE) have published their joint proposal for the development of cryptoassets regulations, with a regime divided into two workstreams: Phase I, which will include the regulation of fiat-backed stablecoins as a means of payment; and Phase II, which will centre around the UK’s regulatory approach for cryptoassets more generally. The intention is, however, to incorporate cryptoassets into the current legislation, instead of creating a separate regime for virtual currency.

Legal analysis of the nature of digital assets is also developing. In June 2023, the Law Commission published its final report on Digital Assets.2 The Law Commission plays a role in influencing how legislation may be implemented in the UK and the report is addressed to the House of Commons. The detailed legal analysis considered the legal categorisation of a digital asset and, while noting that English common law was very capable of recognising digital assets as things to which personal property rights can relate, The Law Commission suggested statutory intervention in this complex area would save court time and bring consistency. The recommendation looks like targeted statutory intervention to establish a new category of personal property distinct from a ‘thing in possession’ (e.g., a car), a ‘thing in action’ (e.g., a debt) so that it would be a third category thing, such as a crypto token. The report refers to this third category as ‘digital objects’. To fall within this third category, objects must comply with the following requirements:

  1. be composed of data represented in an electronic medium, including in the form of computer code, electronic, digital or analogue signals;
  2. exist independently of persons and of the legal system; and
  3. be rivalrous (i.e., use or consumption by one person necessarily prejudices the use or consumption of that thing by other persons).3

Cryptoassets in law and regulation

In legislation, we come across the definition of ‘cryptoasset’ in the Money Laundering, Terrorist Financing and Transfer of Funds (Information on the Payer) Regulations 2017 (MLRs) as ‘a cryptographically secured digital representation of value or contractual rights that uses a form of distributed ledger technology (DLT) and can be transferred, stored or traded electronically’. Similarly, other UK regulatory rules and guidance generally use the term cryptoasset (rather than virtual currency) and so, where we refer in this chapter to virtual currencies, this should be understood as a reference to all types of cryptoassets (as well as e-money tokens).

Similar to any regulatory regime, the regulation of cryptoassets has a perimeter. For cryptoassets, that regulatory perimeter has been somewhat blurred. Certainly, there are types of cryptoassets that are regulated, with the perimeter being determined through structure and the substantive characteristics of the asset. Those characteristics (falling into three broad categories identified by the FCA in its Guidance on Cryptoassets)4 determine the three following applicable regulatory frameworks:

  1. a security tokens: virtual currencies with characteristics that mean they provide rights and obligations akin to traditional instruments, such as shares, debentures or units in a collective investment scheme. Consequently, they fall into the UK regulatory perimeter as ‘specified investments’ under the Financial Services and Markets Act 2000 (FSMA);
  2. e-money tokens: virtual currencies meeting the definition of electronic money (or e-money) under the Electronic Money Regulations 2011 (EMRs). They also fall within the UK regulatory perimeter as specified investments under the FSMA; and
  3. unregulated tokens: virtual currencies that are neither security tokens nor e-money tokens. They are not specified investments under the FSMA and so fall outside the UK regulatory perimeter (save in relation to anti-money laundering related requirements). They include virtual currencies that are not issued or backed by any central authority and are intended and designed to be used directly as a means of exchange, which the FCA refers to as exchange tokens but are often called cryptocurrencies. Unregulated tokens also include ‘utility tokens’. Utility tokens could be securities under the FSMA if they both granted holders access to a current or prospective service or product and also exhibited features similar to security tokens as described above. Alternatively, they could be the same as or similar to reward-based crowdfunding with simple access to products or services (sometimes at a discount).

Since we wrote the sixth edition of this chapter, the most significant development in UK law and regulation has been the proposals put forward by the government. The HM Treasury (HMT) consultation ‘Future financial services regulatory regime for cryptoassets’5 (1 February 2023) and the subsequent response to the consultation published in October 2023 (referred to collectively in this chapter as the HMT Consultation), set out new proposals for the next phase of the UK government’s approach to regulating cryptoassets by building on previous HMT proposals that focused on stablecoins and the cryptoasset financial promotion. As noted above, HMT has proposed to incorporate cryptoassets regulation within the existing framework. The list of specified investments within the Financial Services and Markets Act 2000 (Regulated Activities) Order 2001 is expected to be expanded to include cryptoassets, and firms undertaking relevant activities concerning regulated cryptoassets will need to obtain authorisation and comply with the rules and standards under the FSMA. Although legislation is expected to be laid before parliament in 2024, no draft legislation has been published at the time of writing.6

The proposals seek to place the UK’s financial services sector at the forefront of cryptoasset technology and innovation and create the conditions for cryptoasset service providers to operate and grow in the UK. In terms of risk management, the government states that the proposed measures have been informed by recent market failures (e.g., FTX and BlockFi) reinforcing the case for effective regulation and sector engagement. Given that this remains in the consultation stage, we clearly differentiate proposals from the law in this chapter.

Becoming FCA regulated is a material undertaking for any firm conducting any type of regulated activities. If the experiences of those seeking registration under the MLRs is anything to go by, the FCA will likely impose a significant process of review, investigation and understanding before authorising firms under the new consultation proposals. We are some way from that. The BoE currently estimates that Phase I regulations regarding stablecoins will be implemented in 2025, so we can only expect that the broader cryptocurrency regime under Phase II will be implemented after this, in late 2025.Questions to consider when identifying potentially applicable regulatory regimes

The following questions may be helpful in determining how a particular cryptoasset might be regulated in the United Kingdom.

  1. Is the cryptoasset a type of transferable security or other type of regulated financial instrument or investment under the FSMA?
  2. Are the arrangements relating to the issuance of the cryptoasset such that they may create a collective investment scheme under Section 235 of the FSMA?
  3. Could the cryptoasset give rise to deposit-taking, the issuance of electronic money or the provision of a payment service under the FSMA, the Electronic Money Regulations 2011 or the Payment Services Regulations 2017?
  4. Could the issuance of a cryptoasset or the operation of an exchange for cryptoassets be regulated as crowdfunding under the FSMA?
  5. Would activities concerning cryptoassets fall within the scope of the UK anti-money laundering legal and regulatory regime (under the MLRs or otherwise)?
  6. Where does the cryptoasset sit in the new regime based on HMT consultation and the Financial Services and Markets Act 2023?

This article first appeared on Lexology. You can find the original version here.