The FCA is becoming increasingly hands-on when it comes to cryptoasset regulation and one thing is clear, new rules are coming. Risk managers can expect a key update this summer when the regulator will report back on its consultation, which closed on the 4th April, which looked into how the sector should be regulated.

This is a hugely challenging area to police, but the government is also well aware that failing to take action – and indeed for a regulator to appear indecisive – will be damaging for the UK economy and for the financial services sector.

Coming of age
There is a clear need to try and improve transparency, deter financial crime and encourage investors to see the UK as a well-run and trusted marketplace. As lawyer Jill Lorimer of Kingsley Napley commented recently:

“Regulation is absolutely essential to the UK maintaining its position as one of the most attractive destinations for cryptoasset innovation. It will give investors much-needed comfort and help to attract more interest in the sector. In effect regulation will help  the crypto market to come of age.”

There are a number of important drivers. Firstly, the FCA is required to act by the government, which runs the Cryptoasset Taskforce, of which the regulator is a member.

Last October, the Taskforce produced a report outlining risks and potential benefits and a path towards regulation. Notably, it was also confirmed that the Treasury is to shortly publish a report that will cover “legislative change to potentially broaden the FCA’s regulatory remit to bring in further types of cryptoassets.” A further reason is the UK’s adoption of the 5th Anti-Money Laundering Directive by January 2020. By this date, all cryptocurrency exchanges that trade flat currency for cryptocurrency, must undertake customer due diligence and submit reports on any suspicious activity.

The UK needs to impose regulation or risks being left behind. In the US, the Securities and Exchange Commission has taken a strong stance, bringing sanctions against a number of exchanges, ICOs and individuals it had issues with. This included a $30,000 fine and lifetime ban for David T Lawrence, who attempted to raise funds fraudulently for a crypto coin called Tomahawk that could be converted to equity in oil exploration.

Overseas impetus
Meanwhile a number of countries such as Switzerland, Japan and Bahrain have also made announcements in recent months on introducing cryptoasset regulation. Canada also has a proposed regulatory framework following a countrywide scandal which caused losses of $137m, after the founder of Canada’s largest, but now defunct, crypto asset exchange, QuadrigaCX, died, taking the password of the cold wallet with him.

Although the EU is still feeling its way, the European Securities and Markets Authority has said it wants to see regulation to protect investors and that it supports a bespoke regime, but as yet, no timetable has been announced.

Yet, to coin a phrase, regulating cryptoassets is also akin to herding cats. Bitcoins, for example, have been in existence for over 10 years and no regulation has been forthcoming. Their reputation, along with other cryptoassets, has been tarnished by huge volatility affecting a range of investors and for being a preferred currency for criminals because of the lack of borders and anonymity provided through blockchain technology, which continues to advance. Europol, for instance, has estimated that in 2017 European criminals laundered some $5.5 billion worth of undeclared cash through cryptocurrencies. Many cryptocurrency exchanges conduct limited due diligence on customers.

Meanwhile, a US cyber security firm, CipherTrace, claimed that cryptocurrencies stolen from exchanges or scammed from investors leapt by some 400% in 2018 to $1.7 billion. The crypto sector is gaining momentum, even if it remains small in the UK. Widespread advertising for cryptoasset investment is commonplace and there is belief that there will be an upswing at some point in the near future.

Importantly, the consultation is expected to define whether cryptoassets are financial instruments as covered by the EU’s European Union’s Markets in Financial Instruments Directive II rule book, which the FCA enforces. It also needs to find solutions to issues around custody and to which firms will need to apply for regulation. These are difficult questions, but the pressure is on the FCA to find answers.