The Financial Conduct Authority (FCA) differentiates between regulated and unregulated tokens.
- Regulated tokens: security tokens and e-money tokens are examples of cryptoassets which are regulated by the FCA for money-laundering purposes.
- Unregulated tokens: exchange tokens and non-fungible tokens (NFTs) are not currently regulated by the FCA.
In March 2018 a UK cryptoasset taskforce was announced with the objective of bringing the Treasury, the Bank of England and the FCA together to assess the potential impact of cryptoassets and Distributed Ledger Technology (DLTs) in the UK and to provide appropriate policy responses. DLTs are defined here.
From 10 January 2020 the FCA became the Anti Money Laundering and Countering Terrorist Financing (AML/CTF) supervisor for firms carrying on certain cryptoasset activity. This provided the FCA with new regulatory powers to supervise cryptoasset businesses with regard to AML/CTF.
The AML/CTF regime aims to ensure that businesses carrying on in-scope cryptoasset activity can spot, disrupt or stop money being laundered through the system.
The FCA warns that in the event that something goes wrong with cryptoassets, it is unlikely that the Financial Ombudsman Service (FOS) or the Financial Services Compensation Scheme (FSCS) can assist.
As a result of the FCA’s new regulatory powers, cryptoasset businesses in the UK must comply with the Money Laundering Regulations (MLRs) and register with the FCA. Applications must have been submitted by 15 December 2020 for businesses to take advantage of the Temporary Registration Regime (TRR).
Cryptoasset businesses must also have filed annual reports on their trading activities by 30 March 2022 (and annually thereafter).
This information will be used by the FCA to determine the potential risk of financial crime and target supervisory resources in areas identified as the greatest risk.
The Government is analysing feedback on a consultation paper that ran until October 2021 as to whether it should be a requirement for cryptocurrency exchanges and digital wallet providers to record information on the transfer of cryptoassets of over £1,000 or the equivalent cryptocurrency value.
Stablecoin is any cryptocurrency designed to have a relatively stable price, typically through being pegged (tied to) a commodity or currency or having its supply regulated by an algorithm.
On 4 April 2022 HM Treasury published its ‘Response to the Consultation and Call for Evidence on the regulatory approach to cryptoassets and Stablecoins’.
The Government’s intention is to adopt an amended framework that places emphasis on Stablecoin issuance, and the provision of wallets and custody services.
There will be a requirement for issuers of Stablecoins referring to fiat currencies to seek authorisation from the FCA. Regulators will increasingly require authorised firms to comply with their high-level standards in relation to the firm’s unregulated activities.
The compliance requirements will be extensive, and include prudential requirements in relation to maintenance and management of reserves, safeguarding, and systems and controls.
The European Commission’s Markets in Cryptoassets regulation proposal (MiCA)
On 30 June 2022 representatives from the European Parliament and EU states signed an agreement containing measures to guard against market abuse and manipulation, which requires that crypto firms provide details of the environmental impact of their assets.
The European Parliament’s ‘Markets In Cryptoassets’ (MiCA) law is expected to come into force at the end of 2023.
MiCA will be “the world’s first comprehensive regime for cryptoassets and will contain strong measures to guard against market abuse and manipulation”. MiCA is expected to set a benchmark for other regulatory regimes globally.
Global developments in the regulation of digital assets
The past year has seen a great deal of activity in the field of digital asset regulation.
In October 2021 the Financial Action Task Force (FATF) released its Update Guidance regarding Virtual Assets (VAs) and Virtual Asset Service Providers (VASPs), making clear that VAs and VASPs are subject to the full range of AML/KYC requirements.
On 9 March 2022 President Biden released an Executive Order (EO) on Ensuring Responsible Development of Digital Assets. The focus of the EO was the protection of consumers, investors and businesses.
In March 2022 the Organization for Economic Co-operation and Development (OECD), a 38 member country organization, released a new public consultation document concerning a new global tax transparency framework to provide for the reporting and exchange of information with respect to crypto-assets, as well as proposed amendments to the Common Reporting Standard (CRS) for the automatic exchange of financial account information between countries.
Under CARF, participating countries will now have to seek to collect and report KYC and AML information (including name, address, date of birth, relevant tax identification number, etc.) on entities and their Ultimate Beneficial Owners, as well as information on all transactions involving digital assets.
The US Securities and Exchange Commission (SEC) has been active in enforcing existing securities regulations with respect to digital assets. They are currently engaged in a court battle with Ripple Labs, the creators of currency exchange Ripple, over whether the XRP cryptocurrency issued on the exchange is a ‘security’. The SEC sued Ripple Labs in December 2020 for selling the XRP tokens, which the SEC classified as ‘unregistered securities’. The outcome of this case is likely to have far-reaching consequences for the future of digital asset regulation.
The Law Commission and digital assets
The Law Commission has been asked by the Government to make recommendations for reform to ensure that the law is capable of accommodating both cryptoassets and other digital assets.
The Commission will consider whether digital assets should be “possessable”, which could have significant consequences for the functioning and development of the market.
The Commission published its call for evidence on digital assets on 30 April 2021 and an interim update paper on 24 November 2021. The consultation paper is currently due to be published in mid-2022.
Researchers at Trail of Bits, a cybersecurity firm based in New York, have found that there are 'unintended centralities' in blockchains that can make them vulnerable to corruption and potentially stolen funds. The report claims that blockchains are not as decentralised as they are currently believed to be.
The report highlights concerns that a lack of true decentralisation could lead to manipulation of digital currencies by people, corporations or even governments.
The report found that 60% of Bitcoin traffic in the past five years has been handled by just three internet service providers (ISPs), leaving those ISPs the power to theoretically prevent the transfer and sale of certain cryptocurrency.
Cryptoassets and financial crime
In 2021 the amount of cryptoassets sent to addresses with known criminal associations increased to a record $14 billion (more than doubling from 2020). However, the overall growth of digital market assets has outstripped the rise in scams.
The director of research at Chainalysis, a blockchain analysis firm, suggested that crime is becoming a smaller and smaller part of the cryptocurrency ecosystem. It is believed that regulators and law enforcements have become better at tackling crimes involving cryptocurrencies.
However, regulators are continuously playing catch-up with new markets and the opportunities these create for financial crime.
Fighting financial crime
While there are many new types of cryptoassets, exchanges and tools being developed that override fraud prevention techniques (e.g. by enhancing anonymity), there are also innovative technological approaches being developed by cryptoasset firms that are applicable to financial crime controls.
Solutions based on blockchain can be used to ensure compliance with Know-Your-Customer (KYC) regulations. This would allow financial institutions to hold data from multiple authorities into one single secure, validated and immutable database. This has the potential to be more efficient than traditional methods, reducing costs. Financial institutions spend an average of $60 million per year on KYC and customer due diligence.
IBM completed a successful proof-of-concept of its ‘Shared Corporate Know-Your-Customer’ with Deutsche Bank, HSBC, Mitsubishi UFJ Financial Group and Cargill.
Positive aspects of cryptoassets
More generally, the use of cryptoassets has many benefits, including:
- lower transaction costs as compared to real currency transfers
- transparency of costs and charges, as hidden costs and additional charges which are common in transactions of other online payment modes are absent in Bitcoin transactions
- they provide a faster and more efficient processing of payments
- virtual currencies are not issued by a state or government and, therefore, have the potential to be global in scope without suffering at the hands of the monetary policy of national governments