What’s next for UK cryptoassets regulation?

The UK continues to take purposeful steps towards regulating the cryptoassets sector, focusing especially on protecting consumers and tackling financial crime.

Notably, the Financial Conduct Authority (FCA) has implemented various key measures, including:

• imposing money laundering regulations on cryptoasset exchange and custodian wallet providers
• banning the sale of cryptoassets-backed Exchange Traded Notes (cETNs) and crypto derivatives to retail consumers
• extending financial promotion restrictions to most cryptoassets.

Positive sentiment returns but underlying risks persist

Since the collapse in November 2022 of global cryptocurrency exchange FTX with a reported $9 billion shortfall, the cryptocurrency market has recently undergone a much-needed resurgence in confidence. At the time of writing, Bitcoin had reached an all-time high of $70,000.

This confidence has been fuelled by the participation or association of major financial institutions, such as BlackRock and Fidelity, including through the launch of Bitcoin exchange-traded funds (ETFs). This follows approval by the US Securities and Exchange Commission (SEC) of spot Bitcoin ETFs in January 2024.

While this market continues to move at pace, UK regulation is progressing under a more gradual, phased approach to include various forms of cryptoassets. The intention is to implement a more expansive, comprehensive regulatory regime, underpinned by the Government’s legislative plans.

In doing so, UK regulators must try to strike the right balance between consumer protection and promoting responsible innovation and competition. However, recent events (particularly in the US) have reinforced regulators’ firmly held views of the key risks associated with cryptoassets including:

• sudden, significant and unexpected losses
• firm failure
• deficiencies in governance, risk management and operational resilience
• financial crime
• co-mingling of client and own funds
• propensity for cyber-attacks.

Limited existing UK regulation

For now, cryptoassets are largely unregulated in the UK. Only a few cryptoasset activities have needed authorisation under the Financial Services and Markets Act 2000 (FSMA). This applies to cryptoassets that act like traditional investments falling under the definition of 'specified investments'.

This includes security tokens, such as shares or debt instruments, or units in a collective investment scheme using tokens to represent investors’ interests. However, defining the regulatory perimeter has been challenging and prone to a high degree of interpretation.

Last year, the FCA introduced new financial promotion rules around the marketing of cryptoassets in the UK (applicable to all firms regardless of whether they are based overseas or what technology is used to make the promotion). In effect, promotions must be communicated or approved by an FCA-authorised firm. There are strict rules stating that all promotions must be fair, clear and not misleading, with prominent risk warnings. The FCA has been vigilant and clearly busy in enforcing these rules, issuing hundreds of warnings and stopping unauthorised promotions within a month of the restriction.

Next stages in UK crypto regulation

As the UK moves forward to design and implement a phased regulatory regime, the FCA has published a discussion paper DP23/4. This covers the proposed approach to regulating fiat-backed stablecoins, recognising their potential for widespread adoption including to facilitate trading, lending and borrowing of cryptoassets.

Stablecoins are designed to maintain a steady value by being connected to fiat currency, offering a less volatile option compared to cryptoassets. They commonly operate through centralised entities and are traded on centralised exchanges.

In contrast, decentralisation – a commonly perceived feature of cryptocurrencies – raises regulatory concerns because it puts significant responsibility on individuals to protect their assets. The risk of people losing access to their digital wealth due to forgotten passwords or lost hardware remains a challenge for decentralisation and may strengthen the appeal of stablecoins.

Through our membership bodies and relationship with the FCA, we have contributed to DP23/4 covering the proposed regulation of stablecoins. We are supportive of the proposals, including the core principle of ‘same risk, same regulatory outcome’ – subject to the essential tailoring of rules to consider the unique characteristics and risks associated with cryptoassets.

Meanwhile, as part of its 2024/25 business plan, the FCA has confirmed its proposal for a bespoke market abuse regime for cryptoassets. The FCA has also issued revamped guidance on financial promotions on social media covering crypto ads, which includes attempts to tighten up on the role of so-called ‘finfluencers’. High-profile celebrity endorsements of crypto investments has been a notable trend.

Marked difference in approach to the EU

In comparison to the EU's Markets in Cryptoassets Regulation (MiCAR), the UK's approach is more gradual, initially focusing on stablecoins. MiCAR, due to take effect in 2024, aims to comprehensively regulate the crypto industry across the EU, covering various types of cryptoassets from the start, including stablecoins.

There are notable differences between MiCAR and the UK's regulatory plans, such as categorisation of cryptoassets, the scope of regulated activities and disclosure obligations for cryptoasset issuers. And so, regulatory divergence is an additional challenge for this global and highly interconnected market.

Next steps for financial services firms

While there's much still to work through, crypto regulation continues to take shape and will be one to watch through 2024 and beyond.

Firms should monitor developments closely and take appropriate steps to prepare for the emerging regulatory landscape.

For more insight and guidance, contact Paul Staples.