Treasury consults on crypto regulation

Treasury has published its long-awaited consultation on its plans to regulate cryptoasset activities in the UK.

The consultation, which also includes a call for evidence and is accompanied by Treasury’s response to how to address promotions for crypto services, says the Government wants to take a proportionate approach to regulation of the sector which will both protect consumers and encourage innovation – and will consult using the overarching principles of “same risk, same regulatory outcome”, “proportionate and focused” and “agile and flexible”.  It proposes a phased approach to regulation. In principle, it believes that cryptoassets and the activities that underpin their use should follow the standards expected of other similar financial services activities. The consultation focuses on the future regulatory regime for cryptoassets used within financial services, rather than the wider application of DLT in financial services or the use of crypto outside the sector.

The consultation addresses:

  • a definition of “cryptoasset”: noting the deliberately broad definition in the current draft of the FSM Bill, which is similar to the MLR definition but references a wider range of underlying technology. It is intended also broadly to align with EU and FATF standards, and the FSM Bill contains a power to amend the definition by secondary legislation;
  • the intention to bring “cryptoasset” within the list of specified investments in the RAO, such that any person carrying out certain activities involving cryptoassets “by way of business” will need authorisation – which will be by FCA and FCA will have power to design an appropriate regulatory regime;
  • Treasury’s decision not to expand the RAO definition of “specified investment” to include cryptoassets but rather to put in place equivalent or similar safeguards where cryptoassets present similar risks to financial instruments (although some types of cryptoasset already meet the definition, and will continue to – specifically security tokens and also some crypto derivatives), or may be e-money;
  •  the fact that all activities that are currently within the MLR registration requirement will fall within the FSMA requirements;
  • that supporting legislation (to be laid imminently) will extent the financial promotions perimeter to cover crypto asset promotions;
  • a phased approach, which will first address “Digital Settlement Assets” (that is, fiat-backed stablecoins used for payment), and then move onto wider activities;
  • the need to capture relevant activities carried on both in and into the UK – so would catch any activities of overseas firms provided to UK persons whether natural or legal. This is seen as critical for consumer protection and so as not to create an unlevel playing field for UK-based providers. There may be exceptions to this, such as a potential exception for “reverse solicitation”, and FCA will need to consider whether overseas firms will be required to have a physical presence in the UK. Firms that operate crypto trading venues would be likely to have to have a UK incorporated entity through which to trade;
  • an initial indicative proposed list of activities – showing the intention to regulate activities rather than actual assets:
    • issuance and redemption of a fiat-backed stablecoin
    • admitting a cryptoasset to a cryptoasset trading venue
    • making a public offer of a cryptoasset
    • payment activities such as execution of payment transactions or remittances involving fiat-backed stablecoins
    • exchange activities involving operating cryptoasset trading venues supporting exchange of cryptoassets for other crypto, fiat currency, other assets and post trade activities;
    • investment and risk management activities such as dealing in cryptoassets as principal or agent, arranging or making arrangements in relation to transactions in cryptoassets, advising on cryptoassets and managing cryptoassets
    • operating a cryptoasset lending platform
    • safeguarding and/or administration services for fiat-backed stablecoins and other cryptoassets and
    • validation and governance activities – mining or validating transactions, operating a node on a blockchain or using cryptoassets to run a validator node infrastructure on a proof-of-stake network
  • treating “non-algorithmic stablecoins” in the same way as unbacked cryptoassets;
  • including NFTs and utility tokens within the scope of regulation only where they meet the relevant definitions;
  • creating an issuance and disclosure regime for cryptoassets based on the UK prospectus regime;
  • establishing a regulatory framework for trading based on the RAO activities of regulated trading venues including MTFs;
  • in principle, using MiFID-derived rules as the basis for the “intermediation” regime and the custody regime; and
  • applying a market abuse regime broadly based on MAR.

The consultation also calls for evidence on Decentralised Finance (DeFi) – financial services offered without the use of traditional financial intermediaries. There has been a noticeable increase in use of these in the cryptoasset financial services markets, and Treasury is seeking views on the best way to regulate these. It is considering defining a set of DeFi-specific activities, such as “establishing or operating a protocol”, which would require those operators to be authorised either under the RAO or proposed new DAR.  The Government is not sure there is justification to regulate mining in and of itself, but seeks views on whether any other regulatory outcomes should be pursued.

Finally, the consultation calls for views on sustainability. Proof of Work consensus mechanisms can have a high environmental impact, and the Government is considering the possibility of applying similar ESG reporting requirements as apply to securities markets to cryptoasset markets.

Consultation closes on 30 April 2023.

Emma Radmore