Recent updates to the Financial Services and Markets Act (FSMA) 2023 are being interpreted as the UK government taking the first formal steps towards regulating the crypto and wider digital assets sector.
Under the current PM Rishi Sunak, the UK has publicly announced its intention to establish itself as a digital assets hub. A consultation on how to best approach the sector was announced in February, alongside a bullish statement that its goal was the “firm ambition… for the UK to be home to the most open, well-regulated, and technologically advanced capital markets in the world.”
That was followed up by the assertion:
“Delivering on this ambition means taking proactive steps to harness the opportunities of new financial technologies.”
The amendments that have now been introduced into the FSMA are the first of those “proactive steps”.
But what are the changes that have been made and what do they mean for companies operating in the digital assets sector in the UK and their clients?
Why is the evolution of regulatory frameworks to cover the crypto assets seen as so important?
And what other developments are expected and how are other jurisdictions around the world approaching the question of how to regulate the sector?
The UK has updated its regulatory framework to cover cryptocurrencies and digital assets
The amendments to the FSMA, which will come into effect in October, are focused on clarifying the regulatory framework for digital assets with respect to registration requirements and financial promotions.
The crypto sector in the USA is currently suffering from a huge amount of uncertainty due to cases brought by regulators (The SEC and CFTC) against the exchanges Binance and Coinbase. With the cases focusing on whether cryptocurrencies should be considered and regulated as securities or not, the need for clarity around registration and promotions has been highlighted.
The UK hopes that the updates to be introduced will represent the first stage in providing a working framework that protects investors, especially retail investors, while leaving space for the sector to flourish and evolve – and positioning the City of London as a global crypto assets hub.
The new additions to the act cover crypto assets defined broadly as:
“Any cryptographically secured digital representation of value or contractual rights that (a) can be transferred, stored, or traded electronically, and (b) uses technology supporting the recording or storage of data (which may include distributed ledger technology)”.
Crucially, that description covers both currently regulated forms of crypto assets that identify as securities and stablecoins (eg. Tether) that are pegged to fiat currencies and able to be used as a means of exchange – and ‘utility’ and ‘exchange’ tokens like Ether and BNB.
The latter category have until now been considered outside of the jurisdiction of regulators – something that has been a major factor in Binance and Coinbase’s regulatory woes in the USA.
Among the big changes the Act’s amendments introduce include the requirement for any organisations in the crypto space who want to market products and services that are now considered regulated to have a presence in the UK and secure regulatory authorisation. That means that an exchange based in, for example, Barbados but without a physical presence and FCA approval in the UK, would not be allowed to market itself in the UK.
Essentially, crypto assets and related services such as exchanges will be regulated in much the same way as mainstream securities like stocks, funds and bonds.
If the FCA has the resources and procedures to effectively monitor and enforce the UK-targeted marketing activities of international organisations in the crypto space remains to be seen. But the intention is clear – crypto assets and related services are to be treated as currently regulated financial products and services.
Why is a regulatory framework needed for cryptocurrencies and digital assets?
Crypto assets and regulation are uneasy bedfellows.
Bitcoin, the original cryptocurrency, was launched as a decentralised, rules-based alternative to fiat currencies – positioned as the cure to the ills of value erosion through money printing by central banks. And the ability of global political and financial elites to make decisions that impact the value of money in the pursuit of their own (vested) interests.
Regulation, meanwhile, is the embodiment of centralised power and control.
However, for cryptocurrencies and other crypto assets to be integrated into mainstream financial markets, and marketed to retail investors, there appears no practical way for regulation to be avoided.
The crypto sector has always been plagued by scandal and fraud. Hundreds of thousands of small investors around the world have been convinced to buy into one of the many cryptocurrencies and tokens launched by private companies. Marketing of these tokens typically promises, or strongly implies, spectacular returns only for investors to see them quickly lose all or most of their value – with no recourse.
There have also been countless instances of the tokens or cryptocurrencies sold not even existing – outright fraud.
Even sticking to the more established crypto assets like Bitcoin has often not protected investors. Frequent hacks of online wallets containing crypto assets have led to millions being lost to cyber criminals with victims having no recourse. And several high profile crypto sector services companies including the exchange FTX have collapsed due to mismanagement, fraud and embezzlement – leaving their clients crypto-less. Again, with no or little recourse.
Another issue for the sector when it comes to mainstreaming is the relative anonymity cryptocurrencies provide, which leaves it wide open to accusations of facilitating crime and money laundering.
This combination of risk to investors and threat to established systems designed to stimmy money laundering makes the regulation of crypto assets inevitable – at least in so far as their participation in the “white” economy and mainstream financial markets.
Are other countries regulating crypto assets?
Different countries around the world are taking different approaches to cryptocurrencies and other crypto and digital assets.
The USA is, at least for now, taking a combative regulatory approach and pursuing even the biggest and most established names operating in the country, like the exchanges Binance and Coinbase. The SEC has allowed a number of Bitcoin futures ETFs to list on US exchanges but has continually rejected proposals for spot Bitcoin ETFs.
That could change over the coming months but is far from certain. It is likely to take some time before the USA, the world’s biggest financial market, moves to create a clearly defined regulatory environment for crypto assets. However, as the world’s biggest financial market by a distance, it won’t be overly concerned about the head start other financial hubs like London, Singapore or Dubai might have if and when it does decide to act.
The USA has the luxury of waiting to see how things develop in more crypto-friendly markets before making any significant regulatory moves itself.
China has taken a hardline approach to the sector, declaring all crypto transactions illegal in 2021. However, the country has recently made a slight concession in legally recognising cryptocurrencies as property. They still can’t be transacted but they can be owned.
Singapore, Dubai, Switzerland and the EU are, like the UK, are working on regulatory frameworks in the hope of establishing themselves as crypto asset trading centres in the years to come.
It will take a few years for new regulatory environments for crypto assets to be tested and tweaked. Plenty of disputes and legal cases will also inevitably arise from conflicting interpretations of new rules.
But if regulation does work by protecting investors, it could provide the confidence needed for crypto assets to make their next big step forward and sit alongside fiat currencies and traditional securities and commodities in investment portfolios.