Partner Richard Cannon analyses the UK’s approach to crypto regulation in Thomson Reuters Regulatory Intelligence and Solicitors Journal

Partner Richard Cannon argues that UK crypto regulation must move fast if it is to keep pace with the rapidly evolving sector, in Thomson Reuters Regulatory Intelligence.

Richard’s article was published in Thomson Reuters Regulatory Intelligence, 5 July 2023, which can be found here, and in Solicitors Journal, 20 July 2023, which can be found here.

The FCA recently announced more stringent rules for the marketing of crypto assets in the UK, including requiring companies to use risk warnings on products and services, offer a “24-hour cooling-off period” for first-time investors, and banning incentives for customers to “refer a friend”.

These new rules are yet another measure introduced as part of the UK’s evolving Regulatory strategy on crypto, coming just days after an All-Party Parliamentary Group (APPG) report arguing for swift and decisive action to be taken in regulating the “Wild West” sector and a recent report from the Treasury Committee arguing that trading in unbacked crypto should be regulated as gambling, rather than a financial service.

With high rates of fraud and financial crime having shaken consumer confidence in the digital assets sector, these rules will ease concerns around crypto companies misleading consumers. However, the fact that these rules only extend to the marketing of products and services and will only be complied with by licenses or registered entities will likely do little to help police the sector and protect consumers beyond ramping up the warning of the potential risks of investing in these currencies.

Alongside the price risks inherent in the buying of currencies, buyers of crypto are also exposed to greater risk when it comes to fraud and theft in the bandit country of digital assets. While proponents of the sector seek to draw in many prospective investors by playing on the ‘disruptive’ nature of the crypto space, it is exactly that feature which makes it so attractive to fraudsters. Crypto still remains largely beyond the reach of both domestic and global financial regulation, making it a haven for criminals and leaving investors dangerously exposed, with almost no recourse for redress if they are the victim of crime.

The spectacular collapse of cryptocurrency exchange FTX sent shockwaves through the sector, which was already reeling from the effect of the ‘Crypto Winter’ that saw coin prices plunge across the board. According to a filing in a US bankruptcy court, FTX owes its 50 biggest creditors almost $3.1bn, though the true cost of FTX’s demise is far higher in terms of the ripple effect tearing through the industry. FTX had managed to convince investors that it owned billions of dollars’ worth of assets that it did not have, and as soon as solvency concerns were raised by analysts, the company folded and filed for bankruptcy.

FTX’s ability to fraudulently operate on such a vast scale was allegedly aided by the lack or light touch of scrutiny from regulators, who had been largely apathetic in the face of crypto’s burgeoning size and reach across the globe. In the wake of FTX’s demise, a deputy governor of the Bank of England called for the sector to be brought within the regulatory framework, warning that the continued growth of the crypto market meant action should be urgently taken, before an even greater shock than the FTX implosion could occur.

With fraud and financial crime in crypto still a prevalent issue, the UK must be seen to a leader in investigating and prosecuting in the sector it isto become seen as a safe haven for consumers and investors in the digital assets space. The goal is complicated by the borderless nature of digital assets, with cryptocurrencies able to be marketed, bought and sold across jurisdictions with relative ease, and this will no doubt require regulators and authorities to place an increased emphasis on cross-jurisdictional co-operation in order to combat this.

While any crypto regulation the UK seeks to adopt must tackle the issue of financial crime in the sector, the recent report from the APPG for Crypto and Digital assets recognises not only the risks but also the opportunities that crypto presents. In this sense, acting fast and smart in regulating the sector could not only help mitigate the dangers of fraud and financial crime, but also allow the UK’s crypto industry to thrive.

As this report suggests, speed is of the essence, and policymakers must act fast to ensure that it delivers comprehensive, world-leading crypto regulation that establishes the UK as a leader in crypto regulation and further cements its position as finance and technology hub. This must be backed up with the necessary resources provided for UK regulators and, as such, the government should certainly consider adopting a self-funding sector model if it hopes to not only safeguard the industry, but allow it to grow.

While regulation has the capacity to help safely grow this sector, the Treasury Committee’s recent suggestion of regulating trading in unbacked cryptocurrency as gambling is disappointing, and risks doubling down on the view that the UK is closed for business when it comes to crypto and tech, especially at a time when the US is operating as a hostile environment for Crypto

Modern regulated economies must confront and engage with the evolution of finance, and develop a sophisticated regulatory regime which is not achieved by dismissing crypto investment as gambling and the government must develop the UK as a properly regulated hub for digital assets where customers’ assets are secure and protected, rather than trivialising them. The government must stringently regulate crypto exchanges to build consumer confidence, and the Treasury Committee report wishing the crypto genie could be put back in the bottle misses the point.

For now, it remains to be seen how the FCA and its counterparts overseas can globally police this sector, but crypto regulation must clearly move quickly if it is to keep pace with the rapidly-evolving sector.