Is crypto regulated in the UK? (An overview of financial regulation of crypto in the UK) Part 2

UK regulation of crypto? James Kaufmann looks at: marketing cryptoassets, NFTs, stablecoins, DeFi.

This article first appeared in Silicon Roundabout on 26 July 2022, part 1 of this article series can found here.

Marketing cryptoassets

Under the “financial promotion” rules, as an invitation or inducement to engage in financial activity can only be made by a person with FCA authorisation. Advertising FCA regulated cryptoassets is subject to the same requirements. The content of promotions relating to regulated tokens that fall within the financial promotion restriction (whoever they are issued by) must comply with the FCA’s detailed rules in this area. The primary requirement is that all promotions are clear, fair and not misleading, but the rules are wide-ranging and include content requirements (e.g. risk warnings and prominence) and suitability/appropriateness obligations.

Promotions of unregulated cryptoassets are overseen by the Advertising Standards Authority (ASA) which is the independent regulator of advertising across all media. The ASA proactively monitors and enforces against non-compliant adverts for cryptoassets. Current guidance from the ASA requires that advertisers must:

• State clearly that cryptoassets are not regulated by the FCA or protected by the Financial Services Compensation Scheme or the Financial Ombudsman Service. This information must be sufficiently clear and prominent so that it is both legible and easily seen. The size and legibility of the text, its positioning in the advert, and the nature of the medium will all be relevant.
• Not take advantage of consumers’ inexperience or credulity. Cryptoasset terminology will be new to most consumers and so potentially misleading, although more technical jargon may be possible in a specialist financial publication. It must also be clear that profits from cryptoasset investments attract Capital Gains Tax.
• Include all material information. An advert for “Fan Tokens” did not mention that these were cryptoassets or that to buy them you had to first purchase another cryptocurrency.
• Make clear that value can go down as well as up, state the basis used to calculate any projections or forecasts and make clear that past performance is not a guide for future performance.

What about NFTs?

Just when we thought we’d got to grips with the first wave of crypto-related jargon, NFTs came along. They now seem to be everywhere. NFTs are “non-fungible tokens” and are digital assets whose uniqueness and ownership can be demonstrated and verified using blockchain. NFTs can be used to create a tokenised proof of title to a unique digital version of an underlying digital asset (such as images, videos or other digital content) or physical asset (such as paintings, sculptures or other tangible assets). The issue (or “minting”) of an NFT creates a unique digital version of the work as a data file using blockchain. Each NFT is unique and intentionally non-fungible (mutually interchangeable). In contrast, most other cryptoassets, are intentionally fungible.

The FCA does not (yet) consider NFTs to be a separate category of cryptoasset. As such, we apply the same taxonomy to NFTs as we do to other cryptoassets to assess how they should be treated from a UK financial regulatory perspective. NFTs that do not meet the definition of e-money tokens or security tokens will be unregulated in the UK. But, NFT exchanges will (likely) need to be registered with the FCA under the MLRs.

And, what about stablecoins?

As with crypto generally, there is no single definition of stablecoins. One of the key commercial issues with many cryptocurrencies is the volatility we see in the relevant token’s value. Stablecoins attempt to stabilise their value using a variety of mechanisms. Because stablecoins vary in how they seek to achieve such “stability”, they cannot be classified as a single type of token. The value of many stablecoins are pegged to a specific fiat currency (fiat-backed stablecoins). Some are backed with different types of assets (including other cryptoassets (crypto-collateralised)) or other assets such as specified investments or commodities such as oil or gold (asset-backed)). And algorithmically stabilised tokens attempt stabilisation through algorithms that may, say, control the supply of the tokens to modulate price.

As such, stablecoins can end up being considered an e-money token or a security token provided they meet all the conditions of security tokens and e-money tokens, depending on the nature of the specific stablecoin set up.

However, in April 2022, HM Treasury announced its intention to make rules to bring stablecoins within the payments regulatory perimeter so that they will be a recognised form of payment.^[1] However, not all stablecoins will be subject to the new regime. Fiat-backed and asset-backed stablecoins will likely be in the regime. Algorithmically stabilised tokens will be outside of the regime. There are a number of other variables still to be ironed out, but it is hard not to view the proposals for stablecoins with a degree of irony. Cryptocurrencies first came to the world’s notice when global financial crises had broken trust across markets. Crypto introduced us all to a novel way of transacting. Decentralised. Without the need for central agencies, intermediaries and (un)”trusted” institutions. And yet, when we contemplate the proposals in the UK, we see that the only type of crypto that UKPLC is preparing to tolerate is the very antithesis of what crypto was meant to be. Stablecoins, and the king of stablecoins the Central Bank Digital Currency (for example a Bank of England backed stablecoin version of sterling – maybe a “BitPound”(?)), are centralised. And depend on intermediaries to operate. To decentralised purists, many stablecoins are not even true cryptocurrencies. And where does that leave us? Have banks, government and regulators combined to neutralise the threat of crypto, away from being an innovative system for exchange of value that could shake traditional finance to its core? Or have level-heads stepped in and brought stability to a rodeo ride of an immature asset class? Time and history will tell.

Finally, what is DeFi? And how does DeFi fit in to crypto and all of the above?

Another “buzzword” is DeFi. DeFi is short for “decentralised finance” and was previously known to some as “open finance”. Today, DeFi is an umbrella term for a variety of financial applications in cryptocurrency or blockchain geared toward disrupting financial intermediaries.

Blockchain allows several entities to hold real-time original versions of a history of transactions, meaning there is no single, central source. This decentralisation is at the core of blockchain and crypto. And it is important within the context of DeFi because centralised systems and human gatekeepers limit the speed and sophistication of transactions that can be handled while offering users less direct control over their money. DeFi seeks to leverage off decentralisation, expanding the use of blockchain from simple value transfer to more complex financial use cases.

For now, DeFi remains without a specifically targeted regulatory, but as you can by now no doubt imagine, the fundamental decentralisation DeFi offers challenges centralised traditional institutions. And if the above is anything to go by, it doesn’t take too much imagination to see which way things will go from here.

[1] UK Government has made it known that their intention is to ultimately extend regulation across the crypto sector as a whole, and stablecoins have been selected to be in the vanguard. However, whilst HMT has expressed its intention to make a range of changes to existing legislation “at the earliest opportunity” to give effect to their proposals, the changes remain unimplemented as at the date of this document.