Written by Jad Soubra

The FCA recently hosted a series of CryptoSprint events in May and June of this year. The purpose of these events was to gain an insight into the industry’s perception of the current market and formulate an appropriate regulatory regime with the capacity to manage cryptoasset practices that are now rapidly advancing. Here we touch on some of the main themes to come out of these discussions which the FCA has published:

Approach to regulation

First, participants suggested the application of a principles-based approach to accommodate, and not stymie, the pace of technology and market evolution. A clear digital taxonomy was identified as a useful tool in the development of a regime for cryptoassets. They emphasised that new regulatory standards did not need to completely overhaul the current system and existing instruments like the Clients Assets Sourcebook (CASS) should be maintained where possible as an alternative to creating a new bespoke list of standards. Participants also argued for a more proportionate approach to the regulation of cryptoassets through balancing promising innovations with the protection of consumers and markets.

Disclosure

Another issue addressed was the extent of information available to buyers of cryptoassets and how they should be vetted before being traded. There was a consensus that, within the context of cryptoassets, a disclosure regime is needed to provide consumers with knowledge that will allow them to make more informed decisions in their assessment of risks and opportunities. However, there was ongoing debate regarding the most effective level of disclosure and who would be in receipt of this – a white paper or ‘plain language summary’ at the point of issuing a cryptoasset was one of the many suggestions. This raised questions around who remains responsible for compliance checks and ensuring accuracy of information. The categorisation of cryptoassets in reference to their risk status and volatility was also a possibility considered by participants. 

There was no consensus on whether the responsibility for providing information should fall on the issuer or exchange providers. Many favoured the issuers providing the information. However, in instances where there is no issuer, many thought the exchange should bear disclosure responsibility. There was also no agreement on different disclosure requirements for retail and institutional investors, as some were keen to maintain the notion of ‘crypto is accessible to all’, whereas others noted the risks for retail customers and the benefit of having different rules.

Who should be regulated?

The question of where regulatory obligations should lie to ensure that regulators capture relevant activity posing risks to UK consumers and markets was also discussed. There was agreement between participants that fundamental differences existed between each type of cryptoasset, thus necessitating different regulatory and policy responses to achieve the same outcomes. Some participants were concerned at the potential for regulatory arbitrage due to the global nature of cryptoassets, but believed that this could be avoided by creating a consistent global taxonomy and improving cross-border regulatory cooperation. In addition, contrasting proposals on the use of existing regulation were also provided by participants with some arguing that current standards should be adapted to account for the differences between digital assets and traditional finance whilst others called for an entirely bespoke regime.

Custody

Finally, the issue of custody in respect of cryptoassets was a challenge for many teams. Participants agreed that among existing cryptoasset custodians, there were a wide range of business models, standards and services. It became apparent that clear regulatory standards would promote a uniform comprehension of what custody of cryptoassets involves.

Challenges in this area included evidencing ownership of a cryptoasset in the case of a firm’s insolvency, because, unlike traditional finance custody, there is no clear distinction between legal and beneficial ownership of a cryptoasset as these details are not recorded as such on the underlying distributed ledger technology. A further challenge was the bearer nature of the private key which provides access to the cryptoasset and the need for custodians to apply robust operational and governance controls to help prevent loss and misuse of private keys. The legal issues thrown up by the global nature of cryptoassets were also raised. For example, UK consumers may be serviced by a custodian in another jurisdiction. Participants called on regulators to be prepared to protect UK consumers from the potential harms this could pose.

Overall, these CryptoSprint events have generated valuable feedback that will inform the FCA’s ongoing policy thinking. The FCA is currently working alongside the Treasury, the Bank of England and the Payment Systems Regulator to develop an effective regime that aims to support innovation within the sector while protecting consumers and the market.