Cryptoasset Regulation

The last decade has seen the emergence of a technology that has the potential to revolutionise payments and many other aspects finance – decentralised ledger technology (“DLT”), or as it is more commonly known, “Blockchain”, and the underlying assets to DLT systems, so called Cryptoassets.

First appearing in the form of the now well-known Bitcoin, the first so-called Cryptocurrency, the basic technology has been extended into new areas such as smart contracts (conditional, self-executing contacts constructed as immutable computer code), for which the Ethereum platform and its Ether token were developed, and payment settlement, for which the Ripple platform and its XRP token have come into use.

DLT, with its decentralised, peer-to-peer networks are a crucial technological advancement, permitting individuals and corporations to agree and transact without a central authority. Although the technology is still evolving, it is apparent that it could be the foundation for open, reliable, comprehensive and secure structures and networks traversing both private and public life.

As the Blockchain technology interfaces with other networks, especially in transactions that involve exchanges and payment wallets, financial regulators are realising the need for clarity and codes of conduct while using this technology.  With these issues in mind, the Financial Conduct Authority (“FCA”), the UK’s primary financial regulator, recently issued guidance on their approach to Cryptoassets, and what elements would fall under FCA regulation:

• https://www.fca.org.uk/news/press-releases/fca-provides-clarity-current-cryptoassets-regulation

This FCA guidance is after consultation with the financial sector and it helps firms get clarity on the aspects that are regulated, and those that are not.  In simple terms, if the Crytoassets represents an existing category of regulated asset, such as shares, bonds or electronic money, then they are to be regulated, but if they do not, such as Bitcoin, which represent no underlying asset other than the token itself, then they are not regulated.

In Switzerland, the Financial Market Supervisory Authority (“FINMA”), which has been at the forefront of Cryptoasset regulation, has issued banking and securities dealers licenses to two new Blockchain-focused firms - SEBA Crypto and Sygnum. This is the first time such licenses to “pure-play blockchain service providers” have been issued. The licenses authorise the firms to provide services to institutional and professional clients.

FINMA also provided guidance that stipulated that existing anti-money laundering (“AML”) laws also apply to blockchain payments, as the "inherent anonymity of blockchain technology presents increased risks." Further, it stated that “Institutions supervised by FINMA are only permitted to send Cryptocurrencies or other tokens to external wallets belonging to their own customers whose identity has already been verified and are only allowed to receive cryptocurrencies or tokens from such customers.”  It also added that “FINMA-supervised institutions are thus not permitted to receive tokens from customers of other institutions or to send tokens to such customers.”

FINMA’s approach to AML is inline with the EU’s 5^th Anti-Money Laundering Directive, which is due to come into force during 2020 across the EU.  The UK is expected to implement the directive, even if it departs the EU prior to 2020, and the current HM Treasury consultation can be viewed here:

• https://assets.publishing.service.gov.uk/government/uploads/system/uploads/attachment_data/file/795670/20190415_Consultation_on_the_Transposition_of_5MLD__web.pdf

In simple terms, it is expected that all Cryptoassests will be brought within the AML rules, not just those that fall within the other elements of FCA regulation outlined above, putting them on a par with real property.  This will require any firm providing fiat currency to Cryptoasset exchange or Cryptoasset custodian services to undertake customer due diligence and report suspicious transactions, much as estate agents do for real property transactions.

It is important that individuals contemplating the purchase of unregulated Cryptoassets (such as Bitcoin, Ether and XRP) to consider that as they are not regulated under the FCA, they are not covered by the Financial Services Compensation Scheme. Individuals do not therefore have recourse to the Financial Ombudsman Service. It is therefore prudent to exercise caution if one is purchasing or investing in such Cryptoassets, and to ensure that one understands and can bear any risks incurred in such investments.

It is clear that the wild west of Cryptoassets being beyond the regulatory boundary is coming to an end.

L Ndungu and N Harriss