Cryptocurrencies in the UK: The Cost of Stricter Regulation
January 31, 2023 (Legal Hub Archive Series)
Welcome back to the Jurisprudence Legal Hub Archive Series. In today's post, we're revisiting a key discussion from January 2023: the complex debate surrounding cryptocurrency regulation in the UK.
"Cryptocurrencies in the UK: The Cost of Stricter Regulation," dives into the ongoing tension between protecting consumers and fostering innovation in the fast-growing crypto market.
Article Summary:
The Article presents a balanced look at both sides of the argument:
The case for regulation: Proponents argue that stricter oversight is essential to protect consumers from fraud and criminal activities, citing the collapse of the FTX exchange as a prime example. The piece highlights the UK's legislative actions, such as the Proceeds of Crime Act 2002 and the Economic Crime and Corporate Transparency Bill, which are designed to combat illegal use of cryptoassets.
The case against regulation: On the other hand, the article explores the argument that excessive regulation could stifle innovation and inhibit the growth of cryptocurrencies as a legitimate form of legal tender. It raises concerns about potential governmental control over finances, a loss of personal privacy, and the negative impact on market liquidity.
The article also touches on the Bank of England's exploration of a Central Bank Digital Currency (CBDC), weighing its potential benefits against significant risks like cyber-attacks and reduced banking deposits.
Ultimately, this piece concludes that the most effective path forward requires striking a crucial balance between consumer protection, personal privacy and market innovation, urging both regulators and crypto businesses to adapt to a rapidly changing legal landscape.
We hope you enjoy this insightful article. You can read the full text to explore these important legal and economic considerations in more detail.
Full Article
Cryptocurrencies in the UK: The Cost of Stricter Regulation
Sade Rotibi
Senior Counsel | Founder at Jurisprudence Legal
January 31, 2023
Cryptocurrencies have become increasingly popular in the UK in recent years, and as such, the question of whether they should be regulated as strictly as other financial products remains an interesting topic for cryptocurrency lawyers, particularly in light of cryptocurrency exchange, FTX’s recent collapse. On the one hand, there is an argument that cryptocurrencies should be equally regulated in order to fully protect consumers from fraud and other criminal activities and to hold crypto service providers to minimum capital requirements. On the other hand however, there is a persuasive argument that stricter regulation may inadvertently inhibit growth and market innovation, thereby limiting the potential of cryptocurrencies one day becoming a widely used and trusted form of legal tender in the UK.
Cryptocurrencies have gained notoriety for their volatile market fluctuations and potential for soaring yields. According to the International Financial Statistics (IFS), the total value of all crypto transactions reached $2.7 trillion in 2020, with Bitcoin (BTC) transactions accounting for $1.6 trillion, or 59.9% of the total transaction value. Ethereum (ETH) and Tether (USDT) transactions accounted for $413.6 billion and $243.2 billion respectively. The data from the IFS demonstrates the speed at which the global crypto market is growing, with the total number of crypto users reaching over 100 million in 2020 (a significant increase from the estimated 20 million users in 2018).
While crypto trading has provided obvious advantages for some, it has been long argued that they expose consumers to more illegal activities such as money laundering, fraud and tax evasion. Accordingly, the UK government unveiled the Economic Crime and Corporate Transparency Bill on September 22 2022, which contains provisions for law enforcement organisations like the National Crime Agency to speed up and simplify the seizure, freezing, and recovery of cryptoassets used by criminals to launder the proceeds of crime. This follows the Proceeds of Crime Act 2002 (POCA), the primary legislation dealing with proceeds of crime in the UK, extending its reach to cryptoassets as ‘property’, in order to protect consumers against criminal activities such as money laundering and terrorist financing. The Bill will expand POCA’s powers of criminal confiscation and civil recovery. Cryptocurrency is also considered a ‘cash equivalent’ under the POCA, meaning that in the UK cryptos are subject to the same regulations and obligations as cash. This includes the obligation to report suspicious activity and to keep records of any transactions involving cryptocurrency. As of 10 January 2020, UK cryptocurrency exchanges were required to register with the FCA in order to ensure they meet anti-money laundering and counter-terrorist financing requirements and are carrying out KYC checks on their customers.
Similarly, following the European Council’s ratification of the Markets in Crypto-assets Regulation (“MiCA”) on 5 October 2022, MiCA will be the first pan-European Union regulatory regime for crypto-assets, establishing a legal framework for both issuers and service providers of cryptocurrencies as well as for specific categories of cryptocurrencies.
MiCA is anticipated to be approved and published in the Official Journal in Q1 2023 (entering into force 20 days after), with the majority of the regulations set to take effect 12 to 18 months after that. Although there is a sizeable grace period, when it does come into effect it will require crypto businesses who wish to offer cryptos in the EU (or on an EU crypto-asset trading platform) to have the relevant policies, procedures and systems in place for compliance with the requirements, which range from licensing and authorisation processes to more complex capital requirements, mitigating risks to the stability of the wider financial system.
If passed, the UK Financial Services and Markets Bill, revised and published on 4 November 2022 will subject cryptoasset activity to regulatory oversight of the FCA, and a bill aimed at preventing the use of digital assets for money laundering was brought before the US Senate on 14 December 2022.
However, whilst consumer protection is a priority for any sophisticated financial market, cryptocurrencies are a relatively new form of currency and their growth and adoption has been rapid and so should be fully supported through its inevitable expansion. Meaning that while some experts support stricter regulations as a way to protect investors and promote stability in the industry, there is still a strong argument against potentially draconian regulation.
Too Big to Fail….Again?
In early November 2022, FTX, one of the leading cryptocurrency derivatives exchanges once worth $32bn, collapsed following a report by CoinDesk suggesting potential leverage and solvency concerns. The report highlighted concerns about FTX’s liquidity, suggesting that it had insufficient reserves to pay out on large losses made by traders. Following the report, FTX ceased trading, funds held by traders were frozen, and FTX’s parent company, Alameda Research, began the process of liquidating the exchange.
The news of the collapse of FTX sent shockwaves throughout the crypto industry and was particularly damaging to FTX’s reputation as many traders and investors had trusted FTX as a reliable exchange. The collapse of FTX clearly highlights the importance of regulation in the cryptocurrency market, yet consumer protection must always be balanced against the appropriate level of regulatory intervention.
Proponents of increased regulation will argue that it is necessary to regulate the crypto market as strictly as other financial products, particularly in light of the fact that crypto currencies have been known to be wildly volatile. However, many market participants argue that excessive regulation could have a major impact on how people view and use crypto currencies and other digital assets such as non-fungible tokens (NFTs).
Consumer Protection vs Personal Privacy
If cryptoassets are too strictly regulated, users could be concerned about the level of control that governments and other authorities may have over their finances, particularly with growing levels of technological sophistication available to potentially programme (thereby controlling usage of) the currencies. Such restriction could impact the liquidity of the market making consumers less likely to trust the currency or use it for everyday transactions.
Governmental regulation of cryptocurrency generally involves rules and regulations set by governments or other authoritative bodies that govern the use and distribution of cryptocurrencies. Of concern to backers of less regulation is the possibility that governmental control may include programmable restrictions on the types of transactions that can be conducted, the amount of money that can be transferred, and the amount of taxes that must be paid on profits. It could also include rules about how the currency is stored and how it can be exchanged for other currencies.
Globally, other governments have recognised the importance of cryptocurrencies, with El Salvador, for example, becoming the first country in 2021 to pass legislation making Bitcoin a legal tender alongside the US dollar. Additionally, other countries such as the US, have recognized Bitcoin as a form of property subject to capital gains tax under certain conditions, while others, such as Japan, have accepted it as a form of payment which is subject to the country’s Payment Services Act.
UK Central Bank Digital Currency
The Bank of England (BoE), at the time of this article, is considering the advantages and disadvantages of creating a Central Bank Digital Currency (“CBDC”) for the UK. A CBDC is a digital form of money that is created and issued by a central bank and is used for making payments.
The potential advantages of a CBDC could be significant- for instance a CBDC could provide citizens with improved access to digital financial services, particularly in rural and remote areas. It could also make the financial system more resilient, by providing an alternative payment method in the event of a banking system failure.
The potential disadvantages of a CBDC are also considerable. One concern is that a CBDC could lead to increased cyber-attacks and money laundering, as it would create a new, potentially vulnerable target for criminals. In addition, a CBDC could reduce the demand for traditional bank deposits, which could have a negative effect on the banking industry as a whole. Finally, and potentially of most concern is that a CBDC could lead to a loss of privacy, as the central bank would be able to control and monitor the transactions of its users.
It’s clear that the BoE is taking the potential of a CBDC very seriously, by exploring its advantages and disadvantages, and what it could mean for the UK’s economy. The BoE’s considered approach to this issue is likely to be welcomed by citizens, businesses and the banking industry, and should ensure that any decision on a CBDC is based on sound economic principles. The BoE states on its CBDC page online, “If we issued a UK digital currency, it would be in denominations of pounds sterling. For example, £10 of a UK digital currency would always be worth the same as a £10 note.”
Finding Balance
Ultimately, it’s crucial to strike a balance between encouraging innovation in the market, consumer privacy and consumer protection. Strict regulations, while necessary in certain respects, may not be the most effective way to ensure the success and legitimacy of cryptoassets. It’s essential for governments and regulators to take into account the potential impact of regulations on innovation and the potential of cryptocurrencies as a legitimate and widely accepted form of payment.
Traditionalists argue that regulation of cryptocurrencies should include stricter investor protection regulations, such as limits on the amount of money that can be invested in cryptoassets and ensuring that crypto exchanges properly adhere to specific security and capital protocols.
Conclusion
Both arguments for and against the strict regulation of cryptocurrencies have merit. On the one hand, it’s essential that cryptocurrencies are regulated in order to protect UK consumers from fraud and money laundering, particularly since fraud levels are currently higher than before the COVID-19 pandemic (according to the House of Lords Fraud Act 2006 and Digital Fraud Committee’s 12 November 2022 report “Fighting Fraud: Breaking the Chain”). On the other hand, strict regulation could stifle innovation, jeopardise personal privacy and limit the potential of cryptocurrencies becoming a legitimate form of payment in the UK.
Ultimately, it’s up to the government to assess which approach is best and to ensure that regulations are implemented in a manner which balances consumer protection, market liquidity and personal privacy within the confines of a fast-changing legal landscape.
Cryptoasset businesses and service providers should ensure that their compliance policies and procedures can withstand future developments and that their practices conform to the relevant regulations.
Jurisprudence Legal is highly experienced to support your business through its cryptocurrency whitepaper drafting, policy and procedure review, drafting, audits and other matters requiring a cryptocurrency lawyer. If you would like further information about this area or any of the other services, then please visit www.jurisprudence-legal.com.
