UK-Wide: A FinTech Legal: Blockchain & Cryptocurrencies Overview

The UK So Far

Historically, the UK has walked a tightrope in relation to blockchain and cryptocurrencies, seeking to balance being a place to do business and protecting consumers. In some respects, this can also be seen as a tension between law and compliance.

Law in this context relates to the UK being a jurisdiction that exports its law internationally. In this respect, the work of the UK Law Commission has been exemplary in terms of providing legal clarity in relation to smart contracts, the legal nature of crypto-assets and decentralised autonomous organisations (DAOs). The result has been that English and Welsh law is generally the bedrock of most contractual work done in the sector internationally.

Compliance, by contrast, has had a trickier path. While historically it was common for participants to state that greater regulation was helpful per se, the movement of the UK to implement one of the first registration regimes for certain crypto-asset activities resulted in many companies relocating offshore and then selling into the UK from abroad to avoid the rule. A particular difficulty here has been that compliance, unlike legal, has to balance two competing priorities: consumer (and markets) protection and the promotion of competition.

On balance, given the association of Web3 with dishonesty, much of the focus has been on consumer protection, on the assumption that well-run Web3 companies would welcome the chance to prove their credentials in protecting consumers. This has not been the case.

Compliance with UK requirements was instead seen as too onerous, so many firms left the UK, relocating to jurisdictions perceived as being easier to do business in. To some extent, indeed, compliance with the UK regime was seen as optional and a high cost that could, and should, simply be avoided as unnecessary.

Recapturing the Industry

The initial priority for the UK has been to rebalance the playing field by removing the regulatory arbitrage opportunity of selling into the UK from abroad. The most significant shift here has been the UK expanding its financial promotion rules to certain fungible, transferrable crypto-assets, so that relevant foreign firms have to comply with UK standards in order to access the UK general market.

In some ways this was an easy win, as the financial promotion rules already had their origin in the framework applicable to securities. However, it was interesting to see the Financial Conduct Authority (FCA – the primary UK regulator for crypto-assets) adding a new spin on what is required, showing an increased appetite to chart its own course away from the EU. This included, for example, a UK-specific approach towards disclaimers, cooling off periods and ensuring that crypto-assets are only sold as appropriate for the UK market.

Another point worth noting is that the FCA has shown that it will actively seek to take enforcement action against those in breach – for example, by issuing public notices and warning letters. As the regime becomes increasingly embedded, it will be interesting to see how this plays out, particularly since a breach of the rules is a criminal offence punishable by up to two years in prison and/or an unlimited fine. It is worth noting that the criminal nature of the offence means that any service providers, such as banks, dealing with entities in breach may themselves be holding the proceeds of crime, which constitutes an offence in itself.

All promotional communications (including social media) accessible to UK users may fall within the scope of the financial promotion regime, meaning that firms need to integrate FCA-compliant features into their marketing of relevant crypto-assets from the outset.

A Paradigm Shift at Home

More domestically, UK regulation is evolving, and is caught between two opposing philosophies embodied by the EU and the USA. The EU takes the approach of “regulate to innovate” (taking an aggressive regulatory stance and requiring innovation to adhere to those standards), whereas the US takes the approach of “innovate then regulate” (allowing the industry to grow within a low regulation environment and then innovating to deal with problems that arise over time). For example, the EU’s Markets in Crypto-Assets Regulation (MiCA) has imposed strict licensing requirements on stablecoin issuers, whereas in the US the SEC and CFTC have primarily relied on enforcement actions in the absence of a comprehensive federal framework.

Against this backdrop, the UK has chartered a middle path, generally consisting of seeking to cross-apply the existing regulatory rules and guidance for FCA authorised firms whilst removing/tweaking those requirements that are inappropriate or disproportionate for the industry. This gives firms the advantage of certainty as the existing rules are well established. However, the cost of compliance may be something that firms struggle with, particularly as they may not be used to operating in a regulated environment or may lack the resources for doing so (meaning a bias towards larger institutions against start-ups).

UK: Coming Up

Whilst the position in the UK is not yet entirely settled, it is clear the UK will continue to seek to be a relatively early mover in the global shift towards regulating the crypto-asset industry. In this respect, the UK is seen as a driving force in relation to setting global crypto-asset regulatory standards, with it being notable, for example, that the FCA led the development of the IOSCO Crypto and Digital Assets Recommendations.

Given the UK’s approach, many regulators globally are looking to the UK as a potential model for their own approaches towards crypto-asset regulation, meaning that the UK will influence the global blueprint towards regulation of the sector. Over the next few years, the UK may therefore become an increasingly popular destination for crypto-asset and blockchain companies to set up, as the perceived advantages of offshore jurisdictions diminish and firms look to operate in a jurisdiction that  is internationally respected.

There is still a long way to go, however, and global uncertainty still has the ability to cause a sea change in approach, particularly in an industry as politically complicated as crypto-assets. In this respect, one can look at stablecoins, for example, which have had a tricky path towards acceptance given their perceived threat to global financial markets – a concern epitomised by calls from the banking sector to rein them in.

This illustrates how the regulatory debate is not solely a legal question, but is also shaped by broader geopolitical considerations, lobbying pressures and the perceived need to protect sovereignty. The key point here is that businesses should be designed with flexibility to adapt to regulatory shifts, since political headwinds can quickly alter what is considered acceptable.

What will be the end result of all this for the UK? As is the case for jurisdictions globally, the specific end result is unclear. However, taking a step back, it is nice to see that, whilst the specific destination is to be determined, the general movement of travel is gradating towards certainty. The UK has moved beyond existential debates about banning crypto. The task now is not if blockchain and crypto-assets can be embedded responsibly into global financial markets, but how. The UK is well positioned to play a leading role in shaping that future.