In this chapter we discuss the UK regulatory approach to cryptocurrencies. As in other jurisdictions, the treatment and characterisation of cryptocurrency has not yet been fully clarified, although the UK regulatory authorities are working on this issue, forming a task force to explore issues related to crypto-assets and working closely with market participants under various other initiatives. This work has become particularly pertinent given the increasing media and market focus on cryptocurrencies in the UK, coupled with the reality that the UK’s existing regulatory framework, like many other national regulatory frameworks, was not designed with this new asset class in mind.
Responsibility for the supervision of financial services in the UK rests with the Prudential Regulation Authority (PRA), which is part of the Bank of England (BoE), and the Financial Conduct Authority (FCA). Financial services legislation and policy is also driven by HM Treasury (HMT), which is a ministerial department of the UK Government. The PRA, BoE and FCA operate independently of, but in close cooperation with, HMT to maintain and develop the UK’s financial services legislative and regulatory framework, including in relation to cryptocurrency and the activities performed by market participants in relation to cryptocurrency.
The legal status of cryptocurrency in the UK
It is a common assessment, both in the context of English law and more broadly in terms of economic theory, that money generally possesses three necessary properties: it is a store of value; it is a medium of exchange; and it is a unit of account. Whilst cryptocurrencies, particularly those with larger market capitalisations such as Bitcoin and Ether, certainly possess characteristics that are akin to those three core elements of money, the prevailing view is that cryptocurrencies should not be characterised as money within the UK financial system. In a 2014 paper on this point,1 the BoE concluded that cryptocurrencies are unlikely to be considered money due to their relatively limited adoption within the UK financial system and their seeming inability to form a reliable unit of account, given a lack of inherent value and high volatility, marking them as a relatively immature asset class by comparison. Whilst the adoption and use of cryptocurrency has undoubtedly increased since that BoE paper, the assessment that cryptocurrency should not be seen as money for the time being remains persuasive.
What then is the legal status of cryptocurrencies under English law? It is likely that an answer can be reached by considering the UK’s common law. In this sense, cryptocurrency is generally considered to be a digital form of personal property referred to as a chose in possession,2 whereby the rights of the owner of that property derive from the ability to physically possess it and transfer title to it to others, albeit that cryptocurrencies themselves are intangible. The legal status of cryptocurrencies and crypto-assets continues to remain in a degree of flux, so it cannot be ruled out that legal concepts of property may change to reflect the changing nature and characteristics of our personal property.
Definition of cryptocurrency
There is as yet no formal, statutory definition of a cryptocurrency under English law. In responding to a question raised in Parliament, the UK Government confirmed that, in defining its approach to any possible regulation of cryptocurrency, it is principally guided by the amendments to the Fourth Anti-Money Laundering Directive (MLD5) which must be transposed into English law by 10 January 2020.
Under MLD5, we have for the first time a statutory definition of a “virtual currency”, which is “a digital representation of value that is not issued or guaranteed by a central bank or a public authority, is not necessarily attached to a legally established currency, but is accepted by natural or legal persons as a means of exchange, and which can be transferred, stored or traded electronically”. The definition does not require for the digital representation of value to be encrypted using cryptographic techniques, and it should therefore be considered to include a variety of digital representations of value, including, but not limited to, cryptocurrencies. Barring any change to the Government’s position in the intervening period, this will be the basis upon which cryptocurrencies are defined in English law both up to and following the implementation of MLD5.
Initiatives relating to cryptocurrency and blockchain
The UK authorities have been particularly vocal in the last few years on Fintech matters generally, including in their discussions of cryptocurrencies and crypto-assets. The UK Government has assembled a Cryptoassets Task Force comprising senior representatives from HMT, the BoE and the FCA, who are collectively tasked with plotting the way forward for cryptocurrencies and crypto-assets in the context of UK legislation and regulation. Holding its first meeting in May 2018, the Cryptoassets Task Force is working to publish its initial report in Q3 2018, which will hopefully provide a greater degree of insight as to how the three bodies view the benefits and risk factors presented by cryptocurrencies and other forms of crypto-assets, as well as a proposed approach, if any, to the regulation of cryptocurrencies (discussed further in the “Cryptocurrency regulation” section, below). The establishment of the Cryptoassets Task Force flows from HMT’s Fintech Sector Strategy paper published in March 2018 which, amongst other things, highlights the potential benefit to the UK economy of crypto-assets and blockchain and distributed ledger technology, particularly within the financial services sector.
The work of the Cryptoassets Task Force builds on the existing experience that the BoE and the FCA have gathered via their own respective initiatives. The FCA launched its Project Innovate initiative in October 2014 and, since that time, it has interacted with a range of firms via its Regulatory Sandbox, which allows firms to deploy products and test business models in a controlled testing environment with live customers under a restricted authorisation, with the ability to obtain individual guidance and no enforcement action letters (see “Promotion and Testing” later in this chapter). The FCA’s initiative has been well received by startups and financial institutions alike, particularly those with business models and product offerings related to crypto, blockchain and distributed ledger technology. For instance, 36% of firms who have participated in the Regulatory Sandbox since its first cohort in July 2016 fall within this category of firms, demonstrating that the FCA recognises the benefits that the Sandbox, and Project Innovate more broadly, can contribute to nascent business models and products in this space.
In addition to the activities of the FCA and HMT, the BoE has itself been exploring crypto-assets and blockchain and distributed ledger technology. The BoE’s approach has principally focused on three main areas: (a) whether or not cryptocurrencies and other forms of virtual currencies can be regarded as money; (b) exploring the possible use cases of blockchain and distributed ledger technology in the context of settlement and market infrastructure (including in terms of access to central bank money); and (c) assessing the basis for a central-bank issued digital currency.
This exploratory work has resulted in a range of extensive working papers drafted by the BoE’s economists as to the status of cryptocurrencies,3 the content of which informs the views expressed earlier in this chapter. On a practical level, the BoE has worked closely with a range of firms as part of its proof-of-concepts programme, which is an element of its broader Fintech Accelerator initiative. The programme involves the BoE working with firms across a range of areas, including in relation to blockchain and distributed ledger technology, to test the viability and usability of a range of products and services that are relevant to financial market infrastructure and the operability of the UK financial services framework.
Despite the BoE’s economists considering the economics and functionality of central bank-issued digital currencies at length,4 the UK does not currently have a central bank-issued cryptocurrency or digital currency, although the possibility of such an arrangement being established cannot be ruled out, as the BoE continues to explore how best to ensure that both financial institutions and start-ups have the opportunity and the technical capability to access central bank money and settle a range of transactions through the BoE’s Real Time Gross Settlement System.
A brief summary of the UK’s regulatory framework
The UK’s regulatory framework consists of a range of different individual frameworks, certain of which flow down from European legislation, whilst others represent evolution in legal and regulatory thinking over many years at a national level. The two key considerations that arise in connection with determining whether or not cryptocurrencies are within the scope of the UK’s regulatory perimeter are: (i) whether or not the performance of activities by a firm in relation to those cryptocurrencies results in that person performing a regulated activity requiring either authorisation or registration with the FCA, and potentially also the PRA; and (ii) whether or not there are any restrictions on how those cryptocurrencies can be marketed and distributed in the UK. As the latter question is addressed in the “Sales Regulation” section of this chapter, we will focus on the former question for the time being.
At the heart of the UK’s regulatory framework is the Financial Services and Markets Act 2000 as amended (FSMA),which incorporates the so-called general prohibition that provides that a person may not carry on a regulated activity in the UK unless they are authorised to do so, or exempt. Beyond FSMA, the UK also has two separate frameworks for payment services and electronic money, which are governed by the Payment Services Regulations 2017 (PSRs 2017) and the Electronic Money Regulations 2011 (EMRs 2011) respectively. Given the primary use cases of cryptocurrencies as a means of exchange across certain underlying protocols, these two regimes are particularly relevant when assessing the regulatory status of cryptocurrencies under English law.
Separately to the regulatory status of cryptocurrencies, the UK has implemented the Fourth Anti-Money Laundering Directive into English law via the Money Laundering, Terrorist Financing and Transfer of Funds (Information on the Payer) Regulations 2017 (MLRs 2017)5 and, as discussed above, is currently considering the implementing legislation to incorporate the provisions of MLD5 into English law. The provisions of MLD5 in particular will impact certain operators in the crypto sector, and we explore these requirements in further detail in the Money Transmission Laws and Anti-Money Laundering Requirements section of this chapter below.
Regulatory status of cryptocurrency
A crucial element of the UK’s regulatory regime is whether or not activities are being undertaken in relation to certain types of financial instrument. A person may arrange a transaction in many contexts without falling within the scope of the UK regulatory perimeter, but the arranging of a transaction in relation to certain types of financial instrument that have been designated as such under English law places that person, barring any exclusions, firmly in scope of the UK regime. Whether or not a financial instrument is a specified instrument for the purposes of English law is determined by Part III of the Financial Services and Markets Act (Regulated Activities) Order 2001 as amended (RAO). The RAO designates certain forms of financial instrument, such as shares, debt instruments and a range of contractually-based instruments (such as options, futures and contracts for differences) as within scope of the regulatory regime, such that performing certain types of activities in relation to those instruments results in the carrying-on of a regulated activity if such activities are carried on in the UK by way of business.
Despite the ongoing debate regarding the legal and regulatory status of cryptocurrency under English law, there is currently no legislative or regulatory provision that specifically designates whether or not cryptocurrencies, or other forms of virtual currency, are specified investments. This is largely reflective of three considerations. The first is that the primary-use case of cryptocurrencies continues to be as a means of exchange (albeit that many holders undoubtedly hold them in the hope of capital appreciation); the second is that the nature and scope of cryptocurrencies from a legal and regulatory perspective is not immediately obvious in the same way as other asset classes (it is, after all, hard to regulate something if you do not know how to characterise it); and the third is because the adoption of cryptocurrencies has remained, until recently, relatively limited.
In determining what a cryptocurrency is from a regulatory perspective, it is helpful to approach the matter in the inverse, and consider what we know it is not. The FCA has expressly confirmed that it does not consider cryptocurrencies to be commodities or currencies in the traditional sense.6 Given their nature and form, cryptocurrencies are not what one would typically consider as contractually based instruments, and so it is not appropriate to consider a cryptocurrency to be, in and of itself, a derivative contract such as an option or a future. Given the decentralised nature of cryptocurrencies, it is also clear that cryptocurrencies do not amount to shares or other forms of debt instrument, given the absence of any centralised issuer and the corresponding rights that one typically obtains by holding such instruments.
Given that many of the more mainstream cryptocurrencies are listed on various centralised and decentralised exchanges, there is a question as to whether or not cryptocurrencies should be considered transferable securities, with the consequence that an offer to the public of such transferable securities is governed by the UK’s prospectus regime (discussed in further detail in ‘Sales regulation’,below). A full and detailed analysis as to what constitutes a security under English law could fill a textbook all by itself, but generally speaking the English courts have typically interpreted a security to constitute either an investment (largely speaking a form of property in which an income or profit is expected to be derived in the ordinary course of trade or business as distinguished from pure speculation) or an obligation created by an instrument. Whether or not something is transferable largely depends on whether or not the security in question is negotiable on the capital markets, which itself requires the satisfaction of certain conditions – which it is not yet clear that the increasing number of centralised and decentralised cryptocurrency exchanges satisfy.
In the absence of any further guidance from the FCA, cryptocurrency itself will likely remain outside the scope of the regulatory perimeter, with persons engaging in spot crypto transactions unlikely to be performing regulated activities in the UK for the time being. However, the FCA has stated7 that it considers that derivative contracts with cryptocurrency underlyings will be specified investments and, therefore, any entities engaging in certain types of activities in relation to such instruments should seek authorisation with the FCA. Firms will, therefore, need to consider the exact nature of the instruments in which they are performing activities to determine whether those instruments fall within the scope of the regulatory perimeter.
How does the position differ for other crypto-assets, including tokens?
The position with regard to other forms of crypto-assets, including tokens, is significantly less clear than with more “conventional” cryptocurrencies. Whilst the use cases of the latter are often relatively easy to identify (primarily to act as a means of exchange for transactions occurring on the underlying blockchain), the use cases of tokens, and the regulatory implications of such tokens, often requires significant analysis, with the outcome of that analysis heavily fact-dependent. Whilst other national regulators have sought to clarify their understanding of tokens and implement a form of taxonomy, the FCA continues to consider its position on tokens more generally.
That is not to say, however, that the FCA has been silent in respect of tokens and their issuance and sale via initial coin offerings (ICOs). After initially confirming that it would continue to assess tokens and ICOs,8 the FCA subsequently issued a notice warning consumers of the risks associated with tokens and ICOs. That notice also cautioned that ICOs may involve the performance of regulated activities requiring FCA authorisation given that, in the FCA’s view, certain tokens that the FCA has encountered were effectively specified investments under the RAO.
As with cryptocurrencies, the regulatory assessment of tokens remains in flux until further guidance is received from the FCA, but any firm considering an ICO or seeking to perform activities in relation to tokens or other forms of crypto-assets needs to carefully consider whether or not the nature of their activities and the functionality of their tokens is, when compared against the UK’s regulatory framework, something that would fall within the regulatory perimeter.
As discussed above, whether or not cryptocurrencies and other forms of crypto-asset are within the scope of the regulatory perimeter will also impact how, and to whom, they can be marketed and sold. The regulation of the sale of financial instruments under English law consists of two distinct, but not mutually exclusive, frameworks: the financial promotions regime; and the prospectus and public offer regime.
With respect to the financial promotions regime, FSMA imposes a general prohibition on the communication of an invitation or inducement to engage in investment activity which is made from the UK, to UK persons, or is otherwise capable of having an effect in the UK, unless the person making such communications is an FCA-authorised person or the communication is approved by an FCA-authorised person. The financial promotions regime only applies to “controlled investments”,9 and for these purposes cryptocurrency is not currently designated as a controlled investment under English law. Nevertheless, firms providing activities in relation to cryptocurrencies will need to exercise a degree of caution when marketing such assets in or to persons in the UK, particularly where those persons are the general public and, as a matter of good practice, ensure that their communications are at least fair, clear and not misleading.
As with other prospectus regimes throughout the European Union, the UK’s prospectus rules apply in instances where an offer of transferable securities is made to the public in the UK or an admission of transferable securities is sought to a regulated market in the UK. Given that no cryptocurrencies are admitted to trading on a regulated market in the UK, the primary consideration is whether the ongoing offer or sale of cryptocurrencies via centralised and decentralised exchanges results in a public offer of transferable securities. As noted above, whether or not cryptocurrencies are securities, as well as whether they are in fact transferable in a manner as described under English law, remains open to debate, albeit the UK market thus far has seemingly concluded that ongoing trading of cryptocurrencies via such infrastructure does not result in the need for the publication of a prospectus.
However, the prospectus regime poses harder questions for tokens than it does for cryptocurrencies. Given the vast majority of tokens are issued via an ICO, coupled with the increased regulatory uncertainty as to the nature of tokens, the question as to whether or not a prospectus is required in relation to that offer is arguably more pertinent than with cryptocurrencies. How firms proceed on this point will largely depend on the conclusions they draw from their assessment of the tokens, their use cases and whether or not they are comparable to existing forms of specific investments under the RAO.
Whilst taxation authorities have been challenged by cryptocurrencies and crypto-assets, the first response of the taxman is to bring them into the fold of taxable activities. This has typically been done by applying the existing tax framework – which has led to a number of practical questions as to how such assets fit within such framework. One particular difficulty with the taxation of cryptocurrencies and crypto-assets results from the fact that their value can fluctuate enormously. How cryptocurrencies and crypto-assets will be taxed will typically depend upon the precise nature of the cryptocurrency or crypto-asset.
Her Majesty’s Revenue and Customs (HMRC) was among the first of the global taxation authorities to deal with the concept of a cryptocurrency, publishing a business brief10 which covers the way in which transactions with Bitcoin should be treated for tax purposes. In addition, the European Court considered how the services provided by a Bitcoin exchange in exchanging Bitcoin for fiat currency should be treated for VAT purposes (see Skatteverket v David Hedqvist Case (C-264/14)). At a high level, the UK and European Court’s approach has been to treat Bitcoin as being akin to a fiat currency other than sterling. It should be noted that HMRC’s published guidance pre-dates the increased volumes and advancement of cryptocurrencies, and so largely focuses on Bitcoin. Given the variety in the nature of different types of cryptocurrencies being developed, whether the approach adopted by HMRC in relation to Bitcoin will apply to another cryptocurrency will depend on the exact features of the cryptocurrency in question.
The concept of money transmission under English law is principally governed by the PRSs 2017 and the EMRs 2011, and the extent to which either will apply depends on the activities being performed and the nature of the instruments in question. Whilst cryptocurrencies are not currently considered to be a form of payment instrument, and nor are they considered electronic money, firms should consider whether any ancillary activities in fiat currency connected to any cryptocurrency-related activities, such as remittance of fiat currency between wallets, constitutes payment services under English law for which authorisation or registration may be required.
As to anti-money laundering requirements, the UK regime comprises two pieces of legislation, one applying specifically to certain types of firms; the other applying generally. The MLRs 2017 apply only to certain types of firms, which includes credit institutions and a range of firms performing financial services collectively referred to as “financial institutions”. At present, firms engaging in activities solely in relation to cryptocurrencies, such as cryptocurrency exchanges, are not subject to the MLRs 2017 and are not strictly required as a matter of law to undertake customer due diligence on their customers as prescribed under the MLRs 2017.
It is the general applicability of the UK’s anti-money laundering regime under the Proceeds of Crime Act 2002 (POCA) that has resulted in many crypto businesses voluntarily engaging in customer due diligence to a standard as laid down under the MLRs 2017. POCA, amongst other things, lays down a number of criminal offences which any person, regardless of their status and the nature of their activities, can commit if they are involved with criminal property and so, whilst the concept of identity verification is anathema to many crypto enthusiasts, the largely anonymous nature of cryptocurrencies is often a risk too far for cryptocurrency businesses operating in the UK.
As we mentioned earlier, the FCA’s Regulatory Sandbox provides selected firms with an ability to test product offerings, services and business models in a controlled environment. Applications for the Sandbox are competitive, and successful firms may take the benefit of some or all of the four key available resources: restricted authorisation; individual guidance; waivers or modifications to the FCA’s rules; and no-enforcement action letters. The benefits gained to firms from these tools is significant, particularly in the early stages of a particular product offering, business model or service, when the prospects of success are unclear and the cost of regulatory compliance in order to explore those prospects further are significant.
The essence of cryptocurrencies is that they are decentralised, such that there is no central, governing or controlling authority that claims ownership of any one cryptocurrency. As is commonplace in the crypto space more generally, the underlying protocols that govern cryptocurrencies are typically open-sourced, thereby supporting the collaborative nature of cryptocurrencies. It is entirely possible that creators of cryptocurrencies may have sought to protect their brands through trademark registrations, but it would likely defeat the purpose of cryptocurrencies if participants required a licence to utilise any particular cryptocurrency to effect transactions on a particular blockchain, or to acquire cryptocurrency via an exchange.
Mining is a fundamental underlying activity for many cryptocurrencies, as miners play a key role in obtaining consensus on the underlying blockchains by validating transactions, collating those transactions into blocks and hashing the new blocks to the blockchain. In a proof-of-work system, such as Bitcoin, miners will compete to solve mathematical problems which, once solved, will entail that the block is valid and capable of being recorded to the public blockchain. In exchange for their efforts, miners receive an amount of the relevant cryptocurrency which, in the absence of a central authority issuing new batches of cryptocurrency, is a primary influencer of the overall supply of the cryptocurrency in question. This is, in part, why mining is so resource-intensive – if it were easy, then the supply of a particular cryptocurrency could be significantly greater than that which is needed, leading to deflationary pressures on the cryptocurrency.
For the time being, mining remains outside the scope of the UK regulatory framework and, even if cryptocurrencies were to fall within the regulatory perimeter, it remains to be seen whether the activities of miners in validating transactions via proof-of-work or proof-of-stake would constitute a form of regulated activity under English law.
Like most jurisdictions, the UK has implemented rules and restrictions on certain types of goods and other substances that can be transported within its borders. The current UK rules on disclosures relating to financial matters relate solely to cash, albeit that, for the time being at least, where a person is entering the UK from another EU Member State, there is no requirement to declare cash holdings. When entering from a non-EU Member State, a person must declare cash holdings of €10,000 or more (or the equivalent in another currency). The current rules do not provide that cryptocurrencies are cash for these purposes.
For firms performing activities and services solely in connection with cryptocurrencies outside of the regulatory perimeter, the reporting obligations that typically flow down from existing financial services legislation will largely be inapplicable. The expansion of transparency and transaction reporting requirements under EU Directive 2014/65/EU (MiFID II) and Regulation No 600/2014 (MiFIR) and their delegated legislation, may impact firms in the crypto space in two ways. First, to the extent that firms are themselves engaging in investment activities or providing investment services under MiFID II, such as through the provision of derivative contracts with cryptocurrencies as the underlying assets, those firms will need to consider whether the transparency and transaction reporting requirements in MiFIR will apply to them. The transparency requirements will be particularly relevant where firms are engaging in over-the-counter trading in cryptocurrency derivatives, and it remains to be seen how various cryptocurrency exchanges are to be categorised for these purposes – the definition of a trading venue under MiFID II only captures regulated markets, multilateral trading facilities and organised trading facilities, with many centralised and decentralised cryptocurrency exchanges falling outside the scope as a result.
Secondly, to the extent that firms operating in the crypto space engage in cryptocurrency derivatives trading with other parties who themselves are subject to MiFID II, for hedging purposes, for example, then such firms may find that they need to provide certain information to those parties to allow them to comply with their own reporting obligations.
As previously discussed, the provisions of POCA and the MLRs 2017 impose reporting obligations on firms in instances where money laundering or terrorist financing is suspected. Under POCA, it is typically a defence to the relevant offences under Part 7 for a person to report their suspicions to the appropriate authority, which in the UK is the National Crime Agency (NCA). Anyone who suspects money laundering or terrorist financing can file a Suspicious Activity Report with the NCA and it remains in a person’s interest to do so in such circumstances.
1. The economics of digital currencies, Q3 2014.
2. See, for instance, the paper prepared by the Financial Markets Law Committee dated July 2016, entitled Issues of legal uncertainty arising in the context of virtual currencies.
3. See, for instance, The economics of digital currencies, and Innovations in payment technologies and the emergence of digital currencies.
4. See, for instance, the working papers, The macroeconomics of central bank issued digital currencies, and Central bank digital currencies – design principles and balance sheet implications.
5. The Joint Money Laundering Steering Group’s published guidance is also highly influential in this context.
6. FCA statement, Cryptocurrency derivatives, 6 April 2018.
7. FCA statement, Cryptocurrency derivatives, 6 April 2018.
8. See the FCA’s response to Discussion Paper 17/3 on the use of distributed ledger technology in financial services.
9. Whilst broadly similar, there are slight differences between controlled investments and specified investments. By way of example, electronic money is a specified investment but not a controlled investment.
10. Revenue and Customs Brief 9: Bitcoin and other cryptocurrency (3 March 2014), and Capital Gains Manual – Introduction and computation: chargeable assets: intangible assets: cryptocurrencies.