April 11, 2022
Over the last 2 weeks, the UK government has made a series of announcements about the future of the UK’s place in the crypto industry. On 4 April, Chancellor Rishi Sunak set out the government’s headline-grabbing plans to mint a “Treasury NFT” with more details to follow.
In his keynote speech to Innovate Finance Global Summit, Economic Secretary to the Treasury and City Minister John Glen also laid out a wider set of policy aims as part of the government’s intention to “lead the way” in distributed ledger technology (DLT).
The government aims to cut past the hype and focus instead on what Glen calls the “extraordinary, mercurial, underlying technology which makes ‘crypto’ possible”. This, together with the statement that Britain is to be “the very best place in the world to start and scale crypto-companies” could, if implemented effectively, be a radical step towards mainstream and institutional acceptance of DLT in the UK.
Areas of concern
The government has restated its intention to bring some cryptoassets into the scope of financial promotions regulation.
Correlation & systemic risk
As cryptoassets and associated technologies become more interconnected with the UK’s financial systems, the risk of harm to those systems must be managed carefully, especially in the context of crypto’s price volatility.
Criminals & hostile states
In 2020 the government brought cryptoasset companies (those operating exchange or custodial wallet services, broadly defined) within the scope of the UK’s AML regime, and has recently been working with the Financial Action Task Force on implementing the travel rule for cryptoasset transfers.
At the Innovate Finance Global Summit, the government also specifically called out the need to ensure that the crypto ecosystem does not allow circumvention of sanctions and trade restrictions.
The UK government is aware of the challenges for tax transparency and consumer confidence posed by crypto, and is taking a leading role in negotiations with the OECD’s new reporting framework.
There are significant concerns about the energy usage associated with some DLTs, which the government must seek to address, especially given its commitment to be a world-leading centre for green finance.
Many of the concerns surrounding crypto stem directly or indirectly from the volatility of crypto markets. So, a key focus area for the government is establishing a framework for “stablecoins”.
Stablecoins, unlike uncorrelated cryptoassets like Bitcoin, have a price which is not determined by speculation and demand. Instead, their value is either set by an algorithm or, more commonly, it is “pegged” to a more stable currency or asset, such as USD. For example, USDC, Tether, and Binance USD (BUSD) are all pegged at a 1:1 ratio to USD. Stablecoins are to a crypto portfolio what cash and treasury bonds are to a “traditional” portfolio. They offer hedging against volatility, they can earn interest when they are staked, and are a more stable store of value without converting crypto back into fiat.
Stablecoins are not uncontroversial. There have been cases of issuers allegedly mis-stating the reserves by which they are backed (Tether was fined $41m for this in 2021 by the US regulators). However, they will undoubtedly form a part of any mature crypto economy in the future.
Rather than introduce a regulatory framework from scratch, the UK has proposed to bring stablecoins within its existing regulations on electronic payments.
The proposal to mint and sell a “Treasury NFT” has grabbed headlines but does not look as though it is part of the government’s substantive policy approach. Instead, it is described as an “emblem” of the government’s “forward looking approach”.
NFTs have largely escaped the regulatory focus of the UK government, largely because many, though not all, NFTs fall outside the “specified product” categories for financial services laws and don’t fit the definition of “cryptoassets” for AML purposes.
For the sake of the industry, some will hope this is the extent of the government’s emblematic proposals – since, as set out below, concrete action is necessary to handle the areas of concern above and allow the UK to “lead the way”.
Governance & corporate structure
The government has asked the Law Commission to give its view on the legal status of decentralised autonomous organisations (DAOs).
A DAO is a business that operates on a blockchain. Conceptually, a DAO literally is the rules/protocol by which it is governed; imagine Articles of Association but with no legal personhood. Governance is usually determined by built-in consensus mechanisms and facilitated by automatically fulfilling smart contracts. DAOs are frequently the business model of choice for crypto entrepreneurs, especially those who subscribe more wholesale to the philosophy of decentralisation.
Legal clarity here will be keenly welcomed by lawyers advising crypto start-ups, especially those advising on corporate structure and governance. Depending on the feedback from the Law Commission, there are likely further implications for those seeking to structure funds to invest in novel crypto-businesses.
The government has stated its intention to “lead by example”, referring to its existing work on implementing DLT solutions for customs and international trade to help ease import friction and inefficiency.
Other themes in the government’s proposals
- Embracing a decentralised, open and user-owned ecosystem – known in crypto circles as Web 3.0
- Resolving issues associated with DeFi loans and staking – staking, and other non-mining-based consensus mechanisms, will likely be instrumental in balancing the government’s green commitments and its crypto ambitions. The government has also specifically proposed to amend the “Investor Manager Exemption” to remove disincentives for fund managers wishing to invest in cryptoassets.
- The FCA has announced a series of “crypto-sprints” each focussing on a particular legal, regulatory, or technical challenge
- Establishing the “Cryptoasset Engagement Group”, including ministerial, FCA, and Bank of England representatives
- Exploring the possibility of issuing a UK debt instrument on a blockchain – this would be a very significant step towards the UK embracing DeFi
Where does this leave us?
Ian Taylor, the executive director of the UK’s self-regulatory trade association for the crypto sector, has expressed concerns that the UK industry is failing to live up to its potential. He cites 200 applications to the FCA from crypto businesses, of which 160 were deemed not to meet expectations and criticises (1) the lack of transparency around this seemingly prohibitive benchmark for regulatory approval and (2) lack of consistency in decision making – among other factors.
The noises coming from the UK government this year are positive for the industry, but they must be followed by concrete legislative action and clear regulatory guidance. The origins of crypto are almost necessarily inseparable from scepticism about intermediaries, regulators, and institutions. To “lead the way” in crypto, and make the licensing hub aspiration a reality, the UK government and its regulators must overcome this starting point and show themselves to be practical, innovative, and tech-native.