Regulation is now beginning to catch up with cryptoassets.
The cryptoasset market has evolved quickly and there are now many different types of cryptoassets or “tokens”. In the UK, some cryptoassets are regulated while others are not and different types of cryptoasset require different types of regulatory treatment. This has created a somewhat confusing regulatory landscape for those working with cryptoassets, until now.
Following on from its public consultation, the Financial Conduct Authority (FCA) has now published its finalised Guidance on Cryptoassets PS19/22 (Guidance). The Guidance provides the FCA’s view on categorising cryptoassets and establishing their regulatory treatment.
As a firm, we have been advising clients in relation to cryptoassets from the outset and, whilst useful having the FCA’s view in writing and in a fair amount of detail, the Guidance does not really tell us anything new. In this article we will consider the Guidance and the extent to which the various types of cryptoasset or token do or do not fall within the FCA’s regulatory remit.
By and large tokens fall into two types: those that are regulated and those that are unregulated.
According to the Guidance, there are two types of regulated tokens:
- security tokens; and
- e-money tokens.
Any person who is engaged, by way of business in the United Kingdom (UK), in any activity that relates to a regulated token should consider whether they need to be authorised by the FCA. Carrying out a regulated activity without the required regulatory status (and either being authorised or exempt) is a criminal offence.
Among those to whom this question is likely to be relevant are:
- exchanges and trading platforms;
- payments providers;
- custodians / wallet providers; and
- advisers, brokers and other intermediaries.
Security tokens are tokens that provide rights and obligations akin to those provided by instruments which are “specified investments” which are regulated for the purposes of UK financial services law.
By way of example, shares are “specified investments” which may provide voting or dividend rights in respect of a company. A token which provides voting or dividend rights in respect of a company would therefore be providing rights and obligations akin to those provided by shares. Such a token would be a security token and, therefore, regulated.
It is worth noting that anything which represents “rights to and interests in” another investment is itself a type of “specified investment”. Some tokens, for instance, may represent the beneficial interest in a specified investment (such as a share). Such tokens should be carefully considered so that a determination may be made as to whether they are regulated security tokens.
Similarly, derivative products are products whose value derives from an underlying asset or thing. It will often be the case that the derivative product is regulated while the underlying asset is not regulated. As such, a token whose value derives from another cryptoasset may be a regulated token even if the underlying cryptoasset is unregulated.
E-money tokens are tokens which meet the definition of e-money set out in the Electronic Money Regulations 2011 (EMRs). According to this definition, e-money is “electronically (including magnetically) stored monetary value as represented by a claim on the electronic money issuer which is:
- issued on receipt of funds for the purpose of making payment transactions;
- accepted by a person other than the electronic money issuer; and
- not excluded by Regulation 3 [EMRS]”.
The Guidance states that cryptoassets that establish a new sort of unit of account but which do not represent fiat funds are unlikely to amount to e-money unless the value of the unit is pegged to a fiat currency. However, the Guidance adds that even where the value of the unit is pegged to a fiat currency, the question of whether or not the relevant token is an e-money token will still depend on the facts of each case.
According to the Guidance, there are two types of unregulated tokens:
However, as it is noted in the Guidance, some FCA rules will still be relevant to FCA-authorised firms even when they are providing services in relation to unregulated tokens.
As the name implies, exchange tokens are intended to be used as a means of exchange (rather like traditional fiat currency). However, while it is possible for exchange tokens to be used as a means of exchange, no such tokens are currently recognised as legal tender in the UK and are not considered to be currency or money.
Exchange tokens can be acquired and held for the purpose of speculation, with holders hoping that the tokens will increase in value. The FCA does not, however, consider that exchange tokens are specified investments. Where tokens are acquired and held for the purposes of speculation, the FCA sees this as analogous to acquiring and holding any other type of unregulated asset, such as gold.
Given the nature of exchange tokens, the FCA has confirmed that it is not looking to regulate them.
Utility tokens provide holders with access to particular services and/or products. They often operate in much the same way as pre-payment vouchers and are sometimes used in the context of rewards-based crowdfunding.
As with exchange tokens, utility tokens may be traded on a secondary market and be used for speculative investment purposes. However, this does not in itself mean that these tokens will be “specified investments”.
Given the nature of utility tokens, the FCA is not looking to regulate them.
Unregulated tokens and FCA-authorised firms
The Guidance states an FCA-authorised firm carrying on unregulated activity (including with regard to unregulated tokens) may still need to consider various provisions from the FCA’s Handbook of Rules and Guidance. In particular the Guidance refers to:
- the Principles for Business;
- the Senior Managers and Certification Regime; and
- the Threshold Conditions for authorisation.
Tokens and money laundering
This article has only considered the extent to which different types of cryptoasset do or do not fall within the FCA’s regulatory remit. We have not discussed the law and regulation that applies to cryptoassets more generally. However, as referred to in the Guidance, the European Union’s Fifth Anti-Money Laundering Directive (which is currently due to transposed into UK law by 10 January 2020) would introduce a new anti-money laundering regime for certain cryptoassets and the FCA would be the supervisor for this regime. The FCA will be consulting about this later in the year.
The Guidance provides welcome clarification both on the FCA’s categorisation of cryptoassets and on the approach that the FCA will take to these different categories.
However, the nuanced nature of many cryptoassets and the increasingly innovative approaches being taken by many market participants mean that it will not always be clear whether a particular token falls within or without the FCA’s regulatory remit.
Anyone operating a token-related business should make sure that they are completely comfortable as to the regulatory status of every type of token that they are dealing with; and should seek legal advice if they are not sure.