This note offers a current snapshot of the regulatory approach taken by the main financial and fiscal regulatory bodies in the U.K. to cryptocurrencies and Initial Coin Offerings (ICOs). Further developments are expected during the year.
Financial Conduct Authority (FCA)
The FCA is a main regulator of the U.K. financial markets whose strategic and operational objectives are to protect consumers and the integrity of the financial markets, and to promote effective competition.
Under the Financial Services and Markets Act 2000 (FSMA), no person may carry on regulated activity in the U.K. unless that person is an authorised person or an exempt person. Carrying on regulated activity without required authorisation is a criminal offence. Furthermore, pursuant to the financial promotions rules, a person may not communicate, in the course of business, an invitation and inducement to engage in investment activity unless that person is authorised or the content of the communication has been approved by an FCA (or European Economic Area) authorised firm.
The current regulatory perimeter in the U.K. does not specifically include cryptocurrencies, ICO tokens, or exchanges on which they are initially offered or traded. According to the FCA’s September 2017 consumer warning, most ICOs are not regulated by the FCA. Whether an ICO would be regulated must be considered on a case-by-case basis and would depend on how the ICO is structured, and what features the issued tokens have. In addition, if the tokens are offered to the public in the U.K. and constitute “transferrable securities” (as defined in the Markets in Financial Instruments Directive / MiFID II), their issuance may require publication of a prospectus.
In contrast with this seeming uncertainty, the FCA has stated that if a financial instrument has cryptocurrencies or tokens as the underlying reference asset, the activities of firms relating to these instruments (including any exchanges) may be subject to regulation under the FCA rules.
One example of such products that are regulated by the FCA is cryptocurrency-based contracts for difference (CFDs). In November 2017, the FCA issued a warning to consumers about investments in cryptocurrency CFDs singling them out as extremely high-risk, speculative products, primarily because of the interaction of high volatility, leverage and market manipulation risks. The FCA’s chief executive has also gone on the record to compare buying Bitcoin to gambling with the same level of risk.
In April 2018, the FCA published a statement confirming that firms conducting regulated activities in cryptocurrency derivatives will require authorisation by the FCA and must comply with all applicable rules in the FCA’s Handbook and any relevant provisions in directly applicable European Union regulations. The derivative products in question include cryptocurrency futures, CFDs, and cryptocurrency options.
The regulator has indicated that the door was still open for the government and Parliament to step in and bring cryptocurrencies and ICOs into the U.K. regulatory perimeter. The FCA intends to gather further evidence on market developments in ICOs and cryptocurrencies. Their findings will help to determine whether or not there is need for any regulatory action in this area.
Bank of England
In the Bank’s view, digital currencies do not currently pose a material risk to monetary or financial stability in the U.K. They do not, at present, play a substantial role as money in society, and to the extent that they act as money, they do so in parallel with the traditional currencies.
On the other hand, in his recent speech, the Bank’s Governor has highlighted the downside of digital currencies, including consumer and investor protection, money laundering, terrorism financing, tax evasion, and the circumvention of capital controls and international sanctions. These concerns are likely to continue attracting the attention of policymakers and regulators in the U.K. and globally. In particular, a proposed amendment to the Fourth Money Laundering Directive (MLD5) is envisaged by the European Commission to bring virtual currency exchange platforms and custodian wallet providers within the scope of anti-money laundering regulations, including in respect of obligations to implement preventive measures and report suspicious transactions. However, implementation of MLD5 is not expected until mid-2019, and it is still uncertain how the U.K. will treat EU laws to be implemented after Brexit.
Interestingly, the House of Commons Treasury Committee has recently initiated its own inquiry into digital currencies. It asked for submissions from interested parties on:
- The opportunities and risks digital currencies may bring to consumers, businesses and the government.
- The potential impact of distributed ledger technology (DLT) on financial institutions, including the Bank of England, and financial infrastructure.
- The regulatory response to digital currencies, including in relation to anti-money laundering legislation.
The Bank’s position is that instead of banning digital currencies and their associated activities outright, as done in a number of jurisdictions, it would be better to regulate elements of the digital currencies ecosystem to combat illicit activities, promote market integrity, and protect the safety and soundness of the financial system. This is because the underlying technology (DLT) has the potential to catalyse innovations in payment systems that will help increase efficiency, reliability, and flexibility of payments, as well as drive down transaction costs. DLT and other technologies underlying digital currencies can also have other wide-ranging applications with a potential to transform how people manage their interactions with public agencies, how businesses manage their supply chains, etc.
The Bank is undertaking continued research into the implications of creating a central bank digital currency that would give open access to individuals and firms. However, given the shortcomings in the underlying technologies and the associated risks, the Bank does not consider it as a near-term prospect.
HM Revenue & Customs (HMRC)
In March 2014, the U.K. tax office issued guidance on the tax treatment of income received from, and charges made in connection with, activities involving Bitcoin and other cryptocurrencies. The guidance is aimed at anyone making charges or otherwise receiving income from activities involving cryptocurrencies, including Bitcoin miners, traders, exchanges, payment processors and other service providers.
Bitcoin and other cryptocurrencies are generally outside the scope of U.K. Value Added Tax (VAT). However, VAT will be due in the normal way from suppliers of any goods or services sold in exchange for Bitcoin or other cryptocurrency, calculated by reference to the sterling value of the relevant cryptocurrency at the point the transaction takes place. Taxpayers can rely on the VAT treatment outlined above unless and until HMRC announces any changes. Any changes will not apply retrospectively.
With respect to other forms of taxation (such as Corporation Tax, Income Tax or Capital Gains Tax), whether activities involving Bitcoin and other cryptocurrencies will be subject to tax depends on the activities and the parties involved. They will need to be looked at on a case-by-case basis taking into account the specific facts. In HMRC’s view, no special tax rules for Bitcoin transactions are currently required.
To conclude, digital currencies and ICOs are subject to ever-increasing scrutiny by regulators around the globe, and the U.K. is not an exception. While some aspects of the digital currency ecosystem are already subject to U.K. regulation, new regulations and other forms of market intervention are likely in the near to mid-term. U.K. businesses involved in arranging, dealing or advising on digital currencies, ICOs and related derivative instruments need to consider whether their activities amount to regulated activities under U.K. law and whether they need to be authorised by the FCA. Obtaining independent legal and tax advice in this complex and fast-developing area before engaging in such activities is business critical.