Cryptos – The Regulatory Noose Tightens

29th July 2020 Corporate

The Financial Conduct Authority has decided that it wishes to bring more cryptoassets within its regulatory perimeter, and opened a consultation as to its proposals as to how to do so. This has arisen because the FCA are concerned, perhaps not entirely unfairly, that cryptos are often targeted at retail investors who may not fully appreciate the risks involved in investing and that promotional materials are not typically fair, clear and not misleading. They have also been concerned to see some firms they regulate marketing cryptoassets without making it clear that they are not regulated in relation to those activities

Currently cryptoassets are broadly only regulated by the FCA if the underlying investment is already regulated – for example if the crypto amounts to e-money or represents underlying shares or bonds.

The FCA’s proposal is to add “qualifying cryptoassets” to the list of controlled investments in the Financial Promotions Order and amend the controlled activities in the Regulated Activities Order so that they apply to qualifying cryptoassets. The end result of this is that qualifying cryptoassets will be regulated in the same way as shares or bonds.

The proposed definition of a qualifying cryptoasset is “any cryptographically secured digital representation of value or contractual rights that uses a form of distributed ledger technology and which — (a) is fungible; (b) is transferable or confers transferable rights, or is promoted as being transferable or as conferring transferable rights; (c) is not any other controlled investment as described in [the relevant part of the Financial Promotions Order]; (d) is not electronic money within the meaning given in the Electronic Money Regulations 2011; and (e) is not currency issued by a central bank or other public authority.

The cryptoassets needs to be both fungible and transferable or conferring transferable rights (or be promoted as such), and for these purposes the concept of “fungiblity” refers to an asset being freely replaceable by another of similar nature or kind. The example the FCA uses is that one £5 note can be exchange for another and they are functionally equivalent and therefore fungible.

The requirements for fungiblity and transferability are intended to ensure that the new regulation does not hamper potentially useful developments in the blockchain and cryptoasset worlds. For example, the requirement for fungiblity is intended to exclude digital collectibles such as Cryptokitties. Similarly the requirement for transferability means that closed-system cryptoassets which can only be redeemed via the issuer are excluded. This should be helpful in many smart-contract uses.

Most cryptoassets which are offered to the public at the moment would fall within the definition of qualifying cryptoasset – for example Bitcoin and Ether would clearly be caught, and the FCA expects that most stablecoins would as well.

The FCA is increasingly concerned about risky investments being promoted to retail investors, not least following the recent mini-bond scandals, and it is not surprising that they have looked again at cryptoasset issues. While the exact regulatory wording introduced may change following the consultation it seems inevitable that something along the lines of what has been proposed will shortly become the law. While this may hamper individual cryptoasset launches in the short term, hopefully it will ultimately help ensure that cryptoassets become a mainstream asset class.

Contact Details

JMW Solicitors LLP frequently advises on cryptoasset, fundraising and financial services regulatory issues. If you need any assistance in relation these or other legal issues please contact please contact John Young of our London Office at john.young@jmw.co.uk or 0345 241 5305.

This note is for general guidance only and should not be used for any other purpose. It does not constitute, and should not be relied upon as legal advice. It relates to the position in England only.

JMW Solicitors is a Limited Liability Partnership.

The copyright in this note is owned by JMW Solicitors. Any reproduction of this article should be credited to JMW Solicitors. All rights reserved.

This note is correct as of 29 July 2020

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John Young is a Partner located in Londonin our Corporate and Commercial department

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