Freshfields's global head of fintech, Richard Lister, explores the key regulatory developments as cryptocurrencies continue to evolve.
The crypto space has been a hotbed of activity in the last twelve months. Not only has the highly volatile price of the universally recognised bitcoin generated numerous headlines, but uncertainty also swirls around what the future holds for all types of asset based on distributed ledger technology (DLT).
In fact, the popularity of similarly unpredictable tokens offered through initial coin offerings (ICOs), and security token offerings (STOs), has kept commentators, investors and regulators (not to mention us lawyers!) incredibly busy. These cryptoassets have sprung up over the last few years at a rate of knots, inducing many a legislative headache in the process. What then is the best approach to regulation without stifling innovation?
The UK’s current legal position on said assets has been described by Lord Hodge of our Supreme Court as an area of doubt. However, what can we actually expect to see over the course of the next twelve months? An eroding of the inertia that’s come to characterise the status quo? Or more of the same?
There are three key observations we’ve made that I believe indicate the current regulatory mood.
Both the UK government and national regulators have already demonstrated a strong preference for ensuring that these assets are sufficiently regulated – i.e. given a clear legal classification and set out in statute, which in turn helps to underpin any regulatory regime.
The deluge of recent reports produced by the likes of the ESMA, FSB, FCA and the Cryptoassets Taskforce has collectively made it very apparent that regulators don’t intend to sit still on this matter for much longer. Yet, despite the incremental signs of movement, substantial work is still required to nail down an appropriate regulatory framework.
The need for a case-by-case approach
As is typically the case with any emerging technology however, defining the parameters is extremely difficult. If anything, using precise rules to define what legally constitutes a cryptoasset can mean not covering categories of cryptoasset, as these can be structured in completely different ways. In other words, there is no one size fits all solution.
For example, the way that legal title transfers in a bitcoin transaction may very well be different for Ethereum’s account-based model. Although some existing methods of legal transfer may be easier than others - the Ethereum model looks much more like a typical bank or securities account than the bitcoin model for instance – it’s very likely that each case will continue to require unique and distinct legal analysis. The challenge for regulators is how to cover these accordingly to ensure appropriate protections.
HM Treasury and the FCA exploring options
Interestingly the HM Treasury has advised that it may need to shift certain regulatory boundaries for cryptoassets through legislation. The underlying intention for doing so would be to reflect policy concerns about the effect of a potential cliff edge - i.e. tokens not currently subject to financial services regulation are unlikely to fall under another regulatory regime.
The FCA has said that it will provide technical advice to HM Treasury on extending the regulatory perimeter for utility and exchange tokens (which, generally, are not currently regulated) – this is in addition to the FCA’s proposed guidance on how regulation currently affects so-called securities tokens.
HM Treasury is also looking at changes to the money-laundering regime in the cryptoasset context. The EU’s Fifth Anti-Money Laundering Directive (MLD5), which is required to be implemented across EU member states by January 2020, will apply to wallet providers and fiat-crypto exchanges. HM Treasury is considering going significantly beyond the MLD5 requirements and is consulting on whether to bring other activities into the regime, including issuance of new cryptoassets, crypto-to-crypto exchange service providers, peer-to-peer exchange service providers and cryptoasset ATMs.
Until now, the early and thus far short-lived history of cryptoassets has been akin to somewhat of a wild west (arguably it still is). Notwithstanding previous developments, efforts to regulate such assets have felt much like an attempt to turn an oil tanker. Today though, it’s starting to feel like regulators are highly motivated to move on from this very situation. Let’s see if fitting legislation does indeed follow suit.
Richard Lister is Partner & Global Head of Fintech at Freshfields Bruckhaus Deringer LLP.