Introduction

1. Global regulators are in a race to keep pace with developments in cryptoassets. The authorities have to strike a balance between protecting consumers and businesses, on the one hand, and encouraging innovation, on the other hand. Global regulation of cryptoassets has created a patchwork of different regimes, and developments are occurring frequently. The purpose of this note is to give an overview of the regulation of cryptoassets in the UK, and how the FCA apply the regulatory perimeter to market participants undertaking activities in digital assets. It also looks at the future for cryptoasset regulation. It is intended as a high-level introduction to the topic. For further information, please contact the author. 

What are Cryptoassets? 

2. The term “cryptoasset” is not currently defined in the UK financial services regime. However, the UK Financial Services & Markets Act 2023 includes the following definition for the UK’s financial services regulatory framework, to be introduced into the Financial Services & Markets Act (FSMA): “any cryptographically secured digital representation of value or contractual rights that—(a) can be transferred, stored or traded electronically, and (b) that uses technology supporting the recording or storage of data (which may include distributed ledger technology).” The UK regulatory taskforce and subsequent work has subdivided cryptoassets into four main types of token: (a) security tokens; (b) e-money tokens, (c) exchange tokens; and (d) utility tokens. The first two are already regulated, the second two are currently unregulated. 

1. Security tokens grant some rights of ownership or rights to payment of a specific sum of money, or entitlement to future profits. They are often used as a capital raising tool. Because they provide rights and obligations akin to traditional specified investments, they fall within the regulatory perimeter and are regulated by the FCA. This means that a firm carrying on specified activities involving security tokens need to be authorised under Part 4A of FSMA. 
2. E-money tokens enable users to make payment transactions with third parties, so must be accepted by more parties than just the issuer. They include fiat (i.e. government issued) balances in various types of online wallet or prepaid card. They include where DLT is used to represent fiat funds, but cryptoassets that establish a new sort of unit of account, rather than representing fiat funds, are unlikely to be e-money, unless the value is pegged to fiat currency (see the E-Money Regulations). E-money tokens are regulated (either under FSMA, for credit institutions etc, or the E-Money Regulations). 
3. Exchange tokens are a decentralized mechanism of exchange for buying / selling without intermediaries. The most commonly recognized exchange tokens are cryptocurrencies such as Bitcoin and Etherium. They are not backed by a centralized authority and are generally more volatile than fiat currencies. Stablecoin is a particular type of exchange token, which the UK Government has acknowledged has the potential to develop into a widespread means of payment because it is linked to a fiat currency. Asset-referenced tokens are another subset of exchange tokens which include commodity-linked tokens and crypto-backed tokens; Commodity-linked tokens are a subset of asset-referenced tokens which aim to maintain a stable value relative to the underlying commodity price by being collateralised with one or more commodities or real-world assets, or act as a digital representation of an underlying real-world asset such as gold, property, or oil. Crypto-backed tokens are a subset of asset-referenced tokens which reference their value in relation to other cryptoassets.

Exchange tokens are currently unregulated. They can be traded on a regulated market.

4. Utility tokens grant holders access to a current or future product or service within a discrete network or ecosystem which is typically provided using a DLT platform. They are only relevant for one particular ecosystem, and cannot be used as a means of payment in any other network or ecosystem. They do not grant the holders equivalent rights to those granted by specified investments (unlike security tokens). Utility tokens are unregulated. 

What does being “Regulated” mean? 

3. The term “regulated” in the above means being regulated by the relevant regulator in the UK. There are two relevant regimes: (a) FSMA, and (b) the E-Money/Payments regime. 

1. Under FSMA, any person intending to conduct regulated activities must make an application for permission to the regulator. Such “regulated activities” are defined in the Regulated Activities Order and include activities like accepting deposits, dealing in investments as principal and/or agent, arranging deals in investments, safeguarding investments etc. “Investments” include e.g. deposits, contracts of insurance, shares, debt instruments, instruments giving entitlements to investments, options, futures, contracts for differences, regulated mortgage contracts etc. Except as noted above, cryptoassets do not currently fall within the definition of “Investments” but they may be in future – – see “Changes to UK Regulation of Cryptoassets” below. 
2. There is a separate, and specific, regulatory framework for e-money and payment services under the Electronic Money Regulations and the Payment Services Regulations 2017. As under FSMA, persons intending to conduct payment services or issue electronic money must make an application for permission to the regulator. 

4. An application under (a) or (b) above is an extensive and time-consuming exercise, with a number of ongoing obligations on the regulated firm. 

AML CTF Regime

5. Since January 2020, following an amendment to the Money Laundering Regulations (MLR), cryptoasset exchange providers and custodian wallet providers (‘cryptoasset businesses’) have been required to register with the FCA and comply with the requirements of the MLR, if they intend to provide certain cryptoasset services by way of business, and if this service will be in the course of business carried on by them in the United Kingdom. These services include the exchange, arranging or making arrangements with a view to the exchange of money for cryptoassets, cryptoassets for money, or one cryptoasset for another; the operation of a machine which utilises automated processes to exchange cryptoassets for money or money for cryptoassets; and the safeguarding or safeguarding and administering of cryptoassets or private cryptographic keys in order to hold store and transfer cryptoassets. Consequently, cryptoasset businesses have to comply with the MLR, requiring them to demonstrate that their controls, policies and procedures are adequate to deal with the money laundering and terrorist financing risks of the cryptoasset market, and requiring any officers, managers and beneficial owners of the business to be fit and proper. 

Changes to UK Regulation of Cryptoassets

6. In February this year, following a number of earlier consultations and calls for evidence, the UK government published its “Future financial services regulatory regime for cryptoassets”. The government notes the difficulty of regulating cryptoassets under the existing regimes (primarily FSMA and the E-Money Regulations and the Payment Services Regulations). The government intends to use the existing regimes where possible, but also notes there are some activities where it is not possible to use the existing legislation. The government envisages a multi-phase approach. 

7. The first phase is to bring fiat-backed stablecoins within the FCA’s regulatory remit where they are used as a means of payment. This will cover both issuance and redemption of a fiat-backed stablecoin, and payment activities involving fiat-backed stablecoins. It intends to do this through changes to the Electronic Money Regulations 2011 and the Payment Service Regulations 2017. 

8. The second phase will involve capturing a broader range of activities involving cryptoassets. This will include the following: 

1. Admitting a cryptoasset to a cryptoasset trading venue;
2. Making a public offer of a cryptoasset;
3. Operating a cryptoasset trading venue which supports: (i) the exchange of cryptoassets for other cryptoassets; (ii) the exchange of cryptoassets for fiat currency; (iii) the exchange of cryptoassets for other assets (e.g. commodities);
4. Dealing in cryptoassets as principal or agent; 
5. Arranging (bringing about) deals in cryptoassets; 
6. Making arrangements with a view to transactions in cryptoassets;
7. Operating a cryptoasset lending platform; and
8. Safeguarding and/or administering a cryptoasset.

9. The government is also addressing the risk of misleading crytoasset promotions. The Financial Services and Markets Act 2000 (Financial Promotion) (Amendment) Order 2023 came into force in May this year. The aim is to ensure that cryptoasset promotions are held to the same standards as for broader financial services promotions. The statutory instrument includes a bespoke temporary exemption to the financial promotion restriction for cryptoasset businesses (which are not otherwise authorised persons) on the FCA’s anti-money laundering register (see paragraph 5 above). The requirements of the statutory instrument come into force in September.