Bitcoin’s bull run over the past year has seen its value reach a new peak of US$60,000 per Bitcoin in March 2021. In February 2021, the aggregate value of the 18.6 million Bitcoin tokens currently in circulation surpassed US$1trn, representing approximately half of the entire cryptocurrency market value of US$2trn. In parallel, the global market has seen other cryptocurrency prices rise alongside the share prices of many cryptocurrency-related businesses.
In the USA, financial giants have started embracing cryptocurrency in novel ways: Mastercard is integrating Bitcoin into its payment systems and BNY Mellon has announced plans to hold Bitcoin and other cryptocurrencies on behalf of its clients. These events reflect a surge of institutional interest in the emerging Bitcoin and cryptoasset class. On the corporate side, Tesla recently purchased US$1.5bn of Bitcoin for its corporate treasury.
This growth has been analysed in various ways and there is no consensus as to the reason for the continued rise in Bitcoin’s value. One thing is clear: digital currencies such as Bitcoin are now both firmly rooted and more prevalent in the financial landscape.
Just as we have seen growth in value, so too have we seen a flurry of regulatory and political activity in connection with cryptocurrency in the first quarter of 2021.
On 13 January 2021, the president of the European Central Bank Christine Lagarde called for global regulation of Bitcoin. In an interview at the Reuters Next conference, she said that ‘[Bitcoin] is a highly speculative asset, which has conducted some funny business and some interesting and totally reprehensible money laundering activity’.
Generally speaking, cryptoassets have to date been subject to light-touch (if any) regulation, although we have seen interesting developments in associated areas such as anti-money laundering and terrorist financing.
US regulatory developments
In December 2020, the US Securities and Exchange Commission launched enforcement action against Ripple for raising capital of US$1.3bn by offering allegedly unregulated digital asset securities, leading to Ripple being delisted on various exchanges. In the same month, the US Treasury Department’s Financial Crimes Enforcement Network (FinCEN) announced proposed legislation which introduces data collection and reporting obligations in respect of transactions involving convertible virtual currency (CVC) or digital assets with legal tender status (LTDA).
FinCEN’s notice of proposed rulemaking contemplates that banks and money service businesses will be required to submit reports, eg file a currency transaction report (CTR), keep records, and verify the identity of customers in relation to transactions above certain thresholds involving (i) CVC/LTDA wallets not hosted by a financial institution (ie unhosted wallets), or (ii) CVC/LTDA wallets hosted by a financial institution in certain jurisdictions identified by FinCEN.
FinCEN is proposing to adopt these requirements via the Bank Secrecy Act (BSA) and to prescribe by regulation that CVC and LTDA are ‘monetary instruments’ for the purposes of the BSA. In January and March 2021, FinCEN issued notices reopening the consultation period on the proposed legislation and, latterly, extending time for responses to all aspects.
However, in its notice of January 2021, Fincen stated regarding ‘the proposed reporting requirements’ that:
‘these proposed requirements are essentially equivalent to the existing CTR reporting requirements that apply to transactions in currency. The proposed rule is a vital loophole-closing measure to prevent illicit transactions using CVC and LTDA, including the financing of terrorism, in light of the fact that such transactions would otherwise be subject to familiar and long-established reporting requirements if they were in cash.’
The potential impact of this regulatory development is significant. If implemented in the manner and with the effect contemplated by FinCEN, this legislation strikes at the roots of some of the anonymity associated with cryptocurrency. Some commentators argue the proposed regulations threaten legitimate expectations of financial privacy of individuals and impose on virtual currency transactions a disproportionately broader compliance burden (eg collection of addresses of counterparties of customers) which is not imposed on cash transactions.
UK regulatory developments
Regulators on this side of the pond have also taken steps in relation to cryptocurrency. On 11 January 2021, the Financial Conduct Authority (FCA) issued a notice warning consumers of the risk of investments advertising high returns based on cryptoassets:
‘Investing in cryptoassets, or investments and lending linked to them, generally involves taking very high risks with investors’ money. If consumers invest in these types of product, they should be prepared to lose all their money.’
Current UK policy is rooted in the UK Cryptoassets Taskforce’s Final Report (bit.ly/3rEE8Ln) published in October 2018. This identified cryptocurrencies as a subset of the ‘cryptoasset’. The report provided non-legislative definitions to three sub-categories of cryptoasset:
- Exchange tokens (ie cryptocurrencies such as Bitcoin, Litecoin etc). These tokens use a distributed ledger technology (DLT) platform and are not issued or backed by a central bank or other body, they are a means of exchange or investment;
- Security tokens, which constitute a ‘specified investment’ pursuant to the Financial Services and Markets Act (2000) (Regulated Activities) Order, SI 2001/544, and may also constitute transferable securities or financial instruments under the EU’s Markets in Financial Instruments Directive II; and
- Utility tokens, which can be redeemed for access to a specific product or service provided using a DLT platform.
It is well known that there is no blanket prohibition or restriction on cryptocurrencies in the UK, and nor does the UK yet have a specific regulatory regime for cryptoassets. Accordingly, in terms of financial regulation, whether or not a cryptocurrency is subject to regulation depends on whether the specific cryptoasset falls within (i) the scope of the Financial Services and Markets Act 2000 (FSMA 2000), (ii) the anti-money laundering regime, or (iii) the payment services and electronic money regime established under the Payment Services Regulations 2017, SI 2017/752, and the Electronic Money Regulations 2011, SI 2011/99.
This plurality of regulatory regimes is reflected in the cryptoasset ‘taxonomy’ contained in the FCA Guidance on Cryptoassets of July 2019 (bit.ly/2QYSgCH). In practice, analysing whether a cryptocurrency is subject to UK financial regulation involves navigating the taxonomy on a case-by-case basis. The FCA guidance does, however, note that cryptocurrencies which are not centrally issued and give no rights or entitlements are ‘exchange tokens’ in the taskforce report and ‘unregulated tokens’ in the FCA guidance.
Accordingly, in the FCA’s view:
‘Exchange tokens currently fall outside the regulatory perimeter. This means that the transferring, buying and selling of these tokens, including the commercial operation of cryptoasset exchanges for exchange tokens, are activities not currently regulated by the FCA. For example, if you are an exchange, and all you do is facilitate transactions of Bitcoins, Ether, Litecoin or other exchange tokens between participants, you are not carrying on a regulated activity.’
In a nutshell, this means that exchange tokens are likely to be unregulated unless they are comparable to other regulated investments (eg shares), in which case they are more appropriately classified as a security token.
That is not to say that the UK’s regulatory approach has been static. On 10 January 2020, the UK’s Money Laundering and Terrorist Financing (Amendment) Regulations 2019, SI 2019/1511, entered into force. This updated the Money Laundering, Terrorist Financing and Transfer of Funds (Information on the Payer) Regulations 2017, SI 2017/692 (the MLR) and transposed the EU’s Fifth Money Laundering Directive into domestic law. This development required that all UK cryptoasset businesses must register with the FCA. Existing cryptoasset businesses (ie those that were already carrying on cryptoasset activity immediately before 10 January 2020) were able to continue with that business in compliance with the MLR, provided they registered with the FCA by the deadline of 10 January 2021. Failure to register will mean that the relevant business must stop all cryptoasset activity.
January 2021 also saw another regulatory milestone in the UK. On 6 January 2021, the FCA’s ban on the sale and distribution of crypto-related investment products (derivatives and exchange traded notes that reference certain types of cryptoassets) for retail customers came into force. The FCA had previously announced that it considered those products to be ill-suited for retail consumers ‘due to the harm they pose’ and because of the fact that ‘these products cannot be reliably valued by retail consumers’. Taken together, these developments reflect a gradual encroachment of legislative controls—particularly in respect of (unregulated) exchange tokens—in a currently unregulated environment.
It is clear that the UK government is now fully alive to these issues. On 7 January 2021, the UK treasury announced the first stage of a consultation process with industry and stakeholders on a broader regulatory approach to cryptoassets and, in particular, stablecoins (a type of cryptocurrency whose value is tied to other ‘stable’ assets, eg the US dollar or gold). The consultation, which closed on 21 March 2021, sought views on how the UK can ensure that its regulatory framework ‘is equipped to harness the benefits of new technologies… while mitigating risks to consumers and stability’.
These developments reflect a burgeoning governmental awareness, here and abroad, of the potential of DLT and cryptoassets as they begin to occupy a central position in the financial markets. With this enhanced governmental focus, there is a perceived need to regulate so as to protect consumers and prevent illegal activity. It is clear that 2021 will be a big year for cryptocurrency regulation as we await the findings of the UK consultation.