At the birth of the modern internet in the 1990s, cyber-libertarians argued that it created a “free” World Wide Web beyond any restrictions that could be imposed by any national regulator or government. By the turn of the millennium it was already clear that not only would the internet be subject to the increasing jurisdiction of regulators, but also, under international treaties and other forms of international co-operation, multiple regulators could work together to take jurisdiction over the same internet activity, if they considered it to be in the interests of consumers.
A similar process is currently happening with crypto. The starting point has been the existing investment regulation and e-money frameworks, on the basis that if a token closely mimics certain assets, such as e-money, shares, debt, funds or other regulated investments, then it should be regulated as such. This generally makes sense, except in two places. Firstly, the broad definition of a fund means that tokens not generally intended to function like fund units may be classified as such. (Indeed, almost every company in the UK would be a fund were it not for a specific exclusion designed to deal with this point). Secondly, where payments are made in tokens linked to fiat money this may be regulated as e-money, whereas the same function performed in cryptocurrency is unregulated.
The next factor has been regulation encroaching into new activities, led by a drive to prevent money laundering. The EU has passed its Fifth Money Laundering Directive which covers activities relating to the storage and trading of cryptoassets. In the UK, motivated by a desire to protect consumers, there is a further move to regulate the advertising of unregulated cryptoassets by requiring an FCA authorised firm to sign off advertisements. However, the actual proposed requirements for obtaining sign-off, e.g. in terms of disclosure, are far from clear. Furthermore, there are problems with the proposals as currently drafted.
These include the fact that a business dealing in unregulated tokens cannot be FCA authorised as it is not performing an FCA regulated activity and a simultaneous requirement that the FCA authorised firm cannot sign off an advertisement in relation to an asset in which it is not familiar. A possible result is that it will become practically impossible to advertise new unregulated cryptoassets. Certainly, it will mean that only very few firms, those both authorised to deal with regulated securities and well versed in unregulated tokens, can provide approval. That will lead to difficulties and delays in getting approvals, and presumably qualified FCA firms will be able to charge a hefty premium for the approval service.
Lastly, regulators in the UK and elsewhere may consider certain offerings and certain assets to be “too risky”. From the beginning of 2021, an FCA ban comes into effect on retail investment into both derivatives and exchange traded notes that reference certain unregulated cryptoassets. Whilst a judgement call, it is worth noting that the decision to impose the ban comes after a consultation in which 97% of respondents opposed the proposed ban. So, while there was a clear response, it clearly did not persuade the regulator.
What does the future hold? Looking abroad, in Europe, the Markets in Crypto-Assets Regulation (“MiCA”) takes inspiration from the regulation of investment markets and services in providing a framework for regulating currently unregulated cryptoassets. Similarly, the US is moving towards creating a more harmonised regime for crypto money services businesses. At the same time, countries across the globe ranging from China, France, Switzerland and the Bahamas are looking at implementing Central Bank Digital Currencies (“CBDCs”). This suggests a trend towards regulatory acceptance of crypto, subject to a regulatory framework.
The question, therefore, is whether to work with or against such developments. Crypto-libertarians like to point out that the original architect behind blockchain, who operated under the pseudonym Satoshi Nakamoto, was never identified, and argue that new forms of decentralised finance (“DeFi”) mean that it is (at least theoretically) possible to create fully decentralised blockchain platforms, where arguably there is no “person” against which regulators can take action, and so, they argue, it is possible to create structure outside the remit of state.
In our view it is naïve to take this viewpoint. Firstly, blockchain projects, even decentralised ones, require a person or group to administer the blockchain so that it stays operationally viable. This means that the project has legal entity dependence on its administrator. So, it is possible for regulators to control the blockchain through regulating the administrator. For example, Aave, an iconic DeFi platform, has obtained an electronic money institution licence as part of its business. Secondly, in extreme cases, states can seek to block access to websites, for example as has happened with the great firewall of China.
So, given that the preferable path is to seek to create a regulatory system that works, in which the opinions of the industry are respected, the question is how to achieve this. Part of this is building trust with the regulator, so that, when there is the next consultation, we do not again have a result where our industry goes one way and the regulator another. In this respect, the crypto industry is fragmented compared to traditional financial services which, despite sometimes fierce internal competition, tend to act together, for example through industry associations, when dealing with regulators. In addition, the shortcomings of our industry should be recognised, including the lack of consumer understanding of how it works and the perception, e.g. as stated by the UK Treasury Committee, that it is a “wild west”. It is only by unifying as an industry to overcome these difficulties that our voice will be considered worth listening to, as part of developing innovation friendly and proportionate regulation, rather than a danger that needs to be controlled.
We have to learn from history. Not just from internet libertarians but also as far back as 1720 and the regulatory changes following the South Sea Bubble in the 1700s. Much of the debate regarding crypto has parallels with the critique shares received after the collapse of the South Sea Company in 1720. At the time, the concept of shares was new, and there was general distrust towards this form of investment. After the Bubble burst, the Bubble Act 1720 was passed. It banned the creation of joint-stock companies without royal charter. Eventually this was seen as causing more harm than good, but it took more than a century until the repeal of the Act in 1825. Let us learn from history and not risk making the same mistake again.
James Burnie and Edward Black are financial services regulatory partners at law firm gunnercooke llp, with particular focus on FinTech, blockchain, crypto and DeFi.
For more information on the gunnercooke blockchain practice please see https://gunnercooke.com/practice-area/blockchain-cryptoassets-smart-contracts-and-defi/