The recent Treasury Committee report examining the role of digital currencies in the UK concluded that urgent regulation of the sector is needed to put an end to the "wild west" environment in which firms are operating today.
Three months on from that report, with time to digest its contents and implications, we offer some insight into how the industry sees the crypto landscape changing, what role regulation should play and consider what the regulatory landscape could look like going forward.
Currently the UK digital currency landscape is essentially free from regulation, other than peripheral regulation dealing with crypto derivatives and anti-money laundering regulations that are applicable regardless of the specific sector (which the FCA have re-iterated apply to cryptocurrencies). Sometimes, businesses have a tendency to view regulation as stifling innovation, particularly in fast-growing tech-sectors, by burdening entrepreneurs with undue administration and bureaucratic red-tape. Contrary to this belief, we would argue that the digital currency sector is a unique sector that needs regulation in order to grow and prosper.
Early market movers in this sector are being held back by the general consensus that cryptocurrency is inherently risky (eg: price volatility, security, money laundering and terrorist financing). Even the most basic things like opening a bank account, or taking out an insurance policy for a cryptocurrency company are challenging because of this perception.
By operating in a regulated environment, it could alleviate this perception by demonstrating stability and a sector that both business and retail consumers can trust. This will allow new and existing market participants to grow and build the industry. We have already seen the likes of Malta and Gibraltar invoke digital currency regulatory regimes in order to attract investment and build trust in this space. Such measures are already proving a magnet for legitimate digital currency companies, with Binance, the world’s largest cryptocurrency exchange by traded value, moving its operations to Malta in 2018.
Whilst the UK prides itself on its innovative financial services sector, there is a clear failing with regards to digital currencies, and we see regulation as a major part of the answer. We suggest that the technology behind cryptocurrency (ie: blockchain) will, in the next 5 to 10 years, be a crucial component of the UK financial system, and we should urge regulators to act now before mass market adoption. Left unregulated, the risks to the economy, let alone the cryptocurrency sector, could be too large to ignore.
As a pre-emptive measure, some digital currency industry leaders have taken it upon themselves to self-regulate (eg: Crypto UK was established in early 2018 and includes members such as Coinbase, Pillar and eToro) in an attempt to distinguish themselves from the less reputable market participants. Such measures include implementing their own voluntary code of conduct and adopting increased internal security standards. Whilst this is a step in the right direction, there is no uniformity across the sector, nor any penalties for breaching these codes.
We suggest that it is not a question of "if" cryptocurrency should be regulated, but rather when, and what should it look like in practice?
The industry's answer to the first question is, quite simply, as soon as possible.
The longer the "wild west" environment continues, the longer the industry's consumers and suppliers alike must bear the risks and difficulties associated with it.
The latter question is more difficult to answer. The Treasury Select Committee proposed adding a set of new, "crypto-asset" activities into the existing regulatory framework , via the Financial Services and Markets Act (Regulated Activities Order) 2001. The same approach was taken when regulating the Peer to Peer market.
Whilst the Treasury proposal would arguably seem to be the most logical and efficient method of regulation, we hold the view that attempting to shoehorn the regulation of what is a very complex technology-driven product into the existing financial regulatory regime may not be the answer.
Rather, we suggest establishing a specialist regulator created specifically to deal with digital currencies and distributed ledger technologies (DLT) is the more effective method of regulation (similar to what has been established in Gibraltar). Whilst this may be wishful thinking given the likely very large set up costs, procedures and inevitable teething problems, we see it as essential when dealing with an industry which is rapidly changing even day by day. A specialist regulator means we are less likely to be constantly "chasing regulation" and it would allow for greater adaptability and a quicker and more effective response to new developments and technology in the industry.
It is positive that many of the key players in the industry support the Treasury Committee's position that regulation is key to growing the cryptocurrency sector in a safe, secure way. Now it looks like change is on the horizon, the important next step is for those involved in the industry to shape (and gently nudge) the conversation to help the Government in setting up this regulatory regime.
TLT is focused on bringing together some of the key players in the industry to share ideas, have industry wide conversations, and help shape the future of cryptocurrency/DLT regulation.
Please get in touch if you would like to attend our next roundtable discussion in January where we will discussing ICOs and their relevance in 2019 and beyond.
This publication is intended for general guidance and represents our understanding of the relevant law and practice as at January 2019. Specific advice should be sought for specific cases. For more information see our terms & conditions.