Regulating unbacked cryptoassets

Earlier this year, UK Finance teamed up with one of our associate members, KPMG, to produce a report on regulating unbacked cryptoassets.

The detail of what precise rules may need to apply to an increasingly wide and complex array of crypto products, services and processes will inevitably take time to fully bottom out. However, there was a clear appetite in our member workshops to look at the existing regulations and rules as a starting point. The collapse of a major crypto exchange during the time we were writing the report emphasised the need for some regulatory oversight to reduce consumer harm.

Report: The Future Regulation of Unbacked Cryptoassets in the UK

We looked through the lens of the Financial Conduct Authority (FCA)’s operational objectives, including consumer protections, market integrity and effective competition. Overlaying that, we considered first how these assets interact with financial services’ cross-sectoral regulatory requirements (such as financial resilience, operational resilience, financial crime and governance). We then analysed three use cases to help us tease out what specific regulations might be relevant.

These use cases were trading, custody and payments. It was recognised that the payments use case for unbacked cryptoassets may be a bit more nascent. However, there was nevertheless a view that it would be helpful to include in order to develop thinking early – and during a time when many of the rules are being reviewed.

Looking at the trading use case, our analysis showed that some regulatory requirements, like the financial promotions regime, are already due to apply to unbacked cryptoassets. Suitability tests (like those expounded upon in the EU MiCA Regulation) could also be applied, possibly built into websites/interfaces or through ‘positive frictions’ like the FCA’s suggested self-certification processes.

Defining the trading of cryptoassets or the safeguarding of cryptoassets as a regulated activity would require firms to comply with the FCA’s Principles of Business. Meanwhile, defining cryptoassets as financial instruments could bring them into CASS and the on-shored MiFID and MAR regimes.

In regard to custody, the Financial Stability Board (FSB) proposes that authorities should supervise and regulate custodial wallet service providers, proportionate to their risk, size, complexity and systemic importance. In the UK, it has also been suggested that regulators apply CASS rules as a basis for building a regulatory regime for the custody of cryptoassets. This would provide a framework for identification of client assets, segregation and safeguarding, reconciliation, and registration and legal title.

Finally, for the payments use case (although more nascent) the regulatory considerations share the same focus as that of stablecoins – namely, the Payment Services Regulations (PSRs) and E-Money Regulations (EMRs).

Both of these regulations are likely to be reviewed in the next 12-18 months as part of the Future Regulatory Framework analysis and therefore an opportunity is available to ensure effective application of rules for consumer protection, safeguarding and segregation. In addition, early consideration may be helpful of emerging expectations of ‘payments providers’. These will sit alongside the Consumer Duty, and might apply to unbacked cryptoasset service providers, for example, around purchase protection, reimbursement and fraud data sharing.

Overall, we hope that the report will be a useful addition to the debate around this topic. The existing regulatory framework, though not perfectly suited to these new innovations, is nevertheless a helpful starting point. This report will hopefully assist relevant stakeholders in marrying the UK’s regulatory frameworks to the novel world of unbacked cryptoassets.