Finance: Regulators scramble to get to grips with crypto-assets

Jonathan Watson

Crypto-assets such as bitcoin are now embedded in certain pockets of society and industry, says a recent report from the United Kingdom House of Commons Treasury Committee, an influential group of MPs, published in September. ‘It is highly likely that they are here to stay,’ the report says.

With this in mind, governments and financial services regulators around the world – including in the European Union and the United States – are considering their next moves as they seek to bring law and order to the ‘wild west’ of crypto-assets.

In the UK, representatives of the Financial Conduct Authority (FCA), the Treasury and the Bank of England teamed up in April to form the Cryptoassets Taskforce and they have now published their final report.

Already last year, ICOs helped raise over six billion dollars in funding and this year this figure will be substantially bigger

Valdis Dombrovskis
EU commissioner

In line with this report’s recommendations, the FCA has vowed to launch a consultation in the first quarter of 2019 on whether to prohibit the sale of derivatives – such as contracts for difference, options and futures – based on cryptocurrencies to retail investors.

At EU level, the European Securities and Markets Authority (ESMA) says it plans to spend over €1m on the surveillance of financial technology (Fintech) and crypto-assets with the aim of developing a uniform rulebook for EU financial markets. ‘ESMA recently sent different case scenarios to all the national regulators in the EU and asked them to consider how they would apply existing financial services law,’ says Imelda Higgins, a senior associate at Irish law firm McCann Fitzgerald. ‘Its findings may be used as a springboard for EU-level action.’

Higgins believes the European Commission is now more positive about crypto-assets than it has been in the past. ‘However, the idea is to understand how the existing regulatory framework applies to crypto-assets before starting to look at amending that framework or introducing a bespoke framework.’

Initial coin offerings (ICOs) have the potential to emerge as a viable form of alternative financing, EU commissioner Valdis Dombrovskis said after an informal meeting of EU finance and economics ministers in September. ‘Already last year, ICOs helped raise over six billion dollars in funding and this year this figure will be substantially bigger,’ he said.

However, he noted that a lack of transparency meant there were significant risks attached to ICOs, such as money laundering, potential fraud or hacking. The UK Treasury Committee report used more direct language, describing the current setup as a ‘wild west’ situation. In some countries, notably China and South Korea, ICOs have been banned altogether.

‘The most important development for crypto-assets will be their legitimisation in the financial system through increased institutional involvement in the crypto ecosystem and increased regulatory oversight,’ says Josh Hogan, Young Lawyers Liaison Officer for the IBA Banking Law Committee and head of the Financial Services Regulatory Group at McCann Fitzgerald. ‘Given that we are still very much in the early days of the development of crypto-assets, having regard to their relatively small market capitalisation and limited use adoption, the “wait and see” approach by many regulators to date has probably been the correct stance.’

Josh Hogan, McCann Fitzgerald

However, that is now changing. There is a better and more sophisticated understanding of the different types of tokens and their value propositions by regulators. ‘While a lot of regulatory focus to date has been on ICOs and the trading and custody of tokens, and I expect those are likely to be the first areas to be regulated, we should in time also see more nuanced regulation for different types of tokens,’ Hogan says. ‘For example, the regulatory risks of a payments token such as Bitcoin or Litecoin – which are effectively intended to act as a substitute for money – are probably quite different to that of a utility token such as the Basic Attention Token, which rewards users of the Brave browser for watching advertisements.’

France appears to be bidding to position itself as the jurisdiction of choice for ICOs. The government is currently finalising legislation that is designed to regulate them. If the measure is adopted, France will be the first large EU Member State to create bespoke legislation that clearly defines the process to publicly offer this kind of asset.

The French system would allow ICO issuers to approach the regulator, the AMF, for a ‘visa’ to raise capital via a token offering. The regulator’s blessing would provide a seal of approval for investors. However, ICOs that do not seek a visa would still be allowed.

‘The registration of authorised businesses will help create a “white list” of companies that comply with AMF requirements,’ says Guillaume Morat, a Paris-based senior associate at Pinsent Masons. ‘These companies should be more attractive to investors than those not on the list as it will let those customers see which propositions are deemed to be safe and which are not.’

In the US, the regulation of crypto-assets differs among states and among regulators. Exchanges that operate in New York, for example, have to obtain a ‘BitLicense’ for virtual currency businesses. This has not been popular and the New York State Department of Financial Services has approved few applicants so far. ‘BitLicense has proven to be a disastrous attempt at regulating the industry, and not a template that others should follow,’ says the Bitcoin Foundation.

Crypto-assets are also attracting attention at national level in the US. The US Securities and Exchange Commission (SEC) sees certain crypto-assets as securities within the meaning of the federal securities laws, and earlier this year voiced specific concerns about the cryptocurrency asset class. The regulator has also taken enforcement action where it considered it necessary to deter fraudulent activity.

Noreen Weiss, MacDonald Weiss

‘US regulators’ attention also extends to crypto trading platforms,’ says Noreen Weiss, partner at boutique law firm MacDonald Weiss, ‘with the SEC concerned about trading security tokens and the CFTC (Commodity Futures Trading Commission) concerned with trading commodities.’

In November 2018 the SEC settled charges against the founder of EtherDelta, a trading platform for secondary trades in ERC20 tokens, for operating as an unregulated national securities exchange. ‘Additionally, the CFTC has ruled that digital assets are commodities – securities are not commodities – and commodities must be traded on a regulated commodities exchange,’ says Weiss, who is publications officer of the IBA Closely Held and Growing Business Enterprises Committee.