Crypto and Blockchain

In February, the House of Commons Treasury Committee announced an inquiry into digital currencies. The inquiry covers the role of digital currencies in the UK and the potential impact of distributed ledger technology (blockchain) on financial institutions and financial infrastructure.

Written and oral evidence has been received and on 22 May 2018, the Committee published written evidence from (amongst others) the UK Financial Conduct Authority (FCA), the Bank of England (BOE) and the Financial Reporting Council (FRC, the UK's independent accounting regulatory body) in which they outline their respective work in and views of this area. This note provides high-level commentary on some key points of interest from such written evidence. Details of the inquiry and its publications can be found here.

The FCA's submission commences with a helpful overview of how it considers different forms of crypto-assets (the FCA's term for cryptocurrencies) and products are positioned in relation to its regulatory perimeter.

As the FCA has stated many times before, cryptocurrencies are generally outside the scope of FCA regulation. Cryptocurrency transactions, including operating cryptoexchanges, also typically fall outside the FCA’s regulatory perimeter. Certain other crypto-related products will generally be in scope: derivatives with a crypto underlying, regulated payments services which use cryptocurrency, tokens representing transferable security and investment assets in cryptoassets. The last item is potentially curious, but given the FCA lists "Swedish registered exchange traded notes" as a use case, it seems to refer to ETFs (or other funds/structures) which allow investors to gain exposure to cryptocurrencies. However, the FCA points out that the applicability or otherwise of the FCA regime to a given crypto-asset or product needs to be assessed on a case by case basis.

The FCA also discusses what it sees as the main benefits and risks arising from cryptocurrencies, derived from the FCA's experiences on recent blockchain related initiatives including the Regulatory Sandbox. Benefits include high-speed, secure transfers of assets. Risks include the usual suspects of volatility, market abuse and market disruption by derivatives. On this last point, the FCA mentions ESMA's intention to limit leverage in crypto CFDs to 2:1 for retail products.

The FCA also discusses the risks of money laundering, noting that most crypto-related activities fall outside current anti-money laundering requirements in the UK, but accepting that many cryptoexchanges already carry out a degree of anti-money laundering checks on customers. However, the FCA points out that new EU rules are expected to be introduced later this year, to be implemented late-2019, which would apply anti-money laundering requirements to cryptocurrencies and exchanges.

In its submission, the BOE comes across as more sceptical of cryptocurrencies generally. This could be an outgrowth of the Bank's position as macro-prudential regulator and overall gatekeeper to the UK financial industry (through the PRA and FPC); in contrast to the more accepting tone of the FCA (which as a conduct regulator is faced with the challenges of engaging with businesses already active in the blockchain/crypto space). It could be a reflection of the BOE's position as central bank and/or an acknowledgement of the potential upheaval to traditional banking institutions and processes from blockchain.

The BOE states that it thinks it unlikely that cryptocurrency will replace commonly used payment systems, but this statement belies a monochromatic model of the world. Perhaps the most noteworthy item from the BOE's evidence is that it does not now plan to issue a digital currency, at least in the medium term.

The FRC's submission draws attention to the uncertainty surrounding the accounting treatment of cryptocurrencies or other tokenised assets. In particular, the FRC has flagged that this question is not yet on the agenda of the International Accounting Standards Board who set global accounting standards. This uncertainty leads to divergence of accounting practices as well as uncertainty around those practices as stakeholders seek to adopt appropriate accounting practices in the absence of official guidelines.