Backdrop
The growth rate of cryptoassets is nothing short of phenomenal. The latest statistics from the FCA found that 12% of adults in the UK now own crypto, a 10% increase from previous findings. Many consumers were initially apprehensive about investing in such high-risk products, with events like the collapse of cryptocurrency exchange FTX in 2022 challenging confidence in the industry, but this now appears to have been restored.
No doubt the increasing institutionalisation of cryptoassets has played a role. Industry giants such as BlackRock and Fidelity, are now offering Ethereum Exchange-Traded Funds ("ETFs"), which have seen record in-flows in the final weeks of 2024.
As it stands, the crypto sector continues to operate on a largely unregulated basis in the UK and the US. But cryptoassets are now being traded at a pace so formidable that regulators have no choice but to get on board or risk being left far behind. The frustration for those involved is that the legislation and regulatory processes are moving too slowly, and so any change risks being behind the market before it has even been implemented.
Overview of current landscape for crypto regulation in the UK and US
In the UK, the main tool for bringing cryptoassets into a regulatory ambit is the existing financial promotions regime under Financial Services and Markets Act 2000 ("FSMA"). This sits alongside existing changes to the money laundering regulatory regime which was extended to aspects of the crypto-market from 2022. Only invitations or inducements involving a “qualified” cryptoasset under section 69(4) FSMA will be caught and subject to the financial promotions regime rules. In summary this means promotions must be approved and communicated by an FCA-authorised firm and be fair, clear and not misleading. The FCA has been vigilant to promotions falling short of this criteria, and the regulator issued 146 alerts within the first 24 hours of this new regime coming into force. In addition, cryptoasset entities must be registered for AML and CTF purposes under the Money Laundering Regulations.
This contrasts with the US approach to date (including during the first Trump Administration) which has seen the Securities and Exchange Commission (SEC) pursuing a vigorous campaign of regulation by enforcement alleging most digital assets to be illegal, unregistered securities without providing a pathway to compliance for digital asset issuers, dealers and traders.
Proposed regulatory regime in the UK
In 2023, the UK government announced its plans to put a financial services regime for cryptoassets into legislation. In November, the new government confirmed it intends to proceed in full with this plan, which will bring certain activities regarding cryptoassets under the purview of the FCA.
To this end, the FCA have published various resources and discussion papers requesting feedback to assist in the development of regulations in different areas such as Stablecoins; Crypto trading platforms; custody and safeguarding of assets (including operational resilience). All show pervading themes of prioritising market integrity and consumer protection.
On 16 December the FCA published its discussion paper “DP24/4: Regulating cryptoassets – Admissions & Disclosures and Market Abuse Regime for Cryptoassets” setting out its proposed approach. The FCA claims that it is aiming to develop a balanced cryptoasset regime that addresses market risk without stifling growth. We hope that the regime will improve regulatory clarity for firms and consumers, but it remains to be seen whether this will be the case.
Chapter 2 of the paper includes proposed requirements for disclosures by issuers or offerors at the point of admission to trading on a cryptoasset trading platform. As currently drafted, aside from some differences relating to the specific characteristics of cryptoassets, this appears to align with the UK’s reformed prospectus regime. The FCA is seeking to develop these rules alongside its ambitious plans to overhaul the UK’s prospectus regime and introduce a number of new trading platforms (such as public offer platforms and the PISCES sandbox). We see a risk that developing too many new regimes at once could lead to further delays in implementation as each will throw up different challenges that each need to be addressed before the whole can move forwards.
We expect to see an interplay of this regulation with the new Digital Assets Bill which aims to clarify the legal status of digital assets including cryptotokens as property. This bill is currently progressing through the House of Lords, having passed through its second reading and awaiting the Special Public Bill Committee. We are also expecting further information on the UK’s approach to stablecoins in early 2025 to build on the Discussion Paper from November 2023.
US digital asset legislation
In May 2024, the House of Representatives passed the Financial Innovation and Technology for the 21st Century Act or “FIT21” by a wide bipartisan margin. FIT21 creates three digital asset categories:
- “Restricted Digital Asset” subject to SEC jurisdiction;
- “Digital Commodities” subject to the jurisdiction of the Commodity Futures Trading Commission (“CFTC”); and
- “Permitted Payment Stablecoins” subject to either SEC or CFTC jurisdiction depending on the intermediary involved in the transaction.
Whether a token is a restricted digital asset or digital commodity would depend on the level of decentralization of the token’s underlying blockchain. FIT21 provides a procedure for a restricted digital asset to be reclassified as a digital commodity based on its blockchain’s level of decentralization. Permitted Payment Stablecoins are tokens where the issuer is obligated to redeem the token for a fixed amount of monetary value.
In the Senate, Senators Cynthia Lummis (R-WY) and Kirsten Gillibrand (D-NY) introduced their Responsible Financial Innovation Act and Lummis-Gillibrand Payment Stablecoin Acts (“Senate Bills”). Like FIT21, the Lummis-Gillibrand bills allocate responsibility over digital assets between the SEC and CFTC. The Senate Bills would grant the CFTC greater authority over digital asset issuers and intermediaries and limit stablecoins to those backed exclusively by U.S. currency.
We predict that these pieces of legislation from the 118th Congress will serve as the foundations for legislation that will be passed by the 119th Congress. The biggest remaining challenge will likely be reaching consensus on which digital assets should be subject to a securities regulatory regime and which do not require such extensive mandated disclosures regarding their issuers.
Emerging trends / complexities
In the UK, non-fungible tokens (NFTs) fall outside of scope of the financial promotions regime, as this does not apply to non-financial products, however other advertising standards may apply. An emerging trend for 2025 and beyond that we predict is increased regulation of NFTs in terms of AML compliance requirements such as client KYC checks and record-keeping requirements (they currently fall within scope of registration with the FCA for MLR purposes only).
The importance of ongoing dialogue between regulators, industry stakeholders, and the public cannot be overstated in these early days of development. On the UK side, comments on the FCA’s discussion paper are open until mid-March 2025, and the regulator has indicated that it is particularly keen for feedback from both domestic and international stakeholders that participate in the cryptoasset sector, with a focus on wholesale. The FCA is aiming to understand the impact that its proposals could have on current business models but also the wider market.
Global cooperation in regulating cryptoassets will be paramount due to nature of cryptoassets themselves and the fact their scope is not limited by jurisdiction. To that end we have already seen activity from international bodies such as the Financial Stability Board (FSB) publishing its global regulatory framework for cryptoasset activities in July 2023.
