HM Treasury (HMT) has published its long-awaited consultation (Consultation) and call for evidence (Call for Evidence) on the regulation of cryptoassets that are NOT stablecoins, e-money or already regulated by virtue of amounting to a traditional financial services instrument (a share, bond, unit in a fund, derivative, etc). Its scope is broad and captures a whole swathe of cryptoassets including cryptocurrency such as Bitcoin, as well as non-fungible tokens (NFTs).

This is an important development, with HMT finally revealing how it intends to manage the long-standing challenge of balancing promotion of innovation whilst at the same time upholding good standards of consumer protection. It also sets out HMT's stall on the degree to which it will follow the approach adopted in Europe, in particular the EU's flagship Markets in Cryptoassets Regulation (MiCA) – it will, to a degree, but important divergence is emerging.

Businesses which carry on cryptoasset activities will need to assess whether and how the proposal will impact them. Depending on the geographical scope of their activities, businesses affected by both the UK crypto regime and MiCA will need to navigate the complexity of two slightly disparate but substantially overlapping regimes – here, the equivalence regime proposed in the Consultation may be helpful.

The Consultation and Call for Evidence stage is an opportunity for the industry to feedback and influence the shape of the final crypto regulation.

The Consultation closes on 30 April 2023. The final rules are likely to be implemented at some point during 2024-2025, although this could move quicker. During H1 2023, the statutory instrument for fiat-backed stablecoins (which are subject to a separate consultation and are not covered here) is expected to be laid before Parliament.

At a glance

Wide set of cryptoassets caught – The definition of cryptoassets in the Financial Services and Markets Bill (FSMB) is deliberately wide, and the Consultation now provides an insight as to how broadly HMT intends to cast its net through regulation. Activities involving utility tokens, cryptocurrencies like Bitcoin and – in contrast to MiCA – even NFTs are proposed to be within the scope of UK regulation (see the section on 'Scope' below for further examples).

Wide set of activities caught – Intermediaries providing the below activities in respect of cryptoassets will be subject to licensing requirements and/or regulatory requirements (and firms that are already licensed will need a variation of permission, and cryptoasset firms only registered for anti-money laundering purposes will need FCA authorisation, to carry out the below activities):

  • exchange activities (expanded to cover exchange of cryptoassets for commodities and other assets, not captured by the current anti-money laundering rules);
  • investment activities (for now only trading and arranging, in contrast to MiCA which captures a broader set of investment activities including advising and investment management – which HMT may also regulate eventually but not for now);
  • custody; and
  • an issuance and disclosure regime will apply to anyone issuing cryptoassets.

Territorial scope – Applies to activities of:

  • UK entities (regardless of the location of the client); and
  • non-UK entities with UK clients. Whether a subsidiary or a branch will be required in this case is TBC, but it is clear that firms operating a crypto assets venue are likely to need a UK subsidiary (subject, perhaps, to equivalence rules). The usual mechanisms for cross-border activity in the UK (such as the characteristic performance test and overseas persons exemption) do not appear to apply; instead, like under MiCA, only "reverse solicitation" is mentioned as a possible exemption. Entities with a client base in the UK and EU will therefore potentially have to comply with both MiCA and the UK regime.

Financial crime (interaction with MLRs) – Entities that become regulated under the new regime will be subject to the FCA's same high standards on financial crime as traditional regulated entities, alongside narrower Money Laundering, Terrorist Financing and Transfer of Funds (Information on the Payer Regulations) 2017 (MLRs) which currently apply to certain crypto businesses.

Market abuse – Similar to MiCA, but with some differences, a new market abuse regime is being proposed for cryptoassets. While the general regulatory elements will sit in the FSMA regime alongside those for traditional financial instruments, cryptoasset market abuse will be handled outside the UK Market Abuse Regulation.

In more detail

1. Legislative Approach

Phased regulation: HMT is continuing its phased approach to regulating cryptoassets, prioritised according to risk and opportunity. The section on 'Scope' below sets out the activities within the planned phases.

  • Phase 1: The Government is currently legislating in the FSMB for a regime enabling fiat-backed stablecoins used for payments to be regulated similarly to other payment methods. Those rules will address issuance and custody activities relating to fiat-backed stablecoins and payment-related activities involving them. This is expected to cover, at a minimum, GBP and other fiat-backed stablecoins which are issued in the UK. The Electronic Money Regulations (EMRs) and Payment Services Regulations 2017 (PSRs) will also be amended. The FSMB also contemplates bringing digital settlement assets (DSAs) into the regulatory perimeter for systemic payment systems and service providers.
  • Phase 2: This will cover the regulation of broader cryptoasset activities, which is the subject of this Consultation. Phase 2 will focus on targeting activities associated with (i) a higher degree of risk from a consumer and overall market perspective; and (ii) greater opportunities to support the UK's growth agenda. As a consequence, Phase 2 does not propose to encompass all cryptoasset activities.

Legislation: The Government has ruled out developing a bespoke regime outside the FSMA framework, instead proposing to:

  • expand the list of "specified investments" of the Financial Services and Markets Act (Regulated Activities) Order 2001 (RAO) to include cryptoassets so that any person carrying out certain activities involving cryptoassets "by way of business" would require authorisation under Part 4A of FSMA. HMT is not proposing to expand the list of MiFID financial instruments in the RAO, which means that cryptoasset activities in scope of this Consultation will not amount to MiFID business (though activities in respects of instruments that are already caught by legislation (e.g. cryptoassets that amount to derivatives, shares etc) will be caught by MiFID). The FCA will consult on how it intends to regulate cryptoasset activities in due course; and
  • designate certain cryptoasset activities under the designated activities regime (DAR) set out in the FSMB. This could involve setting direct requirements for, or complete bans on, certain cryptoasset activities. For example, the Government is considering using the DAR to prohibit public offers of cryptoassets which do not meet the definition of security token offering, unless they are conducted via a regulated platform.

Authorisation: Consistent with the existing regulatory approach in traditional financial services, the Government intends to regulate financial services activities, rather than the assets themselves. Anyone carrying out certain activities involving cryptoassets "by way of business" within the regime's territorial scope would be performing regulated activities and will require authorisation under Part 4A of FSMA when the regime comes into force (see 'Scope' below). More details on the authorisation regime will emerge in due course, but it is worth noting that:

  • Interaction with MLRs: HMT and the FCA strongly prefer eventual adoption of a single authorisation process to support supervisory and enforcement processes. Until that is in place, complexities may arise in enforcement cases involving some businesses registered under the MLRs and others which are FSMA-authorised. In addition:
    • Crypto firms already registered under the MLR regime and carrying out those activities would still be required to also seek authorisation under the new FSMA-based regime.
    • New crypto firms that would be covered by both regimes and which not yet registered under the MLR regime would apply only once for Part 4A authorisation, and not separately for registration under the MLRs.
    • All crypto firms in scope of the MLRs will still be expected to comply with them, as with current FSMA-authorised businesses that are subject to the MLRs.
    • The FCA's financial crime rules, which are broader than the rules contained in the MLRs, will apply to those within scope of the broader cryptoassets regulatory regime, alongside the MLRs.
  • For newly defined 'crypto' activities in the RAO, firms which are already FSMA authorised and intend to undertake the activity will generally need to apply for a variation of their permission from the FCA (and the PRA for dual-regulated firms). Regulatory permissions would not be automatically granted for firms which are already authorised. This is stricter than the position under MiCA, where authorised firms only need to notify their regulators that they will begin conducting cryptoasset activities.

Territorial application:

  • HMT proposes capturing cryptoasset activities provided in or to the UK. This would capture activities provided by UK firms to persons based in the UK or overseas, as well as those provided by overseas firms to UK persons. The government is considering whether to allow exceptions e.g. 'reverse solicitation' to this approach, but these appear intended to be narrower than the exemptions for traditional financial services carried out cross-border.
  • The FCA's existing framework for international firms and the nature and scale of (and risks posed by) the firm's activities will determine whether firms require physical presence in the UK, where equivalence arrangements do not exist.
  • Firms operating cryptoasset trading venues would be likely to require UK subsidiaries due to their critical role in the cryptoasset value chain.
  • Equivalence: Firms authorised in third countries will be able to provide services in the UK without a UK presence, provided they are subject to equivalent standards and there are suitable cooperation mechanisms in place.

2. Scope

Cryptoassets

The broad definition in the FSMB aims to capture all current types of cryptoassets. Secondary legislation can be used to update the definition to react to future changes. The currently-proposed definition would capture the use of any of the cryptoassets below for the financial services activities referenced in 'Cryptoasset Activities' below (as well as those already in the UK's regulatory perimeter):

  • Exchange tokens
  • Utility tokens
  • Security tokens
  • NFTs
  • Stablecoins
  • Asset-referenced tokens
  • Commodity-linked tokens
  • Crypto-backed tokens
  • Algorithmic tokens
  • Governance tokens
  • Fan tokens

Cryptoasset activities

The proposed scope and phasing of regulating cryptoasset activities is set out in the two tables below.

Table 2a. Cryptoasset Activities

Activity Sub-activities (indicative/non-exhaustive) Phase 1 Phase 2
Issuance activities Issuance and redemption of a fiat-backed stablecoin ?
Admitting a cryptoasset to a cryptoasset trading venue ?
Making a public offer of a cryptoasset ?
Payment activities e.g. execution of payment transactions or remittances involving fiat-backed stablecoins ?
Exchange activities Operating a cryptoasset trading venue which supports: (i) the exchange of cryptoassets for other cryptoassets; (ii) the exchange of cryptoassets for fiat currency; or (iii) the exchange of cryptoassets for other assets (e.g. commodities) ?
Post-trade activities in cryptoassets (to the extent not already covered) Future phases
Investment and risk management activities Dealing in cryptoassets as principal or agent ?
Arranging (bringing about) deals in cryptoassets ?
Making arrangements with a view to transactions in cryptoassets ?
Advising (to the extent not already covered) on cryptoassets

Future phases

(or exclude from regulatory perimeter)
Managing (to the extent not already covered) cryptoassets
Lending, borrowing and leverage activities Operating a cryptoasset lending platform ?
Safeguarding and /or administration (custody) activities Safeguarding or safeguarding and administering (or arranging the same) a fiat-backed stablecoin and/or means of access to the fiat-backed stablecoin (custody) ?
Safeguarding or safeguarding and administering (or arranging the same) a cryptoasset other than a fiat-backed stablecoin and/or means of access to the cryptoasset (custody) ?
Validation and governance activities Mining or validating transactions, or operating a node on a blockchain

Future phases
Using cryptoassets to run a validator node infrastructure on a proof-of-stake (PoS) network (layer 1 staking)

Table 2b. Overview of the proposed regulation of Phase 2 cryptoasset activities

Activity Overview
Cryptoasset Issuance and Disclosures
  • Cryptoasset issuances will become subject to rules following a similar approach to those for securities. These requirements would tie in with the intended reform of the UK prospectus regime, but be tailored to cryptoassets.
  • The rules would apply on admission of a cryptoasset to trading on a venue, or when making a public offer of cryptoassets.
  • Similar to MiCA, issuers would need to produce a disclosures document at these points comparable to a traditional securities prospectus. Where there is no issuer (as with Bitcoin), this would fall to the venue admitting the token to trading.
  • Disclosure documents would be underpinned by due diligence. Investor protections would also apply to marketing materials, etc.
  • Knowingly or negligently untrue or misleading disclosures would trigger liability and compensation mechanisms. Some prudential requirements would likely apply to issuers (e.g. adequate financial resources or professional indemnity insurance).
  • Trading venues functioning as Regulated Markets would have rules set by the FCA, whilst the rulebooks of multilateral trading facilities (MTFs) functioning as primary markets would be made to require the same disclosures.
Operating a Cryptoasset Trading Venue
  • Rules will derive from those for MTFs and other trading venues, as are expected to be reformed more generally as part of a refresh of UK listing and trading rules.
  • This activity is likely to be narrower than the cryptoasset exchange provider definition in the MLRs and more likely to be defined in line with the Article 25D and 25DA RAO activities for operating trading facilities.
  • Other provisions relating to prudential requirements, reporting, transparency, consumer protection, governance and operational resilience would apply. HMT is also considering whether to develop a bespoke resolution regime for cryptoasset trading venues.
Cryptoasset Intermediation Activities
  • The proposals would apply requirements applying to analogous regulated activities already in existence, like "arranging deals in investments" to cryptoasset activity. These MiFID-derived rules would be augmented to address specialised risks but include familiar requirements such as authorisation, consumer protection, sound governance and reporting obligations. HMT will consider whether a bespoke resolution regime should be developed.
Cryptoasset custody
  • The Article 40 RAO framework for traditional custodians will be modified to accommodate cryptoassets. Safeguarding, or safeguarding and administering (or arranging the safeguarding or safeguarding and administering) of (a) a cryptoasset other than a fiat-backed stablecoin and / or (b) a means of access to a cryptoasset (e.g. a wallet or cryptographic private key) will be within scope.
  • This scope is broader than Article 40 RAO, capturing firms that only safeguard (but do not administer) assets (e.g. firms that solely safeguard cryptographic private keys which provide access to cryptoassets). This broader definition is consistent with the definition of cryptoasset custodians in the MLRs.
  • Existing custody provisions in the FCA's Client Assets Sourcebook (CASS) will be used as a basis to design bespoke custody requirements for cryptoassets.
  • Authorities are also considering custodian liability standards. The government is exploring taking a proportionate approach which may not impose full, uncapped liability on the custodian in the event of a malfunction or hack that was not within the custodian's control. This was a hugely controversial area during the negotiation of MiCA. MiCA does not impose liability on a custodian or other service provider where the events are "not attributable" to it. Where the events are attributable to a custodian or other service provider, MiCA caps liability at the market value of the lost assets at the time they are lost.
  • Other provisions relating to prudential requirements, consumer protection, governance, operational resilience and resolution (including the possibility of a bespoke regime in future) would apply.
Operating a cryptoasset lending platform
  • The Government believes there is a strong case for developing a cryptoasset lending and borrowing regime as a priority Phase 2 activity.
  • Operating a cryptoasset lending platform (including facilitating collateralised and uncollateralised borrowing of cryptoassets or borrowing of fiat currency with collateral provided in cryptoassets) would be regulated.
  • Disclosure: The government is seeking views on whether a disclosure regime would be necessary. To help the regulators monitor the build-up of risk present in collateralised lending transactions, the Consultation suggests improving transparency associated with the use of collateral in cryptoasset financing activities by basing disclosure requirements on those applied to securities financing transactions (e.g. counterparty and transaction details, collateral composition, rehypothecation, substitution of collateral at the end of the day and haircuts applied). Specifying the requirements and scope of the disclosure requirements for these transactions will happen after Phase 2.
  • Other provisions relating to prudential requirements, consumer protection (including a requirement for clear information on the terms of legal ownership, collateral, and margin calls to be provided by platforms to customers), governance and operational resilience, and resolution (including the possibility of a bespoke regime in future) would apply.

Exemptions: Some exemptions will be available to crypto market participants. For example, where a person deals in cryptoassets as principal (Phase 2) or carries out mining or validation (future phases) but does not do so by way of business, they will not be within the proposed regulatory perimeter.

Vertically integrated business models:

  • Vertically integrated cryptoasset exchanges whose activities go beyond solely operating a trading venue (e.g. providing custody, post-trade activities, proprietary trading/market making, lending and admission of cryptoassets to a platform, etc.) should expect to follow rules covering all of these activities and not just those relevant for operating a trading venue.
  • The Government is concerned by these entities' potential conflicts of interest and reinforced risk profiles. It will consider the risks of such combined activities in the cryptoasset sector, and whether and how existing controls on combinations of activity in traditional finance (e.g. comprehensive prudential and conduct regulation or segregation of functions) should apply.
  • Data: Venues would be required to keep, and make available at all times, accurate and comprehensive data on trading on their exchanges. They would not be required to regularly report market data at this stage, though authorities would retain the ability to propose more regular and wider reporting as desired, e.g. if the size or interconnectedness of the crypto markets were to increase and as international standards progress further.

Proposed treatment of different types of tokens: The Consultation also considers the treatment of the following types of tokens:

  • Commodity-linked tokens: These aim to maintain a stable value relative to the underlying commodity price by being collateralised with one or more commodities or real-world assets, or act as a digital representation of an underlying real-world asset such as gold, property, or oil. As the characteristics of and activities connected with these tokens are likely either to fall within the existing regulatory regime (e.g. for derivatives or collective investment schemes/funds) or be adequately covered by the general cryptoasset regime being proposed, the Consultation does not propose a bespoke regime for commodity-linked tokens.
  • Crypto-backed tokens: Crypto-backed tokens should be regulated in the same way as unbacked cryptoassets such as Bitcoin. However, depending on the tokens' structure and characteristics, they could meet the definition of a specified investment and/or the arrangements carried on in relation to them could meet the definition of a collective investment scheme, in which case the tokens and activities carried on will likely be subject to regulation. The Consultation notes that marketing of this type of token using terms such as 'stable' or similar would be misleading.
  • Algorithmic stablecoins: These will not qualify as stablecoins under the proposed regime for fiat-backed stablecoins (part of Phase 1). HMT considers that activities relating to algorithmic stablecoins should be subject to the same requirements as for unbacked cryptoassets. Similar to crypto-backed tokens, the Consultation notes that financial promotions of this type of stablecoin which use terms such as 'stable' or 'payment instruments' or similar would be misleading.
  • NFT/Utility token: Using an NFT or utility token in one of the regulated activities listed would be regulated. An NFT or utility token not used in such a way would not fall within scope unless it constitutes a specified investment and the activities carried on in relation to the token constitute regulated activities that fall within the existing perimeter.

3. Market abuse

HMT refers to significant evidence of abusive behaviour in the cryptoasset markets, particularly of "pump and dump" and "trash and cash" schemes, "wash trading", "spoofing", and "front running" ahead of token listings – activities akin to manipulation and insider dealing in the financial markets. [1] HMT notes that although the activities and behaviours may be similar, crypto markets differ from securities markets in several respects:

  • cryptoassets may have no clearly identifiable issuer, or the issuer may be an individual, making it challenging to place obligations on them to control inside information;
  • price movements in crypto markets are more closely linked to supply and demand, so inside information may be held by miners, validators and oracles rather than the issuer;
  • far higher direct retail participation in the cryptoasset markets (without the involvement of intermediaries who in the securities markets are under regulatory obligations to detect and prevent market abuse);
  • little geographic nexus between the trading venue, the entity issuing the cryptoasset and those trading it – and as yet no agreement between international regulators on how to allocate and enable oversight in practical terms.

Nonetheless, HMT proposes to include a market abuse regime in the proposed crypto regulatory framework, based on elements of the Market Abuse Regulation for financial instruments:

  • The same market abuse activities (insider dealing, unlawful disclosure of inside information, and manipulation) would be prohibited in respect of cryptoassets requested to be admitted to trading on a UK trading venue (the trigger for jurisdictional scope).
  • Instead of being a criminal regime at the outset, the proposed model would place the primary responsibility for detecting, deterring and disrupting market abuse on UK trading venues, who would, subject to FCA supervision, be expected to:
    • have appropriate systems and controls to prevent and detect market abuse, and to establish "who" the offenders are;
    • establish information sharing arrangements with other venues that admit the same cryptoassets; and
    • have an effective regime for disrupting market abuse, including the ability to investigate suspected market abuse and to sanction individuals (e.g. by publicly blacklisting offenders).
  • Persons professionally arranging or executing transactions would also be required to have appropriate systems and controls to prevent and detect market abuse, subject to FCA supervision, and to submit suspicious transaction and order reports to the relevant trading venue.
  • All regulated firms undertaking cryptoasset activities would be required to disclose inside information and maintain insider lists.

4. Call for Evidence

The Government is seeking further views on the following topics before laying down proposals for consultation:

Decentralised Finance (DeFi): The government plans eventually to deliver similar regulatory outcomes across centralised financial services activities and their DeFi equivalents, with the aim of preventing risks of regulatory arbitrage. However, due to the challenges of DeFi, including the rapidly evolving nature of the sector, how this is achieved may differ and take longer to clarify.

One option mentioned in the Call for Evidence is to define DeFi-specific regulated or designated activities, e.g. "establishing or operating a protocol". Carrying out those activities would then require authorisation, for which the FCA could design a bespoke regime.

Other cryptoasset activities:

  • Cryptoasset investment advice and portfolio management: The Government is considering whether there is a case for regulating these activities. Although there are parallels with 'advising on investments' and 'managing investments', it would be difficult for regulated advisors to have the appropriate experience, competence and qualifications, and for them to assess that a cryptoasset is suitable before making a recommendation, given the nature of cryptoassets.
  • Post-trade activities in cryptoasset transactions (e.g. settlement and clearing): HMT envisages that its regulatory approach to these activities will be shaped by lessons learnt from the FMI Sandbox initiative (consultation expected shortly).
  • Crypto mining and validation: There may not be justification to regulate mining in and of itself, but the Government is seeking views on whether any other regulatory outcomes should be pursued in regulating mining, e.g. whether "miner extractable value" should be considered. Further data on staking will be needed before the Government can consider whether or not to bring staking activities within the regulatory perimeter.

Sustainability: Various sustainability-related reporting requirements already apply to other types of financial services firms. HMT notes the parallels between cryptoassets and securities markets, mooting the application of similar ESG-related reporting requirements; this may be more challenging for the cryptoasset market. For now, HMT is seeking views from respondents on:

  • what information about environmental impact or energy intensity would be useful for consumers making decisions about investing in cryptoassets, and when in the investor journey these would be particularly helpful to consumers; and
  • whether particular indicators or metrics exist to calculate these environmental impacts and whether these are interoperable with other recognised sustainability disclosure standards.

5. Other considerations

FSCS protection: The Government does not intend Financial Services Compensation Scheme (FSCS) protections to apply to investor losses arising from cryptoasset exposures. However, the PRA and FCA set the limits of FSCS protection for regulated activities carried out by authorised firms. The Consultation suggests that the FCA may make FSCS protection available for claims against failed authorised cryptoasset custodians. (Liability standards for custodians are also under consideration by the authorities – see 'Cryptoasset custody' in Table 2b above.)

Cryptoasset financial promotions: HMT has announced in a parallel policy statement that it plans temporarily to allow unregulated but FCA-registered cryptoasset businesses to make their own financial promotions without approval by an authorised person. Under its original proposals, such businesses would need to have their promotions for qualifying cryptoassets and related services approved by an authorised person. This change follows feedback that the earlier proposals effectively banned cryptoasset financial promotions as there were unlikely to be sufficiently experienced authorised persons willing to approve the promotions made by unauthorised firms.

To ensure that unauthorised cryptoasset businesses relying on the exemption are subject to the same financial promotion rules as authorised persons communicating equivalent promotions, the government intends to confer powers on the FCA to enable it to make rules applying to financial promotions communicated in reliance on this exemption.

6. Next steps

  • 30 April 2023: Consultation closes.
  • H1 2023: Statutory instrument for fiat-backed stablecoins to be laid before Parliament.
  • Throughout 2023: The "Crypto Engagement Group" chaired by the Economic Secretary to the Treasury will continue to meet.
  • 2024 – 2025: This is when the general cryptoasset regime proposed is likely to become law if the timetable is similar to that for stablecoins (whose consultation ended in March 2021, was responded to in July 2022, and the statutory instrument for which is due for release in H1 2023). The current spotlight on this area and the enabling legislation in the FSMB may result in the regime being finalised earlier in that window.

7. List of resources

HSF articles

MICA – EU legislators agree rules to tame crypto "Wild West"

The Financial Services and Markets Bill – a new vision for future UK financial services

The Law Commission digital assets consultation – a proposal for property rights reform

Update on s.21 gateway: FCA consults on introducing gateway for firms which approve financial promotions for unauthorised persons

Government policy papers

HM Treasury Cryptoasset and Stablecoin consultation

UK regulatory approach to cryptoassets, stablecoins, and distributed ledger technology in financial markets: Response to the consultation and call for evidence

HM Treasury cryptoasset promotions consultation

HM Treasury cryptoasset promotions consultation response

Government approach to cryptoasset financial promotions regulation policy statement

FCA CP22/2: Strengthening our financial promotion rules for high-risk investments, including cryptoassets

PS22/10: Strengthening our financial promotion rules for high-risk investments and firms approving financial promotions

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.