Over recent years, cryptoassets and activities relating to their use have evolved into an increasingly complex market. The failure of several cryptoasset lending and trading platforms, such as Celsius Network and Voyager Digital, and the major crypto exchange, FTX, has revealed risks and vulnerabilities in the cryptoasset markets and highlighted possible risks to consumers. Despite this, both retail and institutional participation in the cryptoasset markets continue to grow, with recent surveys showing that 5-10% of UK adults own cryptoassets, an increase of more than 100% over the last two years.¹ There is also an increasing number of traditional financial institutions that are undertaking crypto-related activities. This combination of the risks and vulnerabilities that have been exposed and the growing participation in cryptomarkets demonstrates the need for regulatory reform and for consumer protection to be properly extended to mitigate the risks to consumers.

Whilst we tend to talk about "cryptoassets" as though they are a homogenous type of assets, there are a number of different types, such as:

• utility tokens;
• payment tokens;
• security tokens; and
• stablecoins.

As might be expected in a reasonably new and innovation-rich industry, within each type there are a range of different structures or approaches to the form of the asset. Accordingly, one of the first challenges facing regulatory authorities is to define what we mean by cryptoassets. The Financial Services and Markets Act 2023 (the Act) introduces into the Financial Services and Markets Act 2000 (FSMA) a definition of cryptoassets:

"Cryptoasset means any cryptographically secured digital representation of value or contractual rights that-

1. can be transferred, stored or traded electronically, and
2. that uses technology supporting the recording or storage of data (which may include distributed ledger technology)."²

This is a very broad definition, which can capture a wide range of asset types, based on an equally wide range of technologies. This definition is very similar to the definition adopted by the EU in its Markets in Cryptoassets Regulation (MiCA).³ Importantly, and in recognition of the fact that cryptoassets are fast evolving, the Act also confers on HM Treasury the power to amend this definition through secondary legislation.⁴

This diversity in asset types means that there are an equally wide range of activities and services which are needed to manage the assets and to facilitate transfer between consumers, many of which are similar but are still subject to important differences. However, it is not just the varied nature of cryptoassets which causes difficulties for regulatory authorities – firms that provide and manage the assets have a wide range of business models and service needs, which further complicates what and how regulators need to regulate. Consequently, "it is highly unlikely that a 'one size fits all' approach to regulation would work for all types of cryptoassets firms, since different activities present different forms of risk."⁵ However, a further complexity for policymakers, in recognition of the benefits that cryptoassets might bring in the future, is that they are keen to encourage continuing innovation in this sector of financial services, and are also keen to make their regulatory frameworks attractive to firms to encourage them into that jurisdiction. Accordingly, appropriate consumer protection must be balanced with encouraging innovation and bringing business into a particular jurisdiction.

Different jurisdictions are meeting these challenges in different ways – the EU, through MiCA, has created a bespoke regulatory regime for cryptoassets which will have harmonising effects across the EU. This highlights an important policy issue for regulatory authorities: whether they create a bespoke regime (following the EU example), amend their existing regulatory frameworks to accommodate cryptoassets, or adopt a hybrid version with elements of both.

The UK's approach to regulating activities relating to cryptoassets

Except for the Money Laundering, Terrorist Financing and Transfer of Funds (Information on the Payer) Regulations 2017 (MLRs) which apply to certain cryptoasset businesses, there is currently no specific financial services regulatory regime for cryptoassets. Cryptoassets and activities relating to their use are generally only subject to regulation where the cryptoasset falls within the scope of an activity or investment type that is captured by FSMA, the Electronic Money Regulations 2011, or the Payment Services Regulations 2017. For example, activities relating to security tokens are already widely regulated.⁶ However, the vast majority of cryptoassets and activities relating to their use are unregulated.

The challenge then for UK regulatory authorities is how to approach the regulation of cryptoassets. In an approach which is different from that of the EU, the UK has chosen to incorporate the regulation of cryptoassets into its existing regulatory frameworks, including:

• the Financial Promotions regime;
• the Regulated Activities regime; and
• the newly created Designated Activities regime.

The Act contains a number of provisions which will be used to create the new cryptoasset regulatory structures and which amend the existing regimes to expressly accommodate the regulation of cryptoassets.

For example, FSMA is amended so that cryptoassets may be expressly brought into the Regulated Activities and Financial Promotions regimes. The mechanism for effecting this change is quite simple – the definition of "investment" in both section 21 (financial promotions) and section 22 (regulated activities) is amended so that it now provides that investments include a situation "where an asset, right or interest is, or comprises or represents, a cryptoasset".⁷ This ties back to the definition of "cryptoasset" which has been introduced into FSMA (see above).

In February 2023, HM Treasury published a consultation and call for evidence (Call for Evidence) on the future financial services regulatory regime for cryptoassets, which closed on 30 April 2023. The Call for Evidence is extensive and sets out, among other things, how HM Treasury anticipates using the powers in the Act to bring activities relating to cryptoassets within the regulatory frameworks, and how the use of these powers will fit into the wider programme of reform around cryptoassets.

The Call for Evidence splits the reform programme around cryptoassets into the following workstreams, which we consider below:

• reform of the Financial Promotions regime, which will not rely on any of the powers in the Act;
• Phase 1 of the reforms that rely on the powers in the Act – relating to stablecoins used for payments; and
• Phase 2 of the reforms that rely on the powers in the Act – relating to high-value cryptoassets.

Future reforms may follow depending on how the markets evolve,⁸ and may rely on powers in the Act, depending on what reforms are required.

The process of prioritisation is based around focusing first on the areas of greatest risk and opportunity.

We anticipate that these reforms will have a significant impact on cryptoasset market participants, including firms that are already authorised to carry out other financial services activities.

Overarching policy objectives and principles

The government's view is that "cryptoassets and the activities relating to their use should follow the same standards expected of other similar financial services activities, commensurate to the risks they pose, while harnessing potential benefits of the technology behind them".⁹ The aim is that this framework will stimulate growth and innovation in the sector by providing regulatory certainty, which will give confidence to both responsible actors to participate in cryptoasset markets and investors to invest in the UK for the long term.

Therefore, in seeking to establish a regulatory framework for cryptoassets, HM Treasury is pursuing four overarching policy objectives to:

• encourage growth, innovation and competition in the UK;
• enable consumers to make well-informed decisions, with a clear understanding of the risks involved;
• protect UK financial stability; and
• protect UK market integrity.

HM Treasury will also be guided by a set of core design principles: "same risk, same regulatory outcome", "proportionate and focused" and "agile and flexible".

Evolving UK landscape

Financial Promotions regime

Following previous consultations by HM Treasury and the FCA, HM Treasury is seeking to lay secondary legislation to extend the financial promotions perimeter to cover cryptoassets in 2023. The Financial Promotions regime will apply to all firms marketing cryptoassets to UK consumers, regardless of whether the firm is based overseas or what technology is used to make the promotion.¹⁰  This will ensure promotions relating to cryptoassets are clear, fair and not misleading. The FCA has asked cryptoasset firms to respond to its questionnaire no later than 4 August 2023 to help it to understand what steps they are taking to prepare for the regime coming into force on 8 October 2023.¹¹

Phase 1 – fiat-backed stablecoins which are used for payment

The Act will introduce the following:

Digital settlement assets

An important category of cryptoassets are digital settlement assets (DSAs). DSAs are a digital representation of value or rights, whether or not cryptographically secured that (i) can be used for the settlement of payment obligations; (ii) can be transferred, stored or traded electronically; and (iii) uses technology supporting the recording or storage of data (including distributed ledger technology).¹²

In another example of bringing activities relating to cryptoassets within existing regulatory frameworks, section 22 of, and schedule 6 to, the Act extends the Bank of England's supervisory reach, under the Banking Act 2009, to payment systems using DSAs and DSA service providers. Section 23 of the Act grants HM Treasury very wide powers to effect regulation of payments which include DSAs.

DSAs will be brought into the regulatory perimeter for systemic payment systems and service providers, falling within the remit of the Payment Systems Regulator or the Bank of England, where they are systemically important.¹³

Fiat-backed stablecoins

Whilst the Act does not contain any specific provisions relating to fiat-backed stablecoins, the Call for Evidence states that the Act will enable HM Treasury to bring activities such as the issuance and custody of fiat-backed stablecoins into the regulatory perimeter via statutory instrument (to fall under the remit of the FCA).¹⁴ Our understanding is that this refers to HM Treasury's new powers to bring cryptoassets within the scope of the new designated activities and regulated activities regimes.¹⁵

This regime will address issuance and custody activities relating to fiat-backed stablecoins and payment-related activities for such fiat-backed stablecoins which are used in payments. It is expected that the scope will cover GBP and other fiat-backed stablecoins which are issued in the UK at a minimum.¹⁶

The government proposes that the indicative list of activities which will be regulated in Phase 1 includes the following:¹⁷

• issuance activities: issuance and redemption of a fiat-backed stablecoin;
• payment activities: for example, execution of payment transactions or remittances involving fiat-backed stablecoins; and
• 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 such fiat-backed stablecoin.

Phase 2 – high-priority cryptoassets

Phase 2 will be focused on targeting the activity areas that give rise to:

• a higher degree of risk from a consumer and overall market perspective; or
• greater opportunities to support the UK's growth agenda.¹⁸

The government proposes that Phase 2 will extend regulation to broader cryptoasset activities, such as the trading of, and investment in, cryptoassets. The Call for Evidence refers to the following indicative activities:¹⁹

• issuance activities: admitting a cryptoasset to a cryptoasset trading venue and making a public offer of a cryptoasset;
• exchange activities: operating a cryptoasset trading venue which supports the exchange of: (i) cryptoassets for other cryptoassets; (ii) cryptoassets for fiat currency; and (iii) cryptoassets for other assets (e.g. commodities);
• investment and risk management activities: dealing in cryptoassets as principal or agent, arranging (bringing about) cryptoassets and making arrangements with a view to cryptoassets;
• lending, borrowing and leverage activities: operating a cryptoasset lending platform; and
• safeguarding and/or administration (custody) activities: safeguarding, or safeguarding and administering (or arranging the same), a cryptoasset other than a fiat-backed stablecoin and/or means of access to such cryptoasset.

Phase 2 is potentially much wider in application than Phase 1, both in terms of the types of cryptoasset and the indicative activities it seeks to capture. For example, if Phase 2 proceeds as currently envisaged, it may well require all persons who trade and invest in cryptoassets to obtain authorisation in order to continue carrying on such activities.

Future phases – medium-priority cryptoassets

The Call for Evidence indicates that future phases relating to medium-priority cryptoassets will depend on market evolution,²⁰ but are likely to include clarifying whether the following (to the extent not already covered by Phases 1 or 2)²¹ fall within the regulatory perimeter:

• exchange activities: post-trade activities in cryptoassets;
• investment and risk management activities: advising on and managing cryptoassets; and
• validation and governance activities: mining or validating transaction, or operating a node on a blockchain, using cryptoassets to run a validator node infrastructure on a proof-of-stake network.

Which types of cryptoassets?

In line with the existing regulatory approach in relation to traditional financial services, the government intends to regulate financial services activities, rather than the assets themselves. The Call for Evidence notes that this approach reduces the risk of regulatory arbitrage through structuring products in particular ways in an attempt to circumvent regulation.²²

The Call for Evidence provides some clarity on how this approach is intended to work in relation to certain cryptoassets:

• Commodity-linked tokens: HM Treasury does not consider a bespoke regime is required. If a commodity-linked token meets the definition of a specified investment, or the arrangement relating to the token meets the definition of a collective investment scheme, it should continue to be regulated accordingly, regardless of whether or not distributed ledgers are used in the underlying technology. If a commodity-linked token does not meet the definition of a specified investment or financial instrument, but does meet the definition of a cryptoasset, then activities relating to that token could be catered for through the broader cryptoasset regime described in the Call for Evidence.²³
• Crypto-backed tokens: HM Treasury's starting point is that crypto-backed tokens should be regulated in the same way as unbacked assets such as Bitcoin. However, depending on the structure and characteristics associated with the token, it 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 token and activities carried on will likely be subject to regulation.²⁴
• Algorithmic stablecoins: HM Treasury considers that activities relating to algorithmic stablecoins should be subject to the same requirements as those for unbacked cryptoassets.²⁵
• Non-Fungible Tokens (NFTs) and utility tokens: NFTs and utility tokens could fall within the future regulatory perimeter if they were used in one of the activities regulated by Phases 1 or 2 (or any future phases). If an NFT or utility token is not used in such a way, it would not fall into scope of financial services regulation unless (as a result of the particular structure and characteristics of the NFT or utility token) it constitutes a specified investment and the activities carried on in relation to the token constitute regulated activities that fall within the existing perimeter.²⁶

Impact on cryptoasset market participants

Under the proposals in the consultation, firms intending to undertake regulated cryptoasset activities will  need permission from the FCA to do so. This means that firms which are currently registered with the FCA for the purposes of anti-money laundering compliance under the MLRs will need to apply for authorisation with the requisite permissions to undertake such cryptoasset activities. These applications are significantly more onerous than those for registration under the MLRs.

Firms undertaking cryptoasset activities which are currently authorised by the FCA will need to apply for a variation of permission (VoP) to cover such cryptoasset activities. The requirements of a VoP depend on the extent of the variation, but at a minimum will require the firm to provide details of how it plans to comply with the relevant regulatory requirements relating to the additional regulated activities for which it is seeking permission.²⁷ The FCA strongly recommends that firms discuss any VoP applications with it before submission and include as much detail as possible with the application.²⁸

The Call for Evidence states that, in order to streamline this transition:

• the FCA will adopt a timely and proportionate authorisation process for complete and accurate applications, and will endeavour to avoid duplicative information requests of businesses, taking into account the supervisory history of businesses during the authorisation process; and
• new crypto firms not yet registered under the MLRs would not need to apply separately for registration under the MLRs (although 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).²⁹

Market view?

Many industry leaders in the cryptoasset sector have published their response to the Call for Evidence and note that they welcome³⁰ and broadly support³¹ HM Treasury's proposed approach to cryptoasset regulation set out in it.

Circle³² supports "the UK government's objectives to bring cryptoassets into the UK regulatory perimeter and create proportionate and agile rules"³³ and Binance agrees that "HM Treasury should seek to use legislative and regulatory mechanisms to put in place equivalent or similar safeguards where cryptoassets present similar risks to financial instruments".³⁴

Whilst the Call for Evidence has largely been well received, some commentators have noted their concerns. In respect of timeframe, the Digital Pound Foundation welcomes HM Treasury's adoption of a phased approach initially to regulate stablecoins, but has also raised its concerns regarding the decision to adopt a sequential, phased approach due to the "potentially lengthy timescales of the legislative/rulemaking processes involved" and that "such an approach may risk undermining the UK as a financial centre and FinTech hub (let alone becoming the crypto hub envisaged by policymakers and Government)".³⁵

The Chartered Institute of Taxation (CIOT) and Association of Taxation Technicians (ATT) took the opportunity to call once again upon HM Treasury to legislate for the tax treatment of cryptoasset transactions. Whilst the CIOT and ATT acknowledge that HMRC has gone significantly further than most tax authorities in seeking to understand and give guidance on the tax implications of involvement in cryptoassets, "the reality is that the pace at which the market has developed and the challenge that the nature of these assets poses for traditional tax rules designed for conventional assets is outstripping these efforts".³⁶

Separately, the House of Commons Treasury Committee (Treasury Committee) published its own report on regulating cryptoassets on 10 May 2023 (the Report). Whilst the Report praised cryptoasset technologies for their potential to improve the efficiency and reduce the cost of cross-border payments, it noted that "the risks posed by cryptoassets to consumers and the environment are real and present".³⁷

In particular, the Treasury Committee emphasised its concerns of regulating retail trading and investment activity in unbacked cryptoassets as a financial service as this may create a "halo" effect that leads consumers to believe that this activity is safer than it is, or that it is protected when it is not. The Report strongly recommends "that the Government regulates retail trading and investment activity in unbacked cryptoassets as gambling rather than as a financial service"³⁸ and that this is consistent with the principle of "same risk, same regulatory outcome" noted in the Call for Evidence.

Dealing with a revolutionary product in an evolutionary way

In recent years, there has been rapid development of new types of cryptoassets, and expansion of activities relating to the use of such cryptoassets, and a significant increase in both retail and institutional participation in the cryptoasset markets. Some may view this rapid development as revolutionary in nature due to the sudden impact and change it presents to the traditional financial markets. Others may view it as a natural (albeit fast) evolution of the financial markets, leveraging off and responding to innovations and advancements in technology.

Regardless of whether cryptoassets themselves are revolutionary or evolutionary, HM Treasury's core design principle of "same risk, same regulatory outcome" and the fact that cryptoasset activities are being slotted into the payments, designated activities and regulated activities regulatory frameworks (rather than creating a bespoke perimeter) demonstrates that, at least for now, the legislative and regulatory response is intended to be evolutionary in nature.

1. Future financial services regulatory regime for cryptoassets – Consultation and call for evidence, February 2023: paragraph 1.7.
2. See section 69 of the Act which introduces the definition of "cryptoassets" into section 417 of the Financial Services and Markets Act 2000.
3. Regulation (EU) 2023/1114 of the European Parliament and of the Council of 31 May 2023 on markets in cryptoassets, and amending Regulations (EU) No 1093/2010 and (EU) No 1095/2010, and Directives 2013/36/EU and (EU) 2019/1937.
4. See section 69 of the Act which introduces section 417(5) into FSMA.
5. Future financial services regulatory regime for cryptoassets – Consultation and call for evidence, February 2023: paragraph 4.2.
6. Future financial services regulatory regime for cryptoassets – Consultation and call for evidence, February 2023: Figure 3.A.
7. Amendment introduced by section 69 of the Act.
8. Future financial services regulatory regime for cryptoassets – Consultation and call for evidence, February 2023: Figure 1.B.
9. Future financial services regulatory regime for cryptoassets – Consultation and call for evidence, February 2023: paragraph. 1.3.
10. PS23/6 Financial promotion rules for cryptoassets: paragraph 1.1.
11. FCA letter to cryptoasset firms dated 4 July 2023: https://www.fca.org.uk/publication/correspondence/letter-to-cryptoasset-firms-financial-promotions-regime.pdf
12. Future financial services regulatory regime for cryptoassets – Consultation and call for evidence, February 2023: footnote 16.
13. Future financial services regulatory regime for cryptoassets – Consultation and call for evidence, February 2023: paragraph. 3.12.
14. Future financial services regulatory regime for cryptoassets – Consultation and call for evidence, February 2023: paragraph 3.12.
15. In relation to the designated activities regime, see section 8 of the Act which inserts a new Part 5A into FSMA (particularly section 71K(7)) and, in relation to the regulated activities regime, see section 69 of the Act which introduces section 417(5) into FSMA.
16. Future financial services regulatory regime for cryptoassets – Consultation and call for evidence, February 2023: paragraph 3.13.
17. Future financial services regulatory regime for cryptoassets – Consultation and call for evidence, February 2023: Table 4.A.
18. Future financial services regulatory regime for cryptoassets – Consultation and call for evidence, February 2023: paragraph 1.16.
19. Future financial services regulatory regime for cryptoassets – Consultation and call for evidence, February 2023: Table 4.A.
20. Future financial services regulatory regime for cryptoassets – Consultation and call for evidence, February 2023: Figure 1.B.
21. Future financial services regulatory regime for cryptoassets – Consultation and call for evidence, February 2023: Table 4.A.
22. Future financial services regulatory regime for cryptoassets – Consultation and call for evidence, February 2023: paragraph 4.13.
23. Future financial services regulatory regime for cryptoassets – Consultation and call for evidence, February 2023: paragraph 4.18.
24. Future financial services regulatory regime for cryptoassets – Consultation and call for evidence, February 2023: paragraph 4.21.
25. Future financial services regulatory regime for cryptoassets – Consultation and call for evidence, February 2023: paragraph 4.25.
26. Future financial services regulatory regime for cryptoassets – Consultation and call for evidence, February 2023: paragraph 4.28.
27. SUP 6.3.25G.
28. SUP 6.3.17G.
29. Future financial services regulatory regime for cryptoassets – Consultation and call for evidence, February 2023: paragraph 3.9.
30. a16z crypto response to "Future financial services regulatory regime for cryptoassets – Consultation and call for evidence" https://api.a16zcrypto.com/wp-content/uploads/2023/04/a16z_HMT-crypto-consultation-response-29-April.pdf
31. Polygon labs response to "Future financial services regulatory regime for cryptoassets – Consultation and call for evidence" https://assets-global.website-files.com/637359c81e22b715cec245ad/644fc3d2c4a4b1a1cba05110_Polygon%20Labs%20-%20Response%20to%20Cryptoasset%20%20Consultation%20.pdf
32. Circle Internet Financial LLC – https://www.circle.com/en/
33. Circle response to "Future financial services regulatory regime for cryptoassets – Consultation and call for evidence"  https://www.circle.com/blog/circles-response-to-uk-future-financial-services-regulatory-regime-for-cryptoassets-consultation-and-call-for-evidence https://assets-global.website-files.com/637359c81e22b715cec245ad/644fc3d2c4a4b1a1cba05110_Polygon%20Labs%20-%20Response%20to%20Cryptoasset%20%20Consultation%20.pdf
34. Binance response to "Future financial services regulatory regime for cryptoassets – Consultation and call for evidence" https://bin.bnbstatic.com/static/policy-doc/binance-response-hmt-future-financial-services-regulatory-regime-for-cryptoassets.pdf
35. Digital Pound Foundation response to "Future financial services regulatory regime for cryptoassets – Consultation and call for evidence" https://digitalpoundfoundation.com/dpf-response-hmt-consultation-and-call-for-evidence-on-the-future-financial-services-regulatory-regime-for-cryptoassets/
36. CIOT and ATT response to "Future financial services regulatory regime for cryptoassets – Consultation and call for evidence" https://assets-eu-01.kc-usercontent.com/220a4c02-94bf-019b-9bac-51cdc7bf0d99/5e45431b-5330-4d81-9c62-3bb1efdd64b7/230408%20Future%20financial%20services%20regulatory%20regime%20for%20cryptoassets%20-%20joint%20CIOT%20ATT%20response.pdf
37. House of Commons Treasury Committee "Regulating Crypto", Fifteenth Report Session 2022-2023 – 10 May 2023.
38. House of Commons Treasury Committee "Regulating Crypto", Fifteenth Report Session 2022-2023 – 10 May 2023.