• May you live in interesting times.

The British Treasury today published a number of proposals as part of a consultation that “sets out proposals for the UK’s financial services regime for cryptoassets, and marks the next stage of the UK’s phased approach”. The consultation is open until the morning of 30th April, 2023, and has received significant coverage as a potential milestone in the development of a British regulatory approach. The generally reactive tenor of British regulation towards new financial activities have led to London being one of the stronger centres of crypto business activity in Western Europe alongside Switzerland and Portugal in particular, and the sector has at times been held up as a potential area in which the country can lead in the post-Brexit period, particularly since the accession to the premiership of Rishi Sunak (and the movement of Grant Shapps, arguably the most outspokenly pro-crypto and pro-digital business voice within the Conservative Party, to the Business, Energy and Industrial Strategy brief).

What can we make of these proposals? The first thing to emphasise is that while they have been commonly referred to as the framework for a ‘cryptoasset regulatory regime’, the omission of the ‘financial services’ precursor unfortunately misleads. While there are references to not ruling out things in the future, the guidance is quick to make clear that the concern here is specificially financial services – “The proposed regulatory framework for cryptoassets is not intended to impose regulation on any underlying non-financial services activity which a cryptoasset might be used for.”

In particular, DeFi activities only merit a ‘call for evidence’ and four pages that can be boiled down to ‘in theory, yes, but in reality, no’. The primary point of concern here, as has consistently been the case across British government and legal missives over the past couple of years, is with respects to indicating that they are aware that DAOs and decentralised organisations exist within crypto, and that they are monitoring the development of the space but crucially see them as a potential legitimate form of organisation going forward (whereas EU and particularly US regulators have tended to take a view that anchors them to existing entities and/or categorises them as ‘unincorporated associations’ with the associated liability questions it brings up).

The key excerpt here (section 11.5) is:

“HM Treasury is of the view that the regulatory outcomes and objectives described in the preceding chapters should apply to cryptoasset activities regardless of the underlying technology, infrastructure, or governance mechanisms. However, due to the challenges outlined above, including the rapidly evolving nature of the sector, the way this is achieved may well differ and take longer to clarify…we are not intending to front run this by developing a prescriptive framework for the UK that would need to be fundamentally re-shaped once international approaches and standards crystalise.”

While leaving the door ajar for a potential future shift, the messaging here generally indicates towards an essentially minarchist approach to regulation of underlying assets. The one exception to this is with respects to initial offerings – while “in line with the approach applied to securities, HM Treasury does not intend to directly regulate the “creation” of unbacked cryptoassets under financial services regulation”, “under the intended reforms there will be a general prohibition on public offerings of securities, subject to certain exemptions.” As has tended to be the case worldwide, the definition of a security as it relates to crypto is left deliberately ambiguous – one thing worth noting is that in cases where there is no apparent central entity, “the trading venue would be required to take on the responsibilities of the issuer if they wish to admit the asset to trading”.

The more substantial part of the guidance here hence is with regards to a financial services framework for a set of entities that ultimately comprise ‘an exchange by any other name’ in real terms. Most of this is in actuality fairly standard for any financial business operating in the UK, and will be familiar to any British financial firm – stringent KYC/AML at point of contact, general anti-financial crimes rhetoric, and close collaboration with the FCA on ‘prudential requirements’ on an ongoing basis. Multilateral trading facilities (MTFs) are one of the key focuses here, with proposals to formalise bringing them under a framework derived from the existing MTF framework, in terms derived from powers granted under the Financial Services and Markets Act 2000 (Regulated Activities) Order 2001.

Two other points in particular seem worth highlighting. One is that the proposals explicitly propose to capture all activities involving either a provider or a customer in the UK as in scope. The other is with respects to crypto lending platforms, which are identified specifically as a category of interest (that will come under the same authorisation regime as exchanges and custodians will). Interestingly, the discussion there mentions the Celsius and FTX collapses, and is keen to emphasise a view of seeing the collapse of those platforms as due to “significant liquidity mismatches”.

Of course, we would expect diplomatic language in a government proposal, but it is nonetheless interesting that in spite of what those platforms were doing, and the fact that they are arguably more of a pain point for low-information consumers than derivatives exchanges and the like could ever be, there still seems to be something of a soft-touch approach with regards to regulation – there are some additional authorisation rules regarding business plan at point of registration, but ongoing compliance is phrased in such a way to imply them as not a fundamentally high-risk business compared to MTFs. It will be interesting to see if this stance shifts with the developing situation within the sector.

In closing, the proposals here do not represent any sort of sea change in the UK approach to cryptoassets, which is on the whole likely a good thing for professional entities operating in the space – the UK’s approach has been permissive compared to its European neighbours, after all. It will provide little solace to retail, who are likely to remain restricted in their trading options. The one thing to keep an eye on will be what it means for retail exchange operations, particularly for Coinbase, who dissolved their UK entity last month, and Binance, whose Binance UK platform has been inaccessible for the better part of three years but have constantly made overtures towards reentering the jurisdiction; the focus on transparency to the FCA above all else may ultimately be of benefit here in the longer term.