CryptoUK welcomes the opportunity to respond to this timely and important consultation. The responses below represent the views of many of our members. In particular we would like to thank Elliptic, B2C2 and Circle for their contributions. CryptoUK would also like to thank Clifford Chance LLP for their assistance in drafting these submissions. You can red the full contents of our response below, or download a PDF version of this response.

About CryptoUK

CryptoUK is the leading trade body representing the crypto and digital assets sector in the UK, representing more than 150 companies within the crypto and digital assets industry. CryptoUK was established to serve as a resource to policymakers and regulators, and to support the development of an informed and balanced regulatory framework for digital assets and blockchain technology which enables a fair and transparent market, consumer protection and supports innovation in the UK.

CryptoUK would welcome the opportunity to provide further information in an upcoming oral evidence session to answer any additional questions and to provide further insight on behalf of the UK crypto and digital asset sector.

Top Priorities for the UK crypto and digital asset sector:

• The sector welcomes regulation: The UK crypto and digital asset sector recognises the importance of a well regulated industry in the UK and welcomes regulation which (i) provides business certainty, (ii) encourages a responsible market with integrity and consumer protections and (iii) enables innovation to flourish. The UK crypto and digital sector wants to see a balanced, proportionate regulatory framework for crypto and digital assets which reflects a ‘same risk, same regulation’ methodology.
• The UK could be a leader in crypto: The UK is an established world leader in financial services and fintech, and there is an opportunity for the UK to be recognised as a destination for innovative digital asset and blockchain companies to thrive. To achieve this, the UK must implement a balanced, pragmatic and holistic regulatory regime for digital assets to attract responsible crypto companies to the UK as a base to invest and grow their business.
• Potential for growth and jobs: There is huge potential for the UK in terms of economic growth, jobs and skills from the UK crypto and digital asset sector.
• A proportionate approach to regulation: We want to see a proportionate approach to regulation that balances the need for consumer protection with the need to support innovation and growth.
• Risk of missing out to other jurisdictions: There is a risk that the UK could lose out to other countries overseas who are implementing clear and bespoke regimes for crypto regulation and supervision, taking into account the nuances and opportunities inherent to the technology.
• A consistent approach to crypto and digital assets: The UK must take a ‘whole of Government’ approach to crypto and digital assets. A consistent approach to regulation and taxation of the sector across all Government departments and regulatory bodies is required.
• Engagement with the sector:We encourage the UK Government(Government) and regulators to work with the sector when developing future policy and regulation for the UK crypto and digital asset sector. We believe public and private sector partnership is a critical 1factor in ensuring that any future framework is fit for purpose and does not hinder growth or stifle innovation in the sector.

Written submissions were invited on the following issues and responses to each are as follows:

To what extent are crypto-assets when used as digital currencies (such as Stablecoin) likely to replace traditional currencies?

We think it likely that digital currencies will operate in parallel to traditional currencies rather than replacing them, at least in the short to medium term. The benefits of digital currencies (such as stablecoins) are balanced by barriers to their expansion and adoption, which we expect would prevent digital currencies from replacing traditional currencies over the medium term. We note that the barriers discussed below do not apply to Central Bank Digital Currencies (CBDCs). Although CBDCs face their own hurdles, they do not face the same barriers that apply to stablecoins (please see further details in our response to question two). This is largely because of the payment infrastructure that surrounds CBDCs, which makes it likely that CBDCs would be used more frequently than stablecoins.

The inherent benefits of crypto-assets (including those used as digital currencies) are numerous and are conducive to their expansion. These benefits include their global reach and the fact that they are often open source and trade over decentralised blockchain networks. Trading via decentralised blockchain networks means that (i) transactions are fast and (ii) the crypto-assets are accessible to anyone with internet access at any time. Although at present digital currencies are primarily used as a store of value and bridge between fiat currencies and crypto-assets, their instant processing and low transaction fees make them suitable for corporate treasury services and global remittances.

However, our members have noted that some of the regulatory requirements applicable to digital currencies, such as the travel rule, may hinder their expansion. Certain other requirements which have been designed in the context of more traditional currencies, such as the AML requirements, are also more burdensome when applied to digital currencies. For example, it is not possible to legitimately accept or pay with cryptocurrency globally without a strong suite of compliance measures which slow down transactions and reduce the uptake of digital assets in the wholesale market. Our members highlight that stablecoin providers should be treated in the same manner as similar financial market participants and that any requirements should be subject to the principles of proportionality and ‘same risk-same regulatory outcome.’

Another challenge in adopting digital currencies is the lack of harmonised regulatory standards at an international level. This problem is compounded by the lack of interoperability between digital currencies. If these regulatory measures are harmonised at a global level, we believe transaction volumes will increase.

Finally, there is a lack of education among retail consumers to shift their behaviour toward the use of crypto-assets and the information that could bridge this gap in knowledge is not always accessible or easily available. It is unclear if investors understand the distinctions between e-money, stablecoins, fiat currency and legal tender (and indeed where these concepts overlap or diverge), let alone their respective advantages in payments or for other purposes. These unknowns may dissuade a significant proportion of the potential retail customer base from switching to digital currencies even where it could be of benefit for them to do so. Therefore, we think it likely that education (around the various types of crypto-assets and wallets and their respective use cases) will have to precede any surge in digital currency expansion that would be of such a scale that digital currencies would replace traditional currencies altogether.

What opportunities and risks would the introduction of a Bank of England Digital Currency bring?

We believe it is important to carefully consider what role a CBDC can play in the financial system, and whether this would serve the public interest. Nevertheless, we note that there is no obvious current market failure that warrants a retail CBDC, making its development more about maintaining a favourable ecosystem in the UK and keeping pace with global innovation and competition.

In terms of opportunities in relation to CBDCs, CryptoUK notes:

Opportunities

• Financial inclusion: CBDCs represent the promise of accessible digital legal tender that can also import sound monetary policy. However, despite this promise, this is not currently an accurate reflection of the status of CBDCs which remain subject to issues of f inancial inclusion; without access to a bank account, there is still no means to access CBDCs.
• Tech innovation: A UK CBDC would encourage technological innovation in the financial services sector. A UK CBDC would represent a major upgrade in the technology stack that supports value transfer and more open financial services innovation. This investment would enhance interoperability and open banking standards, ensuring that the UK keeps pace with crypto-asset developments in the EU and US.
• Settlement and counterparty risk: A wholesale CBDC clearly poses many significant benefits such as reducing settlement time and counterparty risks.
• Facilitate payment for digital assets: A CBDC would involve the payment infrastructure and frequency of use that would facilitate payment for digital assets within the real economy on an everyday basis and on a national scale.

Risks

• Intermediation: The two biggest risks of UK CBDCs are the costs to commercial banks following their disintermediation and the existence of a single source of failure. The current, tiered structure of the commercial banking system is arguably less risk as its structure enables household-name banks to interface directly with a country’s central bank, thereby enhancing consumer protection and spreading risk amongst regulated entities. The extent of the disintermediation risk depends on the architecture of the CBDC and the intermediation model itself (i.e., whether the CBDC is directly held or the CBDC is on the balance sheet of intermediary). These risks may be mitigated by, firstly, selecting architecture which does not disintermediate commercial banks and secondly, imposing (relatively low) limits for retail investors’ CBDC holdings or transactions.
• Cost and risk: The costs involved in creating, maintaining and developing a UK CBDC (and the further costs associated with promotion and adoption of the UK CBDC in the economy) will be significant and likely borne by the Bank of England (BoE). A digital pound would require decades-long investment in new, distinct payment channels that could withstand extreme events and nation-state-level attacks. In contrast, the private sector is able to both develop innovative solutions (although it can’t create legal tender) and shoulder the risk of failure. For example, in the first decade of blockchain, a $2 trillion digital asset and crypto currency industry was born largely on public digital commons rather than on risk-prone and costly technology implied by a Government-administered CBDC. The latter would shift technology risk to the public sector and, thereby, to taxpayers.
• Reducing innovation: CBDCs constitute legal tender, and as such they are likely to be more widely used than digital currencies and may ultimately displace them.. This may limit the use cases for privately issued digital currencies and as a result reduce the scope for investment which may reduce the pace of innovation.
• Security: The widespread use of CBDCs poses two clearsecurity risks. Firstly, individual accounts could be compromised through weakness in cyber security. Secondly, the centralised CBDC ledger, which would be a critical piece of national infrastructure, would be a key target for hackers.
• Privacy: Consumers may be concerned by their digitalidentity and spending details being held by a central bank. It remains unclear how this information would be safeguarded, stored and who it may be shared with.
• Private payments provide similar benefits: Many ofthe benefits of a UK CBDC are already provided by private payments innovations such as payment stablecoins. For the United States (US), USDC is used abroad by populations desperate for wealth preservation in inflationary, unstable environments. This promotes the use of the US dollar abroad and opens new markets for US monetary issuance. A pound stablecoin that is issued in the UK, fully served 1:1 with GBP, held on-shore in the UK regulated financial institutions and has the endorsement of the Government could provide nearly identical benefits. Additionally, it would have the proven benefits of fast settlement, near-feeless exchange, and programmatic capability, without the UK Government bearing the cost.
• Meeting demands: Currently, it is not clear that aCBDC could meet the constant demand for innovation by the market, or that it would improve access and financial inclusion.

Despite the above mentioned risks, it is important to recognise that CBDC and stablecoins can coexist, not least given differences in use cases and the lack of global interoperability of retail CBDCs.

What impact could the use of crypto-assets have on social inclusion?

Crypto-assets create a strong use case for social inclusion in that they have the potential to lower the cost of global remittances and connect the unbanked and underserved to financial services. The crypto economy presents an alternative financial infrastructure that is global, open source, and accessible to all who have access to the internet regardless of nationality, ethnicity, race, gender and socioeconomic class. Crypto-assets are able to achieve this inclusivity by allowing investors to access fast-growing internet lending and yield markets with little more than a digital wallet. This provides mainstream access to financial solutions that were previously only available to the banked and the wealthy, distinguishing crypto-assets from traditional banking, which often locks out the very people it was designed to protect.

The technology that supports crypto-assets therefore presents a real opportunity to service those who are currently unbanked or underbanked. Many unbanked individuals do not present a suitably persuasive economic argument for traditional banks to service them. The technology underpinning crypto-assets is able to solve the issue cheaply and efficiently.

Additionally, crypto-assets can leverage other innovations in financial services to help increase social inclusion. The advent of Decentralised Finance (“DeFi”) presents an example of this. DeFi does not by itself represent a disruption to traditional financial services or products, however it does represent a novel approach to mutualizing financial access for those who have previously found the ladder of economic mobility to be just out of reach. DeFi operates via a peer-to-peer network, which anyone with a smartphone or access to the internet can participate in. Consequently, DeFi opens up investment opportunities to people who have been excluded from traditional finance markets.

There are still barriers to crypto-assets and their potential impact on social inclusion. Most notably, there are practical considerations that need to be navigated so that the benefits of social inclusion remain whilst compliance requirements are satisfied. For example, it is unclear how KYC checks can be completed when creating a digital identity for the unbanked, particularly in terms of who would grant such an identity if not the Government.

Are the Government and regulators suitably equipped to grasp the opportunities presented by crypto-assets, whilst at the same time mitigating against the risks?

Our members have expressed concern that the Government and regulators may not have sufficient resources to grasp the opportunities and mitigate the risks presented by crypto-assets. In particular, our members have noted that conflicting approaches by the Government and regulators to crypto-assets causes confusion which makes it harder to grasp the opportunities presented. Regulators may also lack an in-depth understanding of the subject matter and industry and appear to be too risk averse.

A risk averse approach by regulators is contrasted with the Government’s stated aim of becoming a ‘crypto-hub’. Consequently, there is a lack of clarity over the future of crypto in the UK, which may have stifled investment in the region and could harm the UK’s crypto competitiveness. Despite the Government’s intention to become a ‘crypto-hub’, the Financial Conduct Authority (FCA) is yet to implement any specific rules or guidance on crypto-asset regulation. HM Treasury’s (HMT) consultations are also timed asynchronously, which has led to some confusion within the industry and may have limited the effectiveness of the responses provided. If the Government is keen to develop a jobs and growth agenda spearheaded by the crypto industry, it must act to ensure the regulatory framework is harmonised and consistent with this agenda.

We propose that the Government and regulators implement a unified approach. For the UK to compete on the global stage, especially in light of the clear regulations soon to be implemented in the EU by MiCA, the UK needs to state its crypto aims cohesively. The establishment of a Crypto Czar would be a great opportunity to pull together the various strands of regulation, making the UK competitive in this space.

Our members have also expressed the view that regulators’ risk-averse approach may be due to a lack of in-depth understanding of crypto-assets, particularly as the level of experience within both the UK Government and regulators on crypto-assets is still relatively low and areas of knowledge extremely niche. For example, the BoE and FCA have issued consumer warnings to financial institutions (such as the Dear CEO letter to commercial banks warning them that crypto-asset activity is inherently risky), which focus on dated narratives about unmitigated money laundering and dark web risks. Such warnings have adversely impacted crypto-asset businesses’ access to banking services, amongst other things, hindering financial institutions’ and UK innovators’ ability to build sustainable crypto-asset businesses in the UK.

To resolve this, our members suggest that regulators consider developing greater crypto knowledge in-house, through the training and the recruitment of sufficient numbers of experienced and skilled staff to help to develop a regulatory framework that is conducive to UK crypto competitiveness.

Additionally, many of our members feel that regulators are not sufficiently incentivised to weigh the benefits (commercial and otherwise) of encouraging adoption of digital currencies against the potential risks. Statements by both the BoE and FCA suggest that there is a focus on contagion risk to traditional finance or volatility risks to consumers, which overshadows the benefit of innovation in the industry. By contrast, in the UAE, regulators meet their Government’s desire to embrace crypto-assets wholeheartedly by balancing market integrity with the flexibility that allows the ecosystem to develop.

France’s PACTE regulation also aimed to encourage French Banks to bank with crypto companies who meet regulatory requirements. However, it is clear that French banks do not find the PSAN registration sufficient to enter into business relationships with crypto-asset service providers. This is an example of where the aim of the regulation has not been realised. In some cases French banks have even taken a de-risking approach whereby they have closed the accounts of crypto firms once the firm receives PSAN status. Only education can overcome these misunderstandings.

The key distinction between the UK and these jurisdictions is that regulators focus on the potential for crypto-assets and distributed ledger technology (DLT), both in terms of supporting GDP growth but also future technological advancements and can weigh this up proportionally with any risks that the technology involves. We would also highlight the importance of the UK Government providing a robust regulatory approach that ensures that UK banks are bound by policy to offer fair accessibility to the banking system, in order to avoid replicating the French model which has not worked in practice.

In order to grasp the opportunities presented by crypto-assets, we would suggest that the Government abides by the following principles when implementing policy:

• Equality: Regulation should be technology neutral; we do not want to regulate the technology but what it does. The ‘same activity, same risk, same regulation’ approach should apply. For example, the same regulation applied to P2P lending platforms should apply to analogous crypto lending platforms.
• Proportionality: Adjustments to the regulatory framework and introduction of new regulatory requirements on crypto-asset firms should be proportionate to the risks involved, taking into account key elements including (i) the risk profile of users/consumers of relevant products through the use of technology, (ii) the market 6environment and (iii) the need to foster innovation for the benefit of the market and end-users.
• Universality: A harmonised regulatory approach at a global level should be pursued, applying regulatory requirements to the entities that (i) benefit from the operation of the product and (ii) that can influence its features (and who should therefore bear the compliance burden).
• Extension of the regulatory perimeter: Extension of the regulatory perimeter should be based on the characteristics and taxonomies of relevant crypto-assets and the identification of risks, also bearing in mind the multiple functionalities of the crypto-asset technology. For instance, features of the crypto industry and related technologies that may not be reflected under current regulatory frameworks (or where there are challenges in applying current rules) include:
  • smart contracts are immutable and the systems are permissionless;
  • decentralised applications (dApps) can be accessed via websites and also directly via smart contracts; and
  • sanctioned addresses can be blocked from interacting with the website but it doesn’t stop the individual from interacting with the smart contract, resulting in several gateways to consider.
    The spectrum of crypto-asset transaction structures can be extremely broad and this means there are different challenges and the risks can change, for example, when considering asset backed or algorithmic stablecoins.
• Traceability: Traceability is another huge advantage of crypto-assets, whereas with e-money and cash there is less traceability. What opportunities and risks could the use of crypto-assets—including Non-Fungible Tokens—pose for individuals, the economy, and the workings of both the public and private sectors?

Opportunities

• Digital property rights: Digital property rights present a vast number of unique opportunities including digital identity, property ownership, digital artworks and crowdfunding. ● Non-Fungible Tokens (NFTs): As NFTs may represent either digital or physical underlying assets, they open up huge opportunities for monetisation in the creative sector. Although most NFT activity has been seen in the creative, sports, gaming and fashion sectors, we anticipate issuances across the broader retail sector.
• NFTs make establishing provenance and traceability of assets much easier, making assets such as digital works of art easier to buy, sell and trade.
• NFTs create new asset classes and investment opportunities for individuals and opportunities for innovators and entrepreneurs to access investment as well as a new way of dealing with f inance risk. When used other than for art, NFTs can offer new ways of dealing with trade f inance risks and certificates.
• De-Fi: There are also strong use cases for DeFi, particularly in relation to using smart contracts for enforcing financial arrangements. For example, the cryptocurrency lender Celsius, who ran into liquidity issues in 2022, was able to rapidly pay back its DeFi loans to users as many users had smart-contracts. This was an example of auto-liquidation, made possible because there is no ability to ‘restructure’ or renege on a smart contract.
• Meeting demand:Crypto-assets have evolved to meet varying needs for investment, store of value, currency conversion and payments, while DeFi is gaining momentum by offering new 7services (for example, staking) to users.

Risks

• Illiquidity: NFTs still bring the risk of asset illiquidity, price volatility and/or fraud, not dissimilar to traditional equity and fiat currency markets. The delay by the Government to effectively regulate the sector is the greatest risk to investors and this in turn delays economic benefits due to the lack of regulatory assurances within the sector.

How can distributed ledger technology be applied in the financial services sector?

DLT can successfully be applied to the financial services sector as technological infrastructure that enables simultaneous access, validation and record updating across multiple locations or entities. We have outlined specific example of DLT’s possible use cases in the industry below:

• DLT enables the safe operation of a decentralised, digital database, thereby eliminating the need for a central authority to keep constant checks against fraud or manipulation. ● DLT presents a clear back-office utility allowing parties to share data quickly and offer instantaneous settlements to avoid counterparty risk. For example, DLT’s ability to update several ledgers immediately would provide utility in the mortgage and consumer credit industry.
• DLT can also be built into new contracts for automated actions e.g. derivatives and CIS. Smart contracts are already being used in conjunction with DLT in debt and derivatives markets on a small scale.
• In the longer term, DLT could replace or compete with traditional settlement / clearing processes for shares, bonds and derivatives, disrupting parts of traditional financial firms’ business models.
• DLT has the potential to transform how securities are issued, traded and settled, potentially breaking down barriers to entry (particularly for SMEs) and providing new sources of liquidity for issuers which could then be used for green, social or sustainable projects.

We also note that the speed of DLT at the moment may not make it a strong contender for share trading. However, the integration of DLT technology into the financial services sector is likely to cause an evolutionary change to the sector, enabling innovation and new developments within the sector.

Whilst the use of DLT and smart contracts have the potential to be applied across many traditional financial asset and transaction types, there are challenges in how to apply certain aspects of the current regulatory framework (for example, aspects of UK law and regulation which implemented MiFID and regulation of crypto-asset custody), particularly in a disintermediated world. The FMI crypto sandbox being developed by HMT, the BoE and the FCA provides further opportunities to explore and address some of these challenges and facilitate greater adoption of DLT in financial markets.

What work has the Government (and its associated bodies) done to understand, prepare for and, where relevant, encourage changes that may be brought about by increased adoption of crypto-assets?

Government and regulators have taken steps to understand and facilitate crypto-assets. In particular we welcome the ‘crypto-sprints’ that the FCA recently organised. However, the Government and regulators have implemented strategy sporadically and at intervals. Additionally, for the most part, the attempts have involved retrofitting new technology, products and services into existing frameworks which are ill-fitting, resulting in lack of cohesion.

A ‘whole of Government’ strategy, which addresses issues such as tax, access to talent and financial benefits as well as regulation, is needed. For example, the Law Commission’s consultation on how UK law might need changes to address crypto-assets is a good example for the UK. It is also worth noting that trade bodies dedicated to crypto are still small, not-for-profit, and member funded. In 2010, the Government invested significantly in the Fintech sector to build out the infrastructure to support public/private partnerships and engagements. For example, Innovate Finance, a now integral organisation within the Fintech policy ecosystem, was originally funded through a Government grant. Equally, the UK crypto and digital asset sector would benefit from funding and resources to support the private sector in consumer education and fraud prevention, working with regulators and agencies to establish best practices and facilitate in depth research around the risks and opportunities for the UK to prepare for and encourage adoption of crypto-assets.

Similarly, the necessary engagement groups have not been established. For example, HMT announced the establishment of a crypto-asset Engagement Group in April which would be chaired by a minister with senior representatives from the FCA, the BoE and business. At the time of writing, this group has not yet been established, hindering the pace of progress. Once the group is established, we also suggest that the group should include trade associations such as CryptoUK so that the voice of our 150+ members may be represented.

The industry itself needs to be more proactive and less fearful. Additionally, the risk, control and governance frameworks need to improve within several industry participants. Therefore, we believe that a continued dialogue between industry and regulators is key to inform proportionate and effective policy.

How might the Government’s processes – for instance the tax system – adapt should crypto-assets be adopted more widely?

We believe that crypto trading venues have inadequate systems when compared to traditional equity venues. The Government should consider adapting this process to provide customers with a clear transaction history to ensure transparency and reliability; each key principles of the crypto industry.

The tax system also needs adapting particularly in relation to Capital Gains Tax (CGT) and, to an extent, income from staking. The tax approach in other EU jurisdictions provides an example of the changes that need to be made. For example, some jurisdictions such as Germany and Luxembourg do not impose CGT on crypto-assets held for less than specified minimum time periods. The UK, on the other hand, taxes crypto-assets similarly to other assets. It should be considered whether CGT could be used to act as an incentive to accelerate the UK as a fintech hub and ensure we retain competitive advantage over other jurisdictions.

Further to this, the UK should consider establishing a user-friendly tax regime which aligns with the actual realisation of income principles. Ideally, conversions of crypto into other crypto (without first converting to fiat) should not generate a tax liability to the holder but rather be afforded a deferral under a like-kind property exchange tax deferral regime. The holder should be able to carry over their tax basis in the first crypto-asset to the second crypto-asset.

Finally, rewards from staking or DeFi transactions should be treated as acquiring new property from the efforts/assets of the user and should not result in immediate realisation of income until 9disposition in the future. This will allow a user who receives DeFi or staking rewards to hold their currency without having to immediately sell a portion of it off in order to generate income to pay the f iat tax liability. This will aid the industry, especially proof-of-stake currencies which tend to be more economically friendly and allow users to continue participating in the ecosystem.

How effective have the regulatory measures introduced by the Government – for instance around advertising and money laundering –been in increasing consumer protection around crypto-assets?

Money laundering

The AML/CTF changes were a necessary part of providing regulatory scrutiny of the industry. We welcome the proposed HMT implementation of the Financial Action Task Force (FATF) Travel Rule. In particular, the decision to maintain a risk-based approach by not removing the GBP 1000 threshold for application of the Travel Rule or implementing screening of un-hosted wallets. Such changes would overburden a nascent industry which is different from other jurisdictions such as the EU.

However, more changes need to be made. Following the implementation of the AML/CTF changes, our understanding is that the Government intends to review the changes and consider how they could be made more effective with respect to their application, promotion of innovation and reduction in costs, to firms. We propose that the Government consider the following changes:

• We believe the AML/CTF regulations should be revised to introduce direct investor protection benefits. Currently there are only ancillary obligations, such as making it clear whether FSCS compensation applies.
• Working to resolve remaining issues around the FATF Travel Rule including the lack of harmonisation at global level. Wallet ownership continues to be a point of failure as third party usage is always possible (for example, when a Virtual Asset Service Provider (VASP) verifies ownership, the user could still be someone else).
• The Government should consider actively participating in the FATF’s work to develop further guidance on the Travel Rule for un-hosted wallets and NFTs.
• Above all, we support international alignment and consistency as much as possible, in particular for AML/CFT regulations because consistent global implementation is key to avoiding regulatory arbitrage.

Advertising

We are concerned that the proposed extension of the Financial Promotions Order (FPO) to crypto-assets may harm the potential for innovation and UK competitiveness.

Under the amended FPO, there does not appear to be any interim solution to allow crypto firms to approve their own financial promotions in advance of the potential introduction of a UK regulatory authorisation framework for crypto-asset firms. In this case, crypto-asset firms in the UK would have to find suitable third-party approvers for their own financial promotions. Firms may therefore be expected to rely on a competitor for approval, something which the FCA itself has acknowledged is difficult and possibly unrealistic and which is likely to result, in practice, in a total ban on a number of f irms’ financial promotions.

We believe an interim solution could be to allow crypto firms that are registered with the FCA under money-laundering regulations and who follow rules under the FPO to act as approvers of crypto-asset financial promotions. This could be implemented whilst ensuring that crypto financial promotions are fair, clear and not misleading.

Therefore, we would welcome a new industry consultation on extending the FPO to crypto-assets in a manner that improves consumer protection and supports the UK’s competitiveness as a crypto hub.

General comments

Separately, we support the proportionate use of risk warnings and disclaimers about volatility of crypto-assets as part of the customer onboarding process but believe ‘positive frictions’ should not undermine the customer experience. For example, we believe a 24 hour ‘cooling off period’ for first time investors is disproportionate and would go beyond what is expected in other sectors or other jurisdictions.

Turning to HMT’s approach; under the current regime there does not appear to be any benefit to being established in the UK compared to other jurisdictions. UK registered firms are potentially at a disadvantage based on the FCA’s risk-based enforcement. There should be an emphasis on trust and permissions for businesses that are already authorised or semi-regulated. For example, registered crypto-asset providers and authorised e-money institutions already have a high level of regulatory accountability and the requisite expertise in order to undertake advertising activity.

Is the Government striking the right balance between regulating crypto-assets to provide adequate protection for consumers and businesses and not stifling innovation?

Our members have expressed the view that they do not think the Government is striking the right balance between regulating crypto-assets to provide adequate protection for consumers and businesses and avoiding stifling innovation. In particular they are concerned that the proposed amendments to the FPO as discussed in question 9 above may stifle innovation and harm UK competitiveness.

Additionally, as the Government has not widened access to services such as adequate insurance and banking (i.e., client money safeguarding accounts) that are necessary for crypto firms to operate a regulated business, it has been more difficult for new entrants to emerge. As a result, innovation in the industry may have been suppressed.

Many of our members also feel that the approach to registration and enforcement has been inconsistent, for example, the FCA has faced continued scrutiny over its registration of UK crypto f irms. In terms of enforcement, the Advertising Standards Authority (ASA) has imposed advertising enforcement actions inconsistently. As the ASA has no statutory authority, they are not overseen as other regulators are, and as such many of our members have expressed the view that the ASA should not be able to impose enforcement actions. The ASA also lacks a competitiveness mandate which exacerbates these concerns.

Where new authorisation and permissions requirements are introduced for crypto-asset firms, we propose that transitional provisions should be appropriately calibrated to give firms sufficient time to implement new requirements. Lessons should be learned from the end of the temporary registration regime under the MLRs, where many firms were given very little warning that their registration application was not approved, with temporary registration coming to an end in some cases only days later. Instead, it will be important for firms to have a reasonable period of notice of the outcome of their authorisation application before any temporary or preliminary authorisation ceases. This would allow for an orderly transfer or run-off of existing business should this be required.

Could regulation benefit crypto-asset start-ups by improving consumer trust and resilience?

Yes, proportionate regulation of the crypto industry is key to improving consumer trust. Policy objectives of consumer protection and competitiveness are not necessarily conflicting and should be seen as two sides of the same coin. However, whether this is actually achieved is dependent on the type of regulation. As above, the changes to the FPO create a barrier to entry for SMEs.

How are Governments and regulators in other countries approaching crypto-assets, and what lessons can the UK learn from overseas?

In other countries, we notice that the general trend is towards prioritising regulation of e-money (such as stablecoins) that are backed by fiat currencies, with some differences in composition of reserve requirements between jurisdictions. We believe the UK should approach regulation in a similar way.

Firstly, we believe that a future UK regulatory crypto-asset framework should maintain open access to global crypto markets to deliver on the ambition to become a global crypto hub. By 2024, 27 member states in Europe will be regulated within a holistic regime which allows passporting across all member states. This will be a competitive threat to the UK. While the EU MiCA regime may act as a reference point globally for regulation of CASPs and issuers of crypto-assets, it notably does not include a third country regime.

Secondly, we also believe it is important for the UK Government to develop a transparent and consistent business environment for crypto native companies as well as foster a research and workforce environment, akin to California’s Executive Order to promote responsible Web 3.0 innovation.

Mainland UAE offers a good example of how both regulators and Government are working closely together to diversify their GDP, but not at the expense of investor protection or market integrity. A key difference when comparing the UK with the UAE or Swiss model, for example, is that there is more regulatory dialogue with the industry to understand risks and to find appropriate regulatory solutions, while still protecting investors and upholding market integrity.

Thirdly, the development of trade associations, such as the Japan Virtual Crypto-asset Trading Association (JVCEA), are a progressive way to quickly provide guardrails to protect consumer harms and maintain market integrity. A key benefit of this self-regulatory organisation model is the ability for the top tier advisory firms (such as KPMG) to onboard these entities; something that is not currently possible in the UK. This in turn allows access to top tier Japanese banks as these crypto service providers are regulated through the local trade association.

The environmental and resource intensity of using crypto-asset technology.

We believe there is no trade-off for the UK between the transition to a low carbon economy and being a crypto hub; many newer crypto-assets are already using technologies that are far more energy efficient. We also anticipate carbon emissions in the industry to fall due to the following:

• a reduction in carbon when ETH moves from the Proof of Work to Proof of Stake consensus mechanism, which is due this year.
• increased regulatory scrutiny of the carbon footprint of the consensus mechanisms used to validate crypto-asset transactions has the potential to drive the transition from the energy-intensive Proof of Work method for securing the network to a Proof of Stake model.
• For the Proof of Work method, where the cost of energy is high, there are greater incentives to move to renewables, which we anticipate will impact BTC mining.
• As the crypto-asset class becomes more mainstream and more institutional investors invest, pressure from the public and investors will be an additional driver to reduce the carbon footprint of Proof of Work. We believe sustainability disclosure requirements will enhance this trend.

To encourage shifts to more energy efficient processes we suggest that incentives, rather than restrictions, should be used.

When assessing the environmental and resource intensity of using crypto-asset technology it is also important to consider that:

• the environmental costs of crypto-assets need to be fairly compared against the traditional world alternatives; and
• the environmental impact must also be balanced with the governance benefits crypto-assets bring, in that potentially higher energy costs may deliver better governance/security outcomes.

CryptoUK Response to Discussion Paper 24/4 – Regulating cryptoassets: Admissions & Disclosures and Market Abuse Regime (the “Discussion Paper”)

Collective engagement to collaborate on the Crypto-Asset Reporting Framework

CryptoUK Supports Call for Urgent Reform of Crypto and Digital Asset Taxation to Foster UK Innovation

CryptoUK and Members Respond to House of Lords Special Public Bill Committee – Call for Evidence on the Property (Digital Assets etc) Bill

CryptoUK Responds to HMT Call for Evidence on a Financial Services Growth and Competitiveness Strategy

CryptoUK and Members Respond to the House of Lords Inquiry into the Secondary International Competitiveness and Growth Objectives for the FCA & PRA

CryptoUK and Members Respond to the Bank of England “Approach to Innovations in Money and Payments” Discussion Paper

CryptoUK and Members Autumn Budget 2024 Stakeholder Representation – 10 September 2024.

CryptoUK and members respond to the HMT consultation on improving the effectiveness of the Money Laundering Regulations.

CryptoUK Travel Rule Good Practices Guide