Does trading in unbacked crypto assets present a regulatory dichotomy?
by Wendy Saunders, Head of Financial Services Regulatory, Lewis Silkin
The recent Treasury Committee report on regulating digital assets has caused shock and dismay in the crypto industry.
Much of what it says is uncontroversial. For example, it acknowledges that “effective regulation of crypto assets should help to foster innovation and maximise any potential benefits of crypto asset technologies for the UK, while also mitigating risks”.
It also notes that “it is important that the Government and regulators strive to keep pace with developments, including by ensuring that the Financial Conduct Authority’s authorisations gateway is open and effective, so potential productive innovation in financial services is not unduly constrained”.
These are important, well-made, and valid points.
What is controversial, however, is the view that a specific subset of crypto asset activity – retail trading in unbacked crypto assets – should be regulated like gambling rather than as a financial service, based on both the activity’s characteristics and outcomes.
READ MORE: Treasury Committee’s call for digital assets to be regulated same way as gambling industry is slammed by crypto leaders
The Treasury Committee fears that to regulate retail trading in unbacked crypto assets as a financial service would create a ‘halo’ effect, leading customers to believe that this activity is safer than it is – or protected when it is not.
But to have the FCA regulate some crypto asset activities, and the Gambling Commission regulate others, may not address the halo effect. It could lead to an incoherent regime and cause greater confusion for consumers, who could mistakenly believe that dual regulation affords them more protection (e.g., where firms offer multiple crypto asset or other FCA-regulated products and services).
FCA regulation, rather than GC regulation, could protect consumers more in real terms. Both regulators require anti-money laundering and counterterrorist financing measures to be applied.
However, the FCA has specific statutory goals and experience of regulating analogous activities. It has a strategic objective to ensure that relevant markets function well – and an operational objective to protect consumers.
As highlighted in HM Treasury’s consultation and call for evidence on the future financial services regulatory regime for crypto assets, crypto asset exchanges and traditional exchanges face similar risks; including fraudulent or market abusive trading (amongst others).
The FCA is the regulator best placed to enforce fair and efficient trading practices on crypto asset exchanges, together with addressing other risks e.g., counterparty credit, exchange rate and operational risks. In doing so, it will also be mindful of complying with its strategic and operational objectives, ensuring that crypto asset exchanges in its remit function well – and that consumers are appropriately protected.
Such regulation will not stop consumers from suffering losses. Nikhil Rathi, CEO of the FCA, commented in his evidence to the Treasury Committee, “On the crypto point, whatever we do on regulation, we are not going to be able to put in place a framework that protects consumers from losses… Under no circumstances whatsoever should people expect compensation through this”.
But even if the GC were to regulate this activity, that remains the position. With the FCA as regulator, consumer losses would be more likely to at least be reduced due to the nature of the regulatory regime that would be introduced, and the FCA’s particular focus on the fair and orderly functioning of markets.
The Gambling Commission itself is of the view that it has a limited remit in relation to crypto assets. This can be seen from its recent advice to the government and the Gambling White Paper.
The GC covers two areas relating to acceptance of payments in crypto for gambling: firstly, whether gambling operators can comply with their anti-money laundering and ‘know your customer’ requirements; and secondly, whether they can comply with safer gambling measures, including setting financial limits and identifying unaffordable gambling.
The complexities of operating a full licensing regime for crypto asset exchanges would go beyond the experience and resources available to the GC.
As a concluding observation, the FCA will soon be subject to a further statutory objective: to facilitate the international competitiveness of the UK economy and its growth in the medium to long term. It is likely to be held to account against this objective, under which it will have to provide additional justifications for regulatory interventions – and for deviating from regulatory approaches adopted in other jurisdictions.
Against this backdrop, it is unlikely that retail trading in unbacked crypto assets will be addressed in an entirely new and separate regime – and one which does not necessarily align with earlier Treasury views, will not necessarily deliver benefits to consumers, and would be at odds with international regulatory approaches.