Harnessing the cryptocurrency hype – partners size up prospects for the 'Wild West' market
A recent inquiry into the burgeoning crypto-asset market labelled the current state of affairs as a 'Wild West' - so what do lawyers in the sector think about the prospects of establishing the UK as a global centre for the industry?
October 25, 2018 at 09:26 AM
6 minute read
Last month, a Treasury Committee inquiry into the burgeoning crypto-asset market labelled the current state of affairs a "Wild West", and called on lawmakers to introduce new regulation to "hold industry to account".
The inquiry's report stated that the UK could be "well placed" to become a global centre for the industry, but described the current position as unsustainable, given the market's association with criminality.
Lawyers advising in the sector are in broad agreement with the 'Wild West' characterisation, and cite numerous challenges for regulators looking to set standards and establish this much-touted market in the UK.
Trystan Tether, joint head of Bird & Bird's international finance group, believes the volatility of crypto-asset prices, as well as the "pseudo-anonymity" conferred by some of these products, is partly responsible for the 'Wild West' label: "At the moment, it's fair to say that crypto is definitely being used for money laundering and illicit payments. A thousand bitcoin can be put onto a USB stick and moved through an airport without creating even a bulge in a suit pocket."
Linklaters finance partner Paul Lewis, who has worked on a number of projects involving crypto-assets, says: "A lot of these products [crypto-assets] fall into an odd non-regulated bucket. They are so easy to invest in – you can buy them in a few minutes on a computer – and for many of them there's a real hole in the regulatory regime, offering no protections. People stand to lose a lot of money and it's eminently sensible for the Treasury Committees to suggest regulating those that are not already covered."
The global market capitalisation for crypto-assets exploded in 2017, beginning the year at about $22bn and then peaking at $830bn in January 2018. The market has since deflated and, as of October, sits around the $220bn mark.
However, particular concerns have also been raised around initial coin offerings (ICOs) – the online pre-sale of tokens or crypto-assets to the public to raise funds for blockchain projects – which raised $10bn globally in the first half of 2018. According to recent research by Boston College into 2,400 ICOs, 56% of projects failed within the first four months – for reasons ranging from theft by hacking or clear fraud, to developers leaving the project early and poor business planning.
Despite the concerns, the committee report says it is "highly likely [crypto-assets] are here to stay", so the question becomes whether regulators should encourage the growth of the new industry and, if so, how it can be regulated.
According to the FCA: "Crypto-assets themselves […] are generally not within the scope of FCA regulation. Transferring, buying and selling of crypto-assets, including the commercial operation of crypto-asset exchanges, will also typically fall outside the FCA's regulatory perimeter."
Last year, as crypto-assets boomed, the FCA issued a caution to investors trading in crypto-assets that they should be "prepared to lose [their] entire stake", but later David Geale, director of policy at the FCA, acknowledged that even this warning may "have gone a little bit outside of [the FCA's] remit".
Bird & Bird's Tether believes regulators face a number of important questions in deciding whether to regulate the industry. He thinks the regulators are firstly "very nervous about giving a stamp of approval" to new financial products that lack the safeguards of established financial products. Tether says there is a risk that "if issuing and dealing [crypto-assets] is regulated, the public might start seeing them as equivalent to shares and or debt securities", even though "crypto-assets often don't give the holder any clear rights".
Another part of the challenge, according to Norton Rose Fulbright partner Hannah Meakin, will be defining exactly what the FCA is intending to regulate: "In practice it will be challenging to define exactly what they intend to cover. There are lots of different types of tokens. It might be appropriate to regulate some and not others."
According to Eversheds Sutherland – which has acted on a number of ICOs, including the first for a UK-based organisation last year, and submitted evidence to the inquiry – crypto-assets can be typically categorised into three types: transactional tokens, which look functionally similar to currencies, such as bitcoin; voucher tokens, which carry the right to a pre-defined asset; and 'fuel' tokens, which enable blockchain-supported applications to operate.
Andrew Henderson, a financial services partner who leads the crypto-assets practice at Eversheds Sutherland, explains: "Classifications are important, because the tokens do different things and have different economic functions. If the system of regulation is about ensuring proper outcomes, then it all comes down to what the economic market impact will be of a [crypto-asset]."
To make matters even more complicated, many tokens do not fit neatly into these three camps. Some 'voucher' tokens offer future access to a service, instead of an asset. For example, the Filecoin token, which was publicly issued in September of 2017, will allow holders to access a data storage service when the platform eventually launches in 2019. Yet other tokens – which would not usually be considered as transactional or as assets – are, according to Eversheds, "complicated by market forces", when users trade them speculatively as investments and stores of value.
According to the Treasury committee, if these regulatory challenges are met, the UK could be "well placed to become a global centre for this activity".
RPC legal director James Kauffman is optimistic about the industry and believes the effort required to establish a workable and regulated regime for crypto-assets is "surely worth winning". If the UK were to become a hub for the crypto-asset industry, Kauffman thinks it "may have positive knock-on effects for businesses serving these markets, such as brokers, investment banks and custodians, as well as a potential increase in tax revenues for authorities".
However, Kauffman admits that even if regulatory proposals were fast-tracked, it would take a minimum of two years for them to be put in place, especially given the current distractions presented by Brexit.
Tether also believes the proposals are "a very laudable aim", but also that it would be an "enormous task to take on effectively", without a "clear sufficient upside".
He adds: "In the long term, the business case for crypto-currencies as a means of payment for mass transactions is uncertain. We live in a world which has very efficient conventional methods of transferring value and, as Bank of England Governor Mark Carney has said, a lot of effort is going into making those methods better still."
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