The UK’s Approach to Crypto Regulation: What You Need to Know

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Since the publication of the Bitcoin whitepaper in 2008, the legal status of the cryptocurrency industry has been a highly debated topic. The emergence of cryptocurrencies has presented lawmakers and regulators with a new set of challenges, and their response to this nascent industry has been diverse.

While some governments perceive cryptocurrencies as a threat to monetary control, others view them as a means to foster economic growth, especially for connecting remote economies and enabling trustless global transactions.

Sound cryptocurrency regulations aim to ensure investor protection and financial stability while promoting innovation and increasing the attractiveness of the crypto asset sector. However, most of the world still grapples with legislating, regulating, and prosecuting laws relating to such a nascent industry.

In the United Kingdom, the Financial Conduct Authority (FCA) is responsible for overseeing and regulating anti-money laundering (AML) and counter-terrorism financing (CTF) activities associated with cryptocurrencies. As a result, all cryptocurrency exchanges operating in the UK, with a few exceptions, are required to register with the FCA.

This article explains all you need to know about the UK’s approach to cryptocurrency regulation. We will examine the UK’s approach to money laundering and cryptocurrencies, the FCA’s regulations, and the regulatory standards that are in place for crypto-related businesses.

Defining Cryptoassets

A cryptoasset is a digital representation of value or contractual rights that can be sent, stored, or traded electronically. They are created via the combination of cryptography, distributed ledger technology, or other similar technologies.

Cryptoassets could serve various purposes, from trading digital collectibles to raising capital for new projects. There is no internationally agreed-upon taxonomy or classification of cryptoassets.

The Financial Conduct Authority (FCA) issued “Guidance on Cryptoassets” in 2019, which described three broad categories of tokens and how they fit within existing FCA regulations. These include:

E-Currency Tokens

The Electronic Money Regulations (EMRs) define these as digital payment instruments that store value, can be redeemed at face value at any time, and give the holder a direct claim on the issuer.

Security Tokens

These have characteristics similar to specific investments, such as shares or debt instruments (as defined by UK law). These are tokenized, digital forms of traditional securities. These, like e-money tokens, are already within the UK’s regulatory perimeter and thus subject to FCA oversight.

Unregulated Tokens

These are neither e-money nor security tokens. They include the following:

Utility Tokens: tokens used to purchase a service or access a DLT platform, such as access to online cloud storage.
Exchange Tokens: tokens primarily used as a means of exchange, such as Bitcoin, Ether, and Ripple.

The FCA’s guidance also makes it clear that many tokens can take a hybrid form and fall into different categories at different points in time; for example, they may be used to raise capital at first, then primarily as a means of exchange later on.

Many popular exchange tokens are very volatile, which makes them less useful as payment and more appealing to some holders as a high-risk speculative investment.

In March 2018, the UK’s Financial Policy Committee (FPC) stated that the values of exchange tokens are too unstable to be widely used as a currency or a place to store value. Also, because their transaction costs are high and their settlement times are slow, they are not a good way to exchange money.

The FPC emphasized that cryptocurrencies do not hold any claim on future income streams or collateral. They possess no intrinsic value beyond their present potential for adoption as a form of future currency and may hold no value.

The Rules and Guidelines Set By the Financial Conduct Authority (FCA)

The UK’s Financial Conduct Authority (FCA) has implemented measures to minimize the likelihood of money laundering within cryptocurrency exchanges. As per FCA guidelines, businesses must recognize and evaluate the hazards associated with anti-money laundering (AML) and countering the financing of terrorism (CFT).

After the risk assessment, the next move is to devise policies and tactics to alleviate the recognized threats. The initial stages of a comprehensive risk assessment necessitate conducting

Know-Your-Customer (KYC) and
Customer Due Diligence (CDD) procedures.

The FCA mandates KYC (Know Your Customer) checks to regulate companies that facilitate cryptocurrency transactions in the UK. KYC involves collecting personal identifying information such as customer IDs, passports, driver’s licenses, and photos to allow businesses to verify the accuracy of the information customers provide.

If discrepancies are identified, businesses can use additional verification methods or decline to do business with suspicious customers, depending on their internal policies and risk tolerance.

The Customer Due Diligence procedures are used to evaluate customer risks and implement measures to prevent money laundering and terrorism financing. These measures aim to ensure that crypto businesses comply with relevant regulations.

The FCA has further emphasized that it will take timely action if crypto businesses fail to comply with the expected sector standards. The FCA has highlighted the potential for speculation to be exploited due to the obscurity of the crypto industry, thereby jeopardizing market integrity.

UK’s Approach to Cryptocurrency Regulation and Related Projects

Although it left the EU in 2020, the UK government incorporated the Fifth and Sixth Anti-Money Laundering Directives(5AMLD & 6AMLD) into its domestic legislation for cryptocurrency regulation.

As a result, all UK-based crypto asset companies marketing their products in the UK or offering services to UK customers must register with the Financial Conduct Authority (FCA) from January 10, 2021. This includes popular cryptocurrency exchanges and advisers, investment managers, and other professionals.

The FCA has established guidelines for these companies to follow, such as adhering to Anti-Money Laundering (AML) and Countering the Financing of Terrorism (CFT) reporting requirements, customer protection, and complying with the Money Laundering, Terrorist Financing, and Transfer of Funds (Information on the Payer) Regulations 2017.

Initially, businesses already active in the cryptoasset market could carry on with their operations while the FCA processed their registration applications. However, as the deadline for registration got closer, many businesses sent in their applications at the same time, which caused a backlog of registration requests.

To address the backlog of registration requests, a “temporary registration regime” was introduced in December 2020. This allows cryptoasset companies that have submitted a complete registration application to continue operating while the FCA processes their application.

On January 6, 2021, the FCA banned the sale of crypto derivatives to retail consumers. This ban includes options, futures, exchange-traded notes, and crypto exchange-traded products (ETPs).

The ban was implemented to protect consumers from the risks of investing in these highly volatile financial instruments. However, professional investors and institutional clients are exempt from this ban as they are expected to have a good understanding of the risks associated with investing in cryptocurrency derivatives.

Criticism of the UK’s Approach to Crypto Regulation

The United Kingdom’s approach to cryptocurrency regulation has faced criticism on several fronts. One of the main criticisms is that the regulations are inconsistent and unclear, leading to confusion among businesses and consumers. This lack of clarity has left many wondering how cryptocurrencies should be regulated.

Another criticism concerns the Know Your Customer (KYC) and Anti-Money Laundering (AML) regulations. Some argue that the current regulations are insufficient in preventing money laundering and other illegal activities related to cryptocurrencies. There are concerns that some crypto businesses are not doing enough to verify their customers’ identities or to monitor suspicious transactions.

Finally, some critics argue that the UK’s approach to crypto regulation is stifling innovation. They claim that the lack of clear regulations and slow regulatory change makes it difficult for UK-based crypto businesses to compete with those in other countries, hampering the development of new ideas.

Future UK Crypto Regulations

The UK is expected to follow EU’s footsteps in implementing anti-money laundering (AML) regulations and directives similar to the EU’s proposals on Markets in Crypto-assets and E-Money. However, it is also expected to introduce unique laws changes.

In January 2021, the UK Crypto Asset Task Force released guidance through HM Treasury, stating its intention to consult on bringing specific cryptocurrencies under the “financial promotions regulation” and considering a “broader regulatory approach” to crypto assets.

In January 2022, the government tightened the law to tackle misleading cryptocurrency promotions and align cryptocurrency advertising with traditional financial advertising. Additionally, the Task Force explored options for regulating stablecoins, which are currently prohibited under the Financial Conduct Authority (FCA).

A task force established in April 2021 by Rishi Sunak examined the possibility of issuing a digital currency by the UK central bank (CBDC). The task force’s findings were published in 2022 and indicated that while a UK CBDC would provide certain financial advantages, it would also pose significant risks to consumer privacy and the nation’s financial stability. Consequently, there was no convincing reason for a UK CBDC.

Following Russia’s invasion of Ukraine in February 2022, the UK joined other Western countries in imposing strict measures against the Putin government. In March 2022, the Bank of England, the FCA, and the UK Office of Financial Sanctions Implementation (OFSI) jointly issued a statement reminding cryptocurrency service providers of their obligation to support financial sanctions.

The statement urged cryptocurrency service providers to update their sanctions screening solutions and watch out for “red flag indicators” of sanctions evasion, such as high-risk wallet transactions and the use of mixing and tumbling services that conceal user identities.

Given the ongoing financial instability caused by Russia’s invasion of Ukraine and the cryptocurrency market’s volatility, the UK government is expected to prioritize regulating bitcoin service providers.

Check out our previous article for a more detailed breakdown of the legalese of the UK’s most recent approach to crypto regulation issues.

In Conclusion

As the cryptoassets industry has grown, regulatory efforts have progressed in parallel. The United Kingdom’s regulators have sought to balance promoting innovation and ensuring consumer protection and financial stability.
The Financial Conduct Authority (FCA) has implemented different measures to safeguard consumers, such as issuing cautionary statements about the associated risks and banning the retail sale of certain financial products. The government has also suggested giving the FCA more power to control financial promotions that involve cryptoassets.
Despite the decentralized nature of cryptocurrency trading, which can make regulation challenging, the FCA has established regulations for businesses engaged in cryptoasset activity in the UK. Since 2020, these businesses have had to register with the FCA and follow the rules against money laundering and funding terrorism.