Cryptoassets and NFTs: UK regulatory update

Registration of cryptoasset businesses

Since 10 January 2020, UK cryptoasset businesses have been required to register with the Financial Conduct Authority (FCA) for the purposes of anti-money laundering and counter terrorist financing (AML/CTF) supervision.  Under the Money Laundering, Terrorist Financing and Transfer of Funds (Information on the Payer) Regulations 2017 (MLRs), cryptoasset businesses are those which, by way of business:

• exchange, arrange or make arrangements with a view to the exchange of, fiat currency for cryptoassets, or cryptoassets for cryptoassets (including exchange providers, but also in some circumstances covering businesses offering new token issuances or initial exchange offerings)
• provide cryptoasset ATMs
• safeguard, or safeguard and administer, cryptoassets or private cryptographic keys on behalf of their customers.

The MLRs define a cryptoasset as a "cryptographically secured digital representation of value or contractual rights that uses a form of distributed ledger technology and can be transferred, stored or traded electronically".  Activities involving tokens which do not fit into that definition (which might include non-fungible tokens (NFTs) in certain circumstances) are outside of the MLRs, and therefore the requirement for registration with the FCA.

When the MLRs were amended to include the requirements relating to cryptoasset businesses, the Temporary Registration Regime (TRR) was put in place to give existing businesses which submitted applications by a certain time a period in which to obtain registration from the FCA.  These businesses appeared on a list of temporary registrations maintained by the FCA.  The TRR ended on 31 March 2022, and now cryptoasset businesses that have not been successfully registered need to cease activities in the UK.

In December 2021, the FCA noted that "nearly 90%" of firms which have applied for registration have been refused or withdrawn their application as a result of FCA action, but only one appeal against an FCA decision not to register has so far made it to the Upper Tribunal.  That appeal related to an application for a cryptoasset ATM business, in relation to which the FCA recently reported that no businesses had been successfully registered.  The lack of appeals against decisions is perhaps indicative of the nature of businesses in the crypto sector.  Rather than attempting to fight FCA decisions, they are perhaps simply choosing to move operations to alternative jurisdictions where there is no registration requirement (although such jurisdictions are reducing in number by the day) or, more likely, registration is not as difficult to come by.

While the FCA's attitude to registration might reduce supervisory burden on it in the short term, it does mean that the FCA will have limited ability to prevent cryptoasset businesses based outside of the UK from targeting UK consumers.  Therefore, the FCA's new powers relating to promotions of cryptoassets (see below) will be key in ensuring that consumers in the UK are protected from businesses over which the FCA has no jurisdiction.    

Moving toward increased regulation of cryptoassets

As previously reported, in 2021 HM Treasury opened two consultations regarding the regulation of cryptoassets:

• on the broader regulatory approach to cryptoassets, including new challenges from so-called 'stablecoins'
• on bringing certain cryptoassets into scope of the financial promotion regime to enhance consumer protection.

The consultation relating to the regulation of cryptoassets (and in particular stablecoins) closed on 21 March 2021, and we are still waiting for a read out on the results.

On 18 January 2022, HM Treasury confirmed that "qualifying cryptoassets" will be brought into scope of the financial promotions regime.  The financial promotions regime, which is set out in the Financial Services and Markets Act 2000 (FSMA), and the FCA Handbook, means that communications which are "invitations or inducements" to engage in certain controlled activities are prohibited unless: (i) the communication is exempt, (ii) the content of the communication is approved by a firm that is authorised by the FCA or the PRA, or (iii) the individual or business making the communication is authorised itself.

Separately, HM Treasury is putting in place restrictions which will limit the number of firms able to approve financial promotions.  Under legislation to be put forward in the coming months, authorised firms will need to obtain a specific permission in order to approve the financial promotions of unauthorised firms.   

Although the definition has not yet been confirmed, a qualifying cryptoasset is likely to be any cryptographically secured digital representation of value or contractual rights which is fungible and transferable, and which is not another controlled investment, electronic money, or central bank money (carving out central bank digital currencies).  Notably, and in comparison to the definition of cryptoassets in the MLRs (see above), a qualifying cryptoasset does not necessarily need to use distributed ledger technology.  This is highlighted as an attempt to 'future-proof' the definition against future technologies.

A qualifying cryptoasset has to be fungible, which should exclude most NFTs from being subject to the amended financial promotions regime.  However, HM Treasury has not ruled out extending the regime in the future to capture NFTs should it become necessary in order to protect consumers.  It is also important to note that the definition will apply in accordance with "substance over form": describing a token as an NFT will not be sufficient to bring the token outside of the definition if the token is actually fungible in practice.

If a promotion is caught by the financial promotions regime, it must be approved by an authorised firm (assuming that the promotion is not exempt, and the cryptoasset firm is not itself authorised).  In order for a promotion to be approved by an authorised firm, the promotion will need to adhere to the FCA's rules, and the FCA has consulted on what these will look like (the consultation closed on 23 March 2022).  Generally, financial promotions are required to be clear, fair, and not misleading, but in the case of cryptoassets the FCA is particularly concerned about whether consumers are able to understand the information provided to them about a cryptoasset investment (which the FCA sees as high-risk), the speed and ease with which consumers can make crypto investments, and consumers being driven by "competition" and social media hype.

The FCA wants to add friction into the customer journey for obtaining high-risk investments such as qualifying cryptoassets, and proposes to:

• introduce a risk warning
• ban inducements to invest (like free tokens for introducing friends)
• add "positive frictions" like personalised risk warnings
• make changes to investor declarations so that investors are better able to understand what type of investor they are
• require firms to robustly assess investors' knowledge and experience.

The FCA is also likely to require firms to record the impact of the additional requirements at different stages of the customer's journey (which suggests that if firms' measures do not deter enough investors, further requirements might be imposed).

The extension of the financial promotions regime in this manner means that there will be a mismatch between the requirement for authorisation (which applies for regulated activities, such as advising on investments in securities, for example, but will not apply to any cryptoasset activities), and the requirement for financial promotions to be approved.  Considering this along with the changes to the financial promotions regime, cryptoasset businesses may encounter difficulties in finding an authorised firm willing and able to approve its promotions which fall inside of the regime.  This is likely to limit the ability of cryptoasset firms to make promotions to retail investors (who generally will not fall into an exempt category of recipients).

There is a legislative process to go through for amendments to the financial promotion regime to be made, and alongside that, the FCA will develop rules and guidance for firms.  Once the regime is confirmed, businesses which promote cryptoassets and services involving cryptoassets will need to assess whether their activities are caught by the regime, and if so, make arrangements for promotions to be approved, although we are expecting that there will be a transition period of "approximately six months" for compliance.

In the meantime, businesses should bear in mind the recent guidance and decisions from the Advertising Standards Authority on the marketing of cryptoassets (see here for more on this).