What are the FCA proposals for crypto regulation?

Crypto assets have been the subject of increased scrutiny during the last couple of years, with both the Government and the FCA having expressed concerned over ‘the wild west’ of finance. Following the introduction of the Crypto Asset Financial Promotion Amendments Order 2023, and the Financial Services and Markets Act 2000, together with the Economic Crime and Transparency Bill, the sector is now looking ahead at what the impact of this regime has had, and what is planned for the future. Phase 1 of the current regulation seems to have had little effect (perhaps even a negative effect), with some exchanges moving out of the English promotion markets completely. The sector needs further regulation, and the FCA has just introduced the FCA crypto roadmap for the introduction of phase 2, which is good news.

In September, the Government introduced the Property (Digital Assets etc) Bill, which provides that digital assets may be considered to be personal property under the laws of England and Wales, and so may be afforded the same legal protections as traditional categories of personal property. In practical terms, this legislative confirmation is likely to reduce the scope for residual arguments as to whether cryptoassets can attract traditional property rights and may add to the growing attraction of London’s business and commercial courts as a crypto dispute resolution centre.

It was thought that phase 2 would be introduced in the latter stages of 2024, heralding a wholescale regulation and establishing a more comprehensive set of rules for most cryptoassets, beyond fiat-backed stablecoins.

What are the new FCA proposals?

The proposed new rules will cover a wide range of activities, including issuance, exchange, investment, risk management, lending, custody, borrowing, leverage, safeguarding, and administration. However, the recent election and subsequent new Labour Government’s manifesto priorities have caused these proposed developments to be held in the legislative queue. The FCA’s announcement demonstrates that this is now underway, with the regime anticipated to go live in 2026.

The move to increased regulation is good news and will reassure markets that regulation is back on the agenda. However, the move to increased regulation, although in line with MiCA, appears to be against Trump’s stance on opening up crypto markets through deregulation. Crypto value rapidly increased following Trump’s win and the Director of Security Exchange Commission resigning. This had a direct and immediate impact on the crypto market value, and an increased level of activity. The concern remains that long term this sector needs regulation if it is to offer investors any stability.

Balancing consumer protection with market innovation

Stricter regulations can enhance consumer protection, making the market safer for investors. This can help build trust in the cryptocurrency space, attracting more retail and institutional investors. This sector is heavily targeted by scammers, and the UK is a long way behind other jurisdictions in the use of digital coins. If the UK wants to be considered a leader in the space, it will need to work towards an environment where individuals can buy products (houses, cars, food) with the digital assets. To enable the UK to operate like this, there needs to be regulation. Ultimately, cryptocurrencies could empower individuals and communities, but their integration into society requires careful regulation and thoughtful consideration of their broader social impact. The FCA’s regulatory efforts are a step in the right direction, but there will be pushback from industry, especially in the wake of the US election.

Regulation will, in the long term, lead to increased legitimacy and trust and market stability.

It is extremely important that the right balance is struck between consumer protection, and market growth and innovation. The Government is well aware of this, which has partially led to the differing views of those in Government over the past 24 months. Risk-based approach to the introduction and implementation of regulation is the right approach. The Government will need to ensure a number of things, including:

• Implementing a risk-based regulatory framework that differentiates between high-risk and low-risk activities – this will allow for more stringent oversight on higher-risk entities while providing a lighter touch for lower-risk businesses.
• Continuously assessing and adapting regulations based on the evolving risk landscape and market developments, ensuring they remain relevant and effective without stifling innovation – important in every sector, but especially this one.
• Continuing to consult with industry – engaging with the crypto businesses, and ensuring that the regulations are workable. The UK wants to have a strong crypto offering, so we do not want large crypto businesses leaving London. We have seen this with phase 1, and we certainly do not want to erode this further.
• Creating a regulatory sandbox that allows innovative crypto projects to test their products in a controlled environment without immediate regulatory burdens. This encourages experimentation while ensuring consumer protection.
• Clear communication and guidance, so businesses aren’t caught out. That is not, or ought not to be, the purpose of these regulations. They need to work.

If you have questions or concerns about the regulation of crypto, please contact Louise Abbott.