What is the future for crypto?

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Over the course of 2022, the cryptocurrency market has continued to live up to its reputation as a ‘wild west’ where prices rise and fall at significant levels and, perhaps more importantly, with significant publicity.

Despite their inher­ent present volatil­i­ty, cryp­tocur­ren­cies have shown a unique abil­i­ty to adapt and sur­vive such set­backs, and it is like­ly that this will con­tin­ue to be the case for years to come.

Far from its begin­nings back in 2009, cryp­tocur­ren­cy and, in par­tic­u­lar, Bit­coin, have become house­hold terms. Despite such a lengthy lifes­pan how­ev­er, many ques­tions and con­fu­sion still exists with regards to these cur­ren­cies and the legal frame­work in which they exist.

As cryp­tocur­ren­cy becomes more wide­ly known and under­stood, it has been increas­ing­ly dif­fi­cult for gov­ern­ments to ignore and so more and more focus is being giv­en to the legal and reg­u­la­to­ry issues which it brings. Com­bined with ongo­ing changes in how the under­ly­ing oper­at­ing sys­tems sit­ting behind dif­fer­ent cryp­tocur­ren­cies work, as well as how wide­ly they are accept­ed as a means of pay­ment and exchange, it means that the top­ic con­tin­ues to fea­ture heav­i­ly in the news and is a reg­u­lar top­ic of dis­cus­sion for investors, reg­u­la­tors, politi­cians, and legal professionals.

Here, we have set out some of the key devel­op­ments in the world of cryp­tocur­ren­cy that have tak­en place over the course of the past nine months, and some ideas about what the com­ing years may look like.


Regulation in the UK 

As it present­ly stands, cryp­toas­sets them­selves remain large­ly unreg­u­lat­ed in the UK. The only sig­nif­i­cant excep­tion to this is the require­ment for busi­ness­es who car­ry on cryp­toas­set activ­i­ty to be com­pli­ant with anti-mon­ey laun­der­ing reg­u­la­tions and to be for­mal­ly reg­is­tered with the FCA in order to oper­ate. Addi­tion­al­ly, the acqui­si­tion and dis­pos­al of cryp­toas­sets may give rise to tax lia­bil­i­ties, includ­ing Cap­i­tal Gains Tax. Cer­tain finan­cial activ­i­ties such as the man­age­ment of deriv­a­tives lim­it­ed to cryp­tocur­ren­cies, as well as the man­age­ment of Alter­na­tive Invest­ment Funds deal­ing in cryp­tocur­ren­cies may, how­ev­er, fall with­in the remit of exist­ing reg­u­la­to­ry require­ments and regimes.

Beyond this, there is rel­a­tive­ly lit­tle by way of for­mal reg­u­la­tion of cryp­tocur­ren­cies them­selves, but as they con­tin­ue to grow in use and pop­u­lar­i­ty, the ongo­ing ques­tion for gov­ern­ments to con­sid­er is whether to begin to for­mal­ly reg­u­late these. For the UK, the answer looks to be an unequiv­o­cal yes.

In April 2022, then-chan­cel­lor Rishi Sunak announced the government’s inten­tion to move towards greater legal recog­ni­tion of cer­tain forms of cryp­tocur­ren­cy known as sta­ble­coins, in which the val­ue is pegged to anoth­er cur­ren­cy or finan­cial instru­ment (and so in the­o­ry more sta­ble in day-to-day trans­ac­tions). This would, the gov­ern­ment stat­ed, help pave the way for sta­ble­coins to be used in the UK as a recog­nised form of pay­ment, which was in turn planned as part of a series of mea­sures intend­ing to make the UK a “glob­al hub” for cryp­toas­set tech­nol­o­gy and invest­ment. Plans were even announced that the gov­ern­ment would be work­ing with the Roy­al Mint on a Non-Fun­gi­ble Token (“NFT”) of its own, which was described as “emblem of the for­ward-look­ing approach the UK is deter­mined to take.”

Even amidst changes in lead­er­ship lat­er in the year, the gov­ern­ment reaf­firmed its pledge to embrace cryp­to tech­nol­o­gy by con­tin­u­ing to progress with the imple­men­ta­tion of the Finan­cial Ser­vices and Mar­kets Bill, which aims to intro­duce the new reg­u­la­to­ry frame­work for sta­ble­coins. Polit­i­cal changes, there­fore, seem to have done lit­tle to delay any progress in this area. Long before assum­ing the role of Prime Min­is­ter this year, Liz Truss con­fi­dent­ly stat­ed, in a tweet pub­lished back in Jan­u­ary 2018, that cryp­tocur­ren­cies should not only be wel­comed, but should also be wel­comed in a way which “doesn’t con­strain their poten­tial.”

Around the same time as these announce­ments, the Law Com­mis­sion pub­lished a con­sul­ta­tion paper in July 2022 set­ting out pro­vi­sion­al pro­pos­als to amend the law to ensure that dig­i­tal assets such as cryp­tocur­ren­cies and NFTs are both legal­ly recog­nised and pro­tect­ed. The cur­rent reform pro­pos­als involv­ing cat­e­goris­ing cryp­toas­sets as a new form of per­son­al prop­er­ty known as “data objects”, to allow for a more nuanced set of legal prin­ci­ples which can apply to dig­i­tal assets sep­a­rate to those exist­ing forms which apply to phys­i­cal items and any non-tan­gi­ble rights (such as a right over land).

The con­sul­ta­tion is present­ly invit­ing respons­es and this remains live until 4 Novem­ber 2022, after which for­mal pol­i­cy devel­op­ment will take place and a final report will be issued.

One of the key ques­tions will be what steps are intend­ed to offer con­sumers pro­tec­tion in using cryp­toas­sets. The government’s Response to Con­sul­ta­tion, pub­lished in April 2022, con­firmed that sta­ble­coins as a means of pay­ment were intend­ed to be brought into the UK’s exist­ing reg­u­la­to­ry perime­ter, and that a reg­u­la­to­ry man­date was to  be devel­oped for the rel­e­vant gov­ern­ing and reg­u­la­to­ry bod­ies includ­ing the Bank of Eng­land and the Finan­cial Con­duct Author­i­ty (“the FCA”). The pro­posed sys­tem would grant the FCA pow­ers over not only sta­ble­coin issuers, but also wal­let providers.

Assum­ing that sta­ble­coins are brought into the remit of the FCA in the man­ner pro­posed, then it will like­ly fol­low that the issuers and wal­let providers will be sub­ject to sim­i­lar reg­u­la­to­ry require­ments and approval mech­a­nisms as those cur­rent­ly expe­ri­enced by tra­di­tion­al finan­cial insti­tu­tions. This may serve to cre­ate a high­er thresh­old of entry for busi­ness and firms wish­ing to issue and man­age such cryp­tocur­ren­cies and oth­er cryp­toas­sets, result­ing – the­o­ret­i­cal­ly – in a high­er lev­el of stan­dards for con­sumers. Addi­tion­al­ly, con­sumers may receive the ben­e­fit of pro­tec­tion and sup­port from the Finan­cial Ser­vices Com­pen­sa­tion Scheme, so as to pro­vide a safe­ty net against any improp­er con­duct or the fail­ure of any sta­ble­coin issuers or wal­let providers.

At present, the move towards reg­u­la­tion is slow and it is like­ly to be some time before final leg­is­la­tion is passed and the reg­u­la­tors are suf­fi­cient­ly able to announce a series of pol­i­cy state­ments and oth­er such mea­sures so as to allow cryp­to firms to pre­pare for a reg­u­lat­ed market.

From the devel­op­ments that have tak­en place this year how­ev­er, it appears that the gov­ern­ment intends for cryp­tocur­ren­cies and dig­i­tal assets to have a pres­ence in the future eco­nom­ic land­scape of the UK. Exact­ly how this land­scape will look from a reg­u­la­to­ry per­spec­tive is unclear for now, but the direc­tion of trav­el is unde­ni­ably clear.


A new avenue for financial crime?

In Sep­tem­ber 2022, a new ‘first’ in the world of cryp­to occurred, with the report­ing of the pur­port­ed­ly first known case of insid­er trad­ing. As per a press release issued on 12 Sep­tem­ber by the US Depart­ment of Jus­tice con­firmed that an indi­vid­ual had plead­ed guilty to “one count of con­spir­a­cy to com­mit wire fraud in con­nec­tion with a scheme to com­mit insid­er trad­ing in cryp­tocur­ren­cy assets”. In the case, an employ­ee of a cryp­to exchange pro­vid­ed his broth­er with infor­ma­tion regard­ing cer­tain cryp­to assets which the exchange was plan­ning to list, after which the broth­er made pur­chas­es and trades for those assets ahead of the pub­lic announcement.

It would be true to say that the issue here does not rest with the oper­a­tion of any cryp­tocur­ren­cies, NFTs or cryp­to trans­ac­tions them­selves (i.e., there was no attempt to inter­fere with the under­ly­ing oper­a­tion of the coins and to inter­fere with any blockchains or trans­ac­tions), but does strike at the heart of their role as an asset in their own right and the poten­tial for human inter­fer­ence. Whilst it was, on the face of it, a fair­ly straight­for­ward case of infor­ma­tion being obtained through a “friend­ly con­tact”, the case will still give reg­u­la­tors issues to con­sid­er when con­sid­er­ing the ques­tion of reg­u­la­tion and the clas­si­fi­ca­tion of cryp­tocur­ren­cies as assets.

The present lack of reg­u­la­tion in the UK has also giv­en rise to numer­ous con­cerns about what – if any – pro­tec­tion is avail­able to con­sumers and investors. As of the time of writ­ing, the FCA con­tin­ues to pub­licly regard cryp­toas­sets as being “very high risk, spec­u­la­tive invest­ments” and pro­vides a clear warn­ing that “if you buy these types of cryp­toas­sets, you are unlike­ly to have access to the Finan­cial Ombuds­man Ser­vice (FOS) or the Finan­cial Ser­vices Com­pen­sa­tion Scheme (FSCS) if some­thing goes wrong.”

Above all, the FCA’s most impor­tant warn­ing is per­haps the sim­plest: “if you invest in cryp­toas­sets, you should be pre­pared to lose all your money.”

Many advo­cates of cryp­tocur­ren­cies empha­sise the fact that they are intend­ed to be used as an unreg­u­lat­ed and de-cen­tralised mode of cur­ren­cy, free from the risk of gov­ern­ment con­trol and can hedge against infla­tion and the poten­tial mis­use or inter­fer­ence by enti­ties such as banks and oth­er finan­cial insti­tu­tions. Whilst these ben­e­fits remain hot­ly debat­ed, the fact remains that the risk of con­sumer harm is high and there is lit­tle pro­tec­tion afford­ed to con­sumers who may fall vic­tim to one of the many cryp­to scams which are active. In March 2022, the FCA pub­lished a warn­ing about the ongo­ing oper­a­tion of ille­gal cryp­to ATMs in the UK, and in June they pub­lished updat­ed warn­ings about online invest­ment scams, where­by indi­vid­u­als are encour­aged to invest in an oppor­tu­ni­ty which tran­spires to be a non-exis­tent cryp­to asset, or where­by a customer’s account is imme­di­ate­ly closed once the pay­ment of the required sum is made to the scammer’s fraud­u­lent invest­ment software.

The UK’s nation­al report­ing cen­tre for fraud and cyber­crime – Action Fraud – has also pre­vi­ous­ly issued a warn­ing that scam­mers are increas­ing­ly fab­ri­cat­ing rec­om­men­da­tions from celebri­ties and high-pro­file indi­vid­u­als for par­tic­u­lar cryp­toas­sets and/or fraud­u­lent invest­ment opportunities.

It is hoped that by intro­duc­ing a new, reg­u­lat­ed frame­work for the oper­a­tion of cryp­toas­sets, the risk to the pub­lic may be reduced, if per­haps not elim­i­nat­ed. In the mean­time how­ev­er, the fact remains that there is lit­tle to read­i­ly pro­tect con­sumers in respect of cryp­toas­set invest­ments, whether it be from their inher­ent mar­ket volatil­i­ty or from the poten­tial for crime. Indi­vid­u­als should, there­fore, con­tin­ue to oper­ate with cau­tion when decid­ing whether to com­mit to a cryp­to investment.


Operating changes

Whilst Bit­coin is cer­tain­ly the most wide­ly known cryp­tocur­ren­cy for now, oth­er coins are also paving the way for new changes and devel­op­ments in the oper­a­tion and use of cryp­tocur­ren­cies and the under­ly­ing tech­nol­o­gy with sig­nif­i­cant impact.

In Sep­tem­ber, Ethereum pro­gressed with the next phase of its planned merg­er with anoth­er decen­tral­ized ledger. The inten­tion behind the change is to tran­si­tion the under­ly­ing con­sen­sus mech­a­nism used to ver­i­fy cryp­tocur­ren­cy trans­ac­tions from a ‘proof-of-work’ sys­tem to a ‘proof-of-stake’ system.

Under the exist­ing proof of work sys­tem, which is one of the most com­mon con­sen­sus mech­a­nisms and which is used by cryp­tocur­ren­cies such as Bit­coin, the valid­i­ty of coin trans­ac­tions record­ed on a blockchain is deter­mined by way of a series of com­plex com­put­erised algo­rithms and codes. These in turn are used to cre­ate, in effect, a math­e­mat­i­cal puz­zle which users can solve to ver­i­fy the trans­ac­tion, the act of which is com­mon­ly known as “min­ing”. As dif­fer­ent com­put­ers and users com­plete and ver­i­fy the solu­tion, the con­sen­sus serves to act as a ver­i­fi­ca­tion of the accu­ra­cy of trans­ac­tions record­ed on the chain.

The proof of work sys­tem is gen­er­al­ly con­sid­ered a robust means to pro­vide secu­ri­ty for users, how­ev­er it is also crit­i­cised for requir­ing sig­nif­i­cant amounts of com­put­ing pow­er in order for the trans­ac­tions to be ver­i­fied. This rais­es con­cerns about the envi­ron­men­tal impact of the tech­nol­o­gy, along with the poten­tial for tech­no­log­i­cal abuse. Addi­tion­al­ly, as more and more users embrace the tech­nol­o­gy, the size and val­ue of blockchains increase and so the nec­es­sary lev­els of min­ing and con­sen­sus required in order to ver­i­fy trans­ac­tions become sig­nif­i­cant. The risk there­fore is that the sys­tem can become even­tu­al­ly unsus­tain­able owing to the lev­el of work required to prompt­ly mine and ver­i­fy the transactions.

In con­trast, the proof of stake sys­tem intro­duces a mech­a­nism where­by select­ed users con­tribute a “stake” of their own cryp­tocur­ren­cy to a blockchain and then are tasked with val­i­dat­ing new trans­ac­tions, for which they can earn rewards includ­ing new cryp­tocur­ren­cy. Once an indi­vid­ual has val­i­dat­ed a new set of trans­ac­tions, oth­er val­ida­tors can ver­i­fy the accu­ra­cy of the pri­or ver­i­fi­ca­tion. Whilst this solu­tion may serve to reduce the risk of the sys­tem grow­ing to such lev­els to prove unsus­tain­able, it does sug­gest that those users who already own large amounts of a cryp­tocur­ren­cy have greater prospects of being the ones able to engage with the sys­tem, stake their own coins and begin the ver­i­fi­ca­tion process. Equal­ly, the new sys­tem was intend­ed to sig­nif­i­cant­ly reduce the nec­es­sary ener­gy required to sus­tain the sys­tem, with reports indi­cat­ing the merge was expect­ed to reduce the network’s ener­gy use by 99.5%, and so aim­ing to alle­vi­ate the envi­ron­men­tal con­cerns raised under the pre­vi­ous proof of work system.

Ethereum’s merge into a new mod­el of work­ing may prove to be the next step for­ward for the tech­nol­o­gy as a whole, and if so we may see fur­ther changes in how oth­er cryp­tocur­ren­cies oper­ate and how con­sumers engage with these. A step away from the now-stereo­typ­i­cal idea of users “min­ing away” with walls of com­put­er nodes may result in the tech­nol­o­gy tak­ing a step towards being regard­ed as a more seri­ous enterprise.

Whether oth­er coins will fol­low Ethereum’s exam­ple will remain to be seen, but it is clear that the tech­nol­o­gy behind cryp­to remains some­thing which is con­tin­u­ing to grow significantly.


What is next for crypto in the UK?

Despite their crit­ics, cryp­tocur­ren­cies are clear­ly with us to stay for the fore­see­able future in the UK, and the gov­ern­ment appears clear­ly mind­ed to both embrace and encour­age the technology.

In 2023, we can expect to receive the out­come of the Law Commission’s con­sul­ta­tion and pol­i­cy devel­op­ment of cryp­to tech­nol­o­gy as a legal asset, along with fur­ther steps towards imple­men­ta­tion of the Finan­cial Ser­vices and Mar­kets Bill. The imple­men­ta­tion of this Bill may serve to be the first step towards a full reg­u­la­to­ry frame­work for cryp­tocur­ren­cies and pro­vide the FCA with a sig­nif­i­cant­ly extend­ed remit, which may in turn offer con­sumers greater secu­ri­ty and pro­tec­tion. Such secu­ri­ty may, in turn, serve to fur­ther increase pub­lic under­stand­ing, accep­tance, and con­fi­dence regard­ing the use of cryp­tocur­ren­cies as assets and, in turn, as a means of con­duct­ing day-to-day trans­ac­tions sim­i­lar to that being seen in oth­er countries.

At the same time, we can expect to see con­tin­ued changes and devel­op­ments in how dif­fer­ent cryp­tocur­ren­cies oper­ate and the sys­tems used to sup­port them. The Ethereum merge may prove to be a bench­mark for future cur­ren­cies, and an ongo­ing suc­cess­ful imple­men­ta­tion could bring with it a new con­tender for Bitcoin’s crown as the most com­mon­ly-adopt­ed cryptocurrency.

In terms of the pub­lic accep­tance of cryp­tocur­ren­cy, it is like­ly we will con­tin­ue to see efforts made to encour­age this through fur­ther use of adver­tis­ing cam­paigns present­ly involv­ing celebri­ties and well-known fig­ures such as Matt Damon and Mike Tyson. The pub­lic acqui­si­tion and dis­pos­al of cryp­toas­sets by com­pa­nies such as Tes­la may also go some way to increas­ing a cryptocurrency’s own par­tic­u­lar brand or rep­u­ta­tion, fur­ther legit­imis­ing these as a gen­uine (if unpre­dictable) source of investment.

In the end, it may be the mar­kets them­selves which help deter­mine the over­all future of cryp­tocur­ren­cies. A con­tin­ued series of pub­li­cised “crash­es” may serve to hard­en the views of many that Bit­coin and oth­er such cur­ren­cies are doomed to fail, lead­ing to a reduc­tion in their over­all pub­lic accep­tance, and so the legal and reg­u­la­to­ry focus may in time become less sig­nif­i­cant. How­ev­er, the resilience of cryp­tocur­ren­cy as a tech­nol­o­gy itself sug­gests that, regard­less of what mar­ket fluc­tu­a­tions may take place in the com­ing years, there will still remain a firm place for cryp­tocur­ren­cies in the UK’s economy.


What can we do to help?

At Freeths LLP, we have expe­ri­ence in advis­ing busi­ness­es adopt­ing, trad­ing and offer­ing cryp­tocur­ren­cies and cryp­to tech­nol­o­gy. We are able to advise on the cur­rent reg­u­la­to­ry require­ments which firms may need to con­sid­er before deal­ing with cryp­to, as well as pro­vid­ing risk man­age­ment advice about cryp­to-relat­ed busi­ness ven­tures that may be being con­sid­ered. Our team is also able to advise on tax plan­ning and the tax impli­ca­tions that acquir­ing, hold­ing and dis­pos­ing of cryp­toas­sets may bring.

To organ­ise a free, no-oblig­a­tion dis­cus­sion with one of our spe­cial­ist lawyers, please con­tact Adam Edwards, Daniel Seely or Daniel Mey­er and we will be hap­py to talk you through your options.

The con­tent of this page is a sum­ma­ry of the law in force at the present time and is not exhaus­tive, nor does it con­tain defin­i­tive advice. Spe­cial­ist legal advice should be sought in rela­tion to any queries that may arise.

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