Focus On… Imminent UK Crypto Regulation

It is clear that, like many other countries, crypto-assets have become increasingly popular in the UK. According to the government, around 2.3 million Brits own crypto-assets and their expectation is that this number will only increase further in the years ahead, especially given the accelerated trend for payments to be made electronically following the Covid pandemic. The digitization of money is taking place and there is a risk of failing to respond to this shift in public behaviour. UK policymakers understand this which is why the government and the Bank of England have been actively researching the space over the past few years.

Overall, the UK Chancellor has been favourably disposed to crypto assets highlighting their potential to “provide exciting new opportunities” and “new ways to transact and invest”. Moreover, the UK government is keen for London to remain a financial hub, especially now that it is no longer a member of the EU. Given wider involvement by financial services firms in the market, and significant institutional interest and investment, there are strong incentives for the UK to embrace cryptocurrencies and help foster innovation in the crypto space. So our expectation is that with this package they want to send a favourable signal about the UK’s crypto intentions, but in a manner that safeguards its users.

It is clear from previous statements from HM Treasury they are concerned that the public’s understanding of this new asset class is failing to keep up with their popularity. One obvious area of focus, therefore, will be advertising. At present most cryptocurrencies lie outside the regulatory perimeter in the UK meaning that adverts are not subject to the same degree of scrutiny as other financial adverts. The government is set to alter this by amending the Financial Promotion Order which would provide the Financial Conduct Authority with the ability to fine crypto-related companies whose adverts are deemed not to meet the fair, clear, and not misleading threshold.

Another obvious area of focus will be stablecoins whose combined market capitalization has surged to over $180bn – see chart. Because their valuations are anchored, typically to fiat currency (most often the US dollar) they do not experience the same level of price volatility as other cryptocurrencies, such as Bitcoin and Ethereum. As such, they are viewed as having the potential to facilitate faster, cheaper payments, particularly cross-border. They are also much closer to deposits held in the commercial sector and therefore seen as a greater threat to the traditional financial infrastructure.

StableCoins – Total Supply (USD bn)

Source: Coin Metrics

By bringing these stablecoins under the regulatory umbrella the UK authorities will be able to apply greater financial safeguards. Measures are likely to include prior authorization for issuers to operate, capital and liquidity requirements as well as auditing and accounting requirements including the obligation to have sufficient reserves held in high-quality liquid assets. These additional requirements, on top of standard KYC/AML requirements, increase the regulatory burden and will naturally favour larger crypto firms who have the infrastructure and financial resources to satisfy these demands. So we anticipate some consolidation in the number of firms operating in the UK.

Although it is probably still too early, over time the key objective of maintaining financial stability will likely see stablecoin issuers be given access to the central bank’s balance sheet (in return for Bank of England oversight) as currently is the case with systemically important financial institutions. It is possible that the UK government provides greater clarity as whether this will be the case and on what basis any such decisions will be made.

That said, not all stablecoins will likely be subject to increased UK regulation. Algorithmic stablecoins, for example, are likely to remain outside the regulatory scope. In part this is because the UK government views them as more closely resembling unbacked cryptocurrencies and hence considers them as unlikely to be as widely used as a medium-of-exchange as fiat-backed stablecoins. It is also an implicit recognition that it would be nigh impossible to apply regulations to them anyway given their decentralized nature and the fact they do not touch the commercial banking system unlike fiat-backed stablecoins. This may enhance their popularity with those users seeking to avoid government scrutiny due to privacy concerns (or for other reasons).

Overall, the UK’s regulatory package should be seen as a manifestation of the old adage “With great power, comes great responsibility”. The regulation push is to the ensure that crypto-linked companies live up to their responsibilities, but it also acknowledges what many in the crypto space have long recognized – the potential for cryptocurrencies to disrupt traditional financial. Even though crypto die-hards consider increased government regulation to be a complete anathema, to the extent that it makes them more appealing to the broader populace it should be welcomed. By giving people confidence cryptocurrencies are safe to use it will serve to increase public acceptability and this is a fundamental requirement of money because in whatever form it takes it requires a network of participants prepared to accept it for economic transactions to be valuable: no adoption, no network, no value.

Until next time,

Ryan Shea, crypto economist at Trakx