UK FCA Crypto Regulation: What Crypto Exchanges & VASPs Need to Know

In the UK -- we have arrived at a point where – as of early 2023 - the government has announced its intention to produce what it says will be ambitious plans to regulate crypto asset activities.

This has to be viewed as a significant step – both in terms of the official recognition that crypto is receiving -- and what this could mean for those who invest in, use or provide services for crypto.

The UK government’s announcement, talks of the need to “robustly regulate’’ cryptocurrency and provide “confidence and clarity’’ to consumers and businesses.

In more concrete terms, this translates as the government looking to strengthen the rules for crypto trading platforms and create a world-first regulatory regime for crypto lending. It is seeking to both boost innovation (and the UK economy) and at the same time, protect consumers.

Such ideas are understandable, given the constantly-developing and sometimes unpredictable nature of crypto. Not to mention the series of scandals that have been cryptocurrency related, with the late-2022 collapse of the cryptocurrency exchange FTX being the most notable one of recent times.

The Government’s Approach To Regulating Crypto Asset Activity in 2023

The government believes it will be capable of both reducing the risks of crypto and taking full advantage of its potential benefits. It aims to do this by regulating crypto asset activities in a way that will be consistent with the way it approaches regulation of the more traditional financial sector.

It is looking to place standards on crypto exchanges. The government also wants to strengthen the rules-- regarding those who are responsible for enabling transactions to be conducted and for storing customers’ crypto assets. It has set a deadline for 30th April 23 for responses to be submitted regarding its proposals. The government will then consider -- the responses.

When legislation is laid before Parliament, the Financial Conduct Authority ( or the FCA) will consult on its detailed rules. As the regulatory body for financial markets in the UK, the FCA has already been taking steps to regulate cryptocurrencies in order to protect consumers and prevent financial crime. 

What changes to UK crypto asset regulation should we expect in 2023?

The UK government published its consultation paper setting out its intention on how to regulate the crypto sector. It builds on information that is already known but also focuses on its intention going forward.

The consultation paper sets out a three-phase approach:

• Phase one – stable coins used as payments – the government will bring digital settlement assets into the regulatory perimeter. This will focus on the regulation of issuer, custodians and payment service providers for fiat backed stable coins
• Phase two – crypto asset regulation. The intention is to capture crypto asset activities in the UK including activities provided to UK persons by overseas firms.
• Phase three – future regulation. Here the government will be focussing on crypto asset trading venues, i.e. exchanges. The regulatory framework is set to be based on existing activities of regulated trading venues. The government is also proposing a cryptoasset market abuse regime based on elements of the Market abuse regulation.

Furthermore , I should add that the FCA's anti-money laundering and counter-terrorism financing regulations can help prevent financial crime and illegal activities in the crypto space.

But (and it is a big but) adding extra regulation to any activity will never be any guarantee of success. It can, in certain circumstances, be a harmful step backwards rather than a positive, purposeful stride in the right direction. I hope that those with the task of formulating crypto-related change recognise this.

Are there any risks associated with crypto asset regulation?

The short answer is yes. The FCA stated that 85% of crypto asset firms who applied for registration, failed to meet basic regulatory standards. These failings include lack of anti-money laundering compliance, customer risk assessments and ongoing monitoring.

What that shows to me is that crypto firms will need to adapt and mould themselves to be able to properly enter into the regulated space.

Crypto firms will need to focus on a wider corporate and regulatory strategy which includes compliance.

The FCA have also indicated how in many cases, key personnel lacked the appropriate knowledge when dealing with control risks effectively.

The FCA statistics also show that external professional support is something that will need to be quickly embraced. This will help gain credibility, obtain authorisation and ultimately build trust between the regulators and the crypto firms who want to operate in this sector.

Other risks include how the FCA handle regulation. If the UK government is sincere in its wish for crypto to flourish, it has to be careful that any measures it introduces do not deter those who would otherwise be interested in exploring that particular market. The government will need to interact with the private sector when it looks to achieve its economic goals, in order to ensure that the measures introduced are the right ones.

If companies operating in the crypto space were to find themselves facing increased compliance costs – or even the possibility of them – as a result of government measures, they may think twice before expanding or even continuing.

Conclusion

We are in a situation where the government’s intentions towards crypto appear to be genuine – as do the FCA’s.

But, from this point onwards, so much will depend on the FCA's approach to regulating cryptocurrencies striking a balance between protecting consumers and promoting innovation. As the body with responsibility for “getting the job done’’, the FCA will be taking the mandate from the government once the exact nature of regulation has been finalised.

The FCA will need to be careful. The wrong approach may drain creative resources from productive activities.

The exact risks and benefits of regulation will depend on the specific details of the regulations themselves. It is important that those with the ultimate responsibility for those details make sure they get them right.