Yesterday the FCA released PS19/22, their first policy statement on cryptoasset guidance. But what does it mean for the industry? The Copper Team takes a deeper look.What does it say?

In January the FCA set out its stall and attempted to classify cryptoassets in broad strokes. After weeks of feedback, internal deliberation at the FCA, and a few developments internationally, they are refining their stance on what the crypto regulatory landscape (or lack thereof) could look like.

The policy statement doesn’t introduce any massive changes to the previous paper, but it has been built on with assistance from the UK's crypto industry.

Exchange Tokens – Unregulated

‘Cryptocurrency’ is so 2017. The FCA is referring to these cryptoassets as ‘Exchange Tokens.’ Anything not backed by a central authority (central banks or governments) and is used as a means of exchange is going to fall into this category. This means typical cryptocurrencies are inherently unregulated.

The one exception to this is where payment services are offered using Exchange Tokens. The token remains unregulated, but the FCA points out that the act of payments (money remittance) is itself regulated, regardless of the currency used. A crypto business offering payments with any cryptoasset (to purchase assets or services, for example) could therefore fall under the PSR regime.

Nothing changed in PS19/22 though, with the majority of the market agreeing with the FCA’s viewpoint. Feedback did voice that the market wants some form of regime for Exchange Tokens, to which the FCA pointed towards the upcoming 5th Anti Money Laundering Directive (5AMLD). The new legislation is likely to give more guidelines surrounding potential AML controls for cryptoassets, though with Brexit on the horizon it is unclear how strictly the UK will adopt these rules.

• Positives: Clarity on cryptocurrencies and clear guidance on crypto/payment services cross over
• Negatives: Still a lot of grey area on AML requirements for cryptoassets with no clear answer in sight

Security Tokens – Regulated

The only type of cryptoassets that are explicitly regulated are Security Tokens. In simple terms, the characteristics of these tokens mean they meet the existing definition of a specified investment under current legislation (The Regulated Activities Order, or ‘RAO’ and MiFID II (Financial Instruments)). The FCA has taken the common sense approach; if it looks like a security, and smells like a security, it's probably a security.

This is useful, and with a clearly established set of rules for what is or isn’t a specified investment/financial instruments it goes some way to helping crypto businesses know what is and isn't covered.

However, with these answers come more questions. Once a cryptoasset is classified as regulated, not all FCA rules can be applied as easily as they are to traditional securities. Take custody for example. Many of the FCA's rules around custody and client assets rely on traditional accounting and banking elements which apply to traditional securities or fiat currencies. They simply won’t work or are insufficient for cryptoassets. So what does that mean? Will a regulated crypto firm that fails to safeguard assets in line with FCA's rules be in breach? It’s a tricky area.

Furthermore, the rules for traditional assets are ingrained into the UK financial services infrastructure, and pretty exhaustive lists can be sourced. Everybody knows what a bond, share or option looks like, and it will likely be attributed an ISIN swiftly. But a newly issued crypto token? It could take considerable research on each asset before one knows for sure whether it is regulated; and if so, which FCA rules apply.

The policy statement doesn’t give much more information than the FCA gave in January, with emphasis on the need for further legislative development before the FCA can give specific rules to the market.

• Positives: a clear set of rules to identify regulated assets (Security Tokens)
• Negatives: A lack of clarity over how other rules apply to these assets, no definitive classifications on the horizon

Utility Tokens – Unregulated

A Utility Token grants the holder of the asset access to a current or prospective product/service. For example, a token that could be redeemed or exchanged for hours of a lawyer's time, or electronic goods. In some ways a token with these characteristics could overlap with Security Tokens, but where this is the case the FCA makes clear they will fall into the regulated space.

In many ways, a Utility Token is a catch all for a cryptoasset with some rights or redemptions attached to it, that does not fall within the FCA's perimeter as a Security Token.

The caveat explored by the FCA in this policy statement is that a Utility Token could potentially become “E-Money,” an area regulated by the Electronic Money regulations and therefore a regulated asset. E-Money typically takes the form of E-wallets, services such as Paypal, where a customer tops up their balance for the purpose of making payments. The FCA admits that the applicability to cryptoassets is unlikely, limited mainly to where the cryptoassets are pegged to fiat currencies (sometimes referred to as stablecoin or deposit backed).

This is because E-Money must be “electronically stored monetary value” and of course, cryptoassets are not legally, “money". Rather unhelpfully, the FCA do state that this is not the sole criteria, and that cryptoassets could be deemed E-money if they meet EMR definitions. This is a huge point to clarify, as it could be that if some cryptoassets were legally defined as money (including Exchange Tokens) they could quickly become regulated under EMR.

• Positives: Addresses non-regulated tokens with rights attached, addresses E-Money feedback
• Negatives: A lack of further clarity on E-Money, Utility Token is less defined than others (more of a catch all)

Where are we in the process?

The FCA have known about cryptoassets for some time, with statements on the subject from 2017. It took a little time though for the UK financial regulator to make their first official move on this potential new asset class.

The FCA, Bank of England, and HM Treasury released their Cryptoassets Taskforce report in October 2018. This was the primary launch pad for the information above, and other work by the FCA and Treasury.

The FCA’s guidance on cryptoassets process started in January this year with CP19/3, declaring first thoughts and an initial approach. A ten-week feedback process ensued, inviting market participants to voice their opinions on the subject.

In response, on the 31st of July, the FCA published PS19/22. This policy statement considers the feedback and how it affects the FCA’s position. Crucially, it's not the final guidance, which we will see at the end of the process, but it gives us a good indication of which direction the regulator is leaning.

What’s next?

As the FCA makes clear in their policy statement, they are only the regulators of the law, they can’t write the law. There is still a lot of work on the legislator’s side to get into the detail of cryptoassets and how exactly they will be treated in the UK going forward. Before this happens, an element of uncertainty will remain in the UK crypto space.

Until then, it's up to us to prepare, remain diligent and vigilant, and build robust but flexible frameworks that set a high standard for compliance that can withstand volatility from the regulators, legislatures, and the open market.