On 22 May 2018, the Financial conduct Authority (FCA) and the Bank of England (BoE) submitted their written positions on cryptocurrencies to HM Treasury’s inquiry on digital currencies. Both institutions have not provided any significant diversion from their earlier public positions but nevertheless shed light on the issues they are considering and their views on the potential benefits and current risks of crypto assets and DLT.
From the onset of its 8 page submission, the BoE opted to draw attention to the difference between what they termed as ‘privately-issued digital currencies (or crypto-assets) and distributed ledger technologies (DLT) on which they are based’. The Bank is of the view that crypto-asset or tokens ‘are very unlikely to replace commonly used payment systems’. It based this view on its persuasion that the crypto-assets are currently failing to perform the three key functions of money, namely, as a store of value (due to its volatility), as a mean of payment (due to low acceptance, capacity constraints, high cost of transaction, low speed and inherent cost due to energy consumption) and as a unit of account (due to the problems outlined above).
It is quite clear from the Bank’s submission that it primary interest is establishment of possible impact of crypto-assets on UK financial stability in particular and its role in influencing monetary policy. Currently, the Bank does not see crypto-assets posing any threat to financial stability due to the absence or negligible linkages of financial institutions to these assets and relatively low scale of crypto-asset compared to global financial system. The Bank’s Financial Policy Committee (FPC) is however, quick to caution that this position may change unexpectedly given the rapid development in the space.
In the event that crypto-asset gain widespread usage, the Bank admits that such scenario will not only impair the bank’s ability to influence monetary stability but also will have significant policy implications including around consumer and investor protection, market integrity, money laundering and terrorism financing.
On DLT, the Bank projected a very optimistic view on the potential benefit the technology will have in the financial sector giving examples of specific use-cases including domestic and cross-border payments, securities settlements and trade finance. The Bank also cautioned that despite the increasing exploration and even adoption by banks, the technology was still at its infancy with little evidence of its real-world deployment at scale in financial services. The technology posses significant challenges in its application especially as regards its scalability and reliability, questions of privacy and security.
From regulatory point of view, FCA maintained, albeit in more defined terms, its position that crypto-assets designed as means of payment or exchange, are ‘generally not within the scope of FCA regulation’. FCA clarified that these assets will not meet the ‘criteria to be to be considered a specified investment under the Regulated Activities Order. Nor would they typically qualify as ‘funds’ or ‘e-money’ in Payments Services Directive 2 and E-money Regulation 2009. However, those which do have elements which make them akin to securities, or e-money, could constitute regulated investments or e-money for the purposes of the FCA perimeter’.
The FCA pointed at existing gap in the Money Laundering, Terrorism Financing and Transfer Funds (Information on the Payer) Regulation 2017 (MLR) which does not cover the activities of crypto-asset exchange activities, meaning that firms are not currently subject to AML requirements. This is expected to be addressed by EU’s fifth Anti-Money Laundering Directive (5AMLD) which is expected later this year and henceforth transposed by member states by late 2019/early 2020.
The FCA provided the table below as a guideline in establishing if a crypto-asset falls within its regulatory perimeter or not. The table is admittedly not exhaustive as new crypto-assets with unique characteristics keep being introduced to the market. As previously stated and given the non-standard development of crypto-assets (tokens) including ICOs, the FCA process is basically fact specific.
The FCA also shared findings application of crypto-assets that they established through their innovate initiative including the Regulatory Sandbox and Techsprints. The evidence they gathered pointed to three broad ways in which crypto-assets could enhance the delivery of existing financial activities, namely: ‘improving operational resilience by reducing single point of failure; cost and time reductions arising from the removal of intermediaries required for processing transactions’.
A notable submission from FCA is acknowledgement of the banking problems faced by businesses using certain crypto assets. The FCA is of the belief that deployment of crypto assets or DLT should not result in a wholesale denial of access to traditional banking services for firms. The FCA viewed the practice of certain banks to put AML requirements that are incompatible with using certain crypto assets may have negative impact on competition and by extension negatively impact on consumers benefit.