Blockchain 2024 Comparisons

The blockchain market has continued to steadily grow in the United Kingdom in the last 12 months, and there is increasing specialisation within the market into specific sub-sectors. There are early signs of an influx of firms into the United Kingdom, encouraged by moves to make it a “crypto hub” for business.

We are seeing an array of different proofs of concept, ranging from stablecoins to tokenisation of real world assets, and new NFT concepts. There has been a particular focus on companies locating head offices and intellectual property in the United Kingdom, and then setting up subsidiaries in other markets.

This issue is subject to consultation with the Law Commission (“Digital Assets: Consultation paper”). Whilst the position is not yet settled, current indications are that a state change in the blockchain would be indication of a change in ownership. However, it is unlikely that this will be definitive in itself, for example because if there is a change in the holder of a private key giving access to a crypto-asset that might indicate a change of ownership even if there is no on-chain state change.

The Financial Conduct Authority (FCA) has provided a helpful guide which clearly sets out the different bases on which crypto-assets can be categorised, and was one of the first regulators globally to do this. The approach aligns with the general position under United Kingdom law, in that if a crypto-asset meets the definition of a specified investment then it is regulated, and otherwise it is an unregulated token. The nature of the regulated specified investment depends on whether the crypto-asset meets the definition of electronic money (in which case it is classified as an e-money token) or a security token (in which case it is classified as a security token).

Tokenised securities are generally regulated analogously to their traditional securities counterpart. The exception to this is that there may be a requirement to register with the FCA under the Money Laundering, Terrorist Financing and Transfer of Funds (Information on the Payer) Regulations 2017 (MLRs), in addition to obtaining the relevant authorisation under the Financial Services and Markets Act 2000 (Regulated Activities) Order 2001 (RAO). However, over the next few years, the MLRs are likely to be amalgamated into the RAO, meaning that this distinction will cease to exist.

Currently, the key question regarding the characterisation of stablecoins is whether the crypto-asset falls within the definition of e-money. The definition of e-money is relatively restrictive, for example it requires that the crypto-asset have a 1:1 fiat value.

This is likely to change, as stablecoins used for the purpose of payment transactions are likely to become regulated. This regime will have its roots in traditional payment services regulation; however, it will be adapted to take account of the specific characteristics of stablecoins, for example in terms of requiring that asset-backed stablecoins do in fact have the required backing. This change is perceived as both closing a loophole within the existing regulatory framework as well as making the United Kingdom a more attractive jurisdiction to launch stablecoins (because of the certainty of a robust legal framework behind any UK projects).

The MLRs apply to NFTs.

The RAO could technically apply to NFTs, however most use cases of NFTs do not involve giving NFTs the characteristics of a security.

An interesting point has been as regards the Financial Services and Markets Act 2000 (Financial Promotion) Order 2005 (FPO), which generally prohibits invitations or inducements to invest in fungible, transferable crypto-assets unless the activity either falls within an exemption or the promotion has been approved by an FCA-authorised entity competent to provide such approval. These financial promotion rules generally do not apply to NFTs, meaning it can be easier to sell NFTs in the UK than other crypto-assets.

Payments may be made in crypto-assets in the United Kingdom. Generally, payment in unregulated crypto-assets for goods and services is not a regulated activity.

However, the act of converting unregulated crypto-assets for fiat/crypto-assets, as well as making arrangements with a view to the conversion of crypto-assets into fiat/crypto-assets, is a registrable activity under the MLRs, and furthermore may involve a financial promotion subject to the restrictions contained in the FPO. As such, care does have to be taken to not undertake this activity unless any required registration/approvals are in place.

Generally, there is no regulatory issue with using digital assets as collateral. Depending on the set-up, however, there may be licencing requirements (for example if there is custody of the digital asset).

A broader concern has, however, been the fact that where a digital asset is constituted solely of data, whether the concept of “possession” would be able to apply, on the basis that such asset may or may not be property. The Law Commission has done good work here in getting digital assets recognised as a new form of property; however, the specific implications of this are still being determined.

The law in the United Kingdom is sufficiently flexible to recognise the ability to form a contract using smart contracts, so long as the relevant requirements for a contract are met (such as offer, acceptance, consideration, intention to create legal relations, authority and capacity, and certainty). This means that a smart contract is not, by definition, a validly enforceable legal contract. For example, a smart contract to perform a service simply by virtue of a timing requirement being met (eg, to pay GBP10 every Monday at 9am) is not in itself a legal contract because there is no consideration in return for the payment being made.

In this respect, therefore, a smart contract can be considered as evidence, and evidence of the terms, of a legal contract.

The framework for investment funds/regulated firms does not have a special regime for crypto-assets.

Generally, funds investing in crypto-assets are not eligible for the retail market, because unregulated tokens are generally not an investment of a type which allows for the fund to be marketed to the UK retail market.

As such, it is usual for funds with crypto-asset exposure to be set up within a hedge, venture capital or private equity wrapper. There is no specific differentiation in the regulation of these funds from their equivalent investing in more traditional securities; however, there is an expectation that they will be cognisant of the specific risks of the asset class that they invest in and the risk to capital investors – and as part of this that they consequently make investors very aware of the potential to lose capital invested into this type of fund.

There is a sandbox run by the FCA which is targeted at innovation, in particular, where that innovation raises regulatory considerations. Whilst the sandbox is not specifically geared towards blockchain-based projects, they are heavily represented.

More broadly, the Bank of England is also looking at sandboxes supporting the development of security token concepts, as part of putting the UK forwards as a leading hub for financial services innovation.

The United Kingdom has actively sought to implement laws and standards proposed by international bodies such as the Financial Action Task Force and the Bank for International Settlements, and in certain aspects has sought to go further than is required by these bodies, with a view to being perceived as a gold standard jurisdiction for the industry.

Please also see the Travel Rule section of 4.1.4 Anti-money Laundering and Counter-Terrorism Financing (AML/CTF) Requirements.

For most firms, the relevant regulator will be the FCA, whose jurisdictional remit is determined by whether the relevant activity in relation to the particular crypto-asset falls within the scope of one of the frameworks set out above.

The FCA has had resourcing issues when dealing with the crypto-asset sector, and has responded by building up the required resources to more effectively supervise the industry. The FCA’s approach to the industry has always been to require high (but achievable) standards, and the general approach in that respect has not changes since the bankruptcies in the blockchain sector in 2022.

The Prudential Regulatory Authority is also relevant to certain type of business, such as banks and insurers, and has a core focus on issues such as ensuing that the level of exposure of these businesses to crypto-assets and blockchain is properly managed.

The Advertising Standards Authority, whilst not a licensing regulator, has general jurisdiction as regards any advertising, and ensuring that any advertising complies with the UK’s code on advertising. The Advertising Standards Authority has authority to impose fines on firms which fail to comply with the UK’s standards for advertising.

There are no such organisations performing regulatory or quasi-regulatory roles in the UK.

The FCA has undertaken various surveys in relation to the benefits and risks of blockchain and crypto-assets generally, with a view to obtaining greater insights into the industry.

The Law Commission has also investigated how best to accommodate blockchain and crypto-assets within the existing United Kingdom common law framework. Work here has included confirming the nature of crypto-assets as a form of property, despite being based on data (which has not to date been generally treated as property), and considering whether the United Kingdom legal regime should be altered to cater more specifically for decentralised autonomous organisations (DAOs).

Currently, the most important litigation in the United Kingdom is around the extent to which coders of a network could owe fiduciary duties to holders of a token. The final position is still being determined but the consequences are potentially far-reaching, as they may impact the willingness of coders to get involved in projects where may incur liability as a result of their work.

The regulatory perimeter for the securities framework is the same as that for traditional securities, which is well defined.

Currently, there is some confusion regarding the scope of the MLRs, in particular as regards the scope of “making arrangements with a view to” a crypto-asset transaction. However, with the expected move towards the expansion of the regulatory perimeter pursuant to the RAO, we are likely to get more clarity on this point.

The UK tax authorities have provided welcome guidance regarding how they will treat blockchain and cryptocurrencies, covering activities such as staking. In very broad terms, the approach is influenced by the desire to maintain similar treatment to analogous pre-existing forms of tax.

The UK does not impose ESG/sustainable finance requirements on digital assets.

The data protection laws and regulations in the United Kingdom apply to the use of blockchain-based products or services broadly in the same way as for any other business. They are therefore triggered by the act of processing personal data, and there are obligations to safeguard this information and to make certain disclosures in relation to how this information is used.