Last month, the House of Commons Treasury Committee published its report on crypto-assets. The report expresses serious concerns about the risks of consumer harm and financial crime and calls for regulation “as a matter of urgency“.
It is striking that the Committee did not consider it appropriate to refer to “crypto-currencies” in the current landscape. They felt that these assets were failing to perform key functions of a currency, because:
- The price volatility of such assets meant they were not a good store of value. The Bank of England gave evidence that Bitcoin is 10x more volatile than sterling against the US dollar. Other crypto-assets showed even greater fluctuations.
- There was insufficient market liquidity and capacity for these assets to act as a medium of exchange. The Committee noted evidence that the blockchains for some crypto-assets were struggling to handle current payment volumes, leading to higher transaction fees and/or delays in executing transactions. The transaction fees were exacerbated by the higher energy costs of blockchain’s decentralised system.
- There were no crypto-assets being routinely or widely used as a unit of account. Even Bitcoin is not widely accepted.
The term “crypto-assets” was preferred.
The Committee’s conclusions
The Committee acknowledged some of the advantages and opportunities of crypto-asset and distributed ledger technology. But it found there were interlinking limitations. In particular:
- The same reasons crypto-assets could not be termed ‘cryptocurrencies’ also put a limit on the extent to which they were capable of replacing traditional payments systems.
- The price volatility made crypto-assets “especially risky, particularly for inexperienced retail investors”.
- The Committee looked at the hacking of exchanges, noting a lack of compensation scheme or arrangements put in place by the exchanges themselves. The Committee considered that “The risk of hacking associated with crypto-assets may not be something investors in conventional assets have experience of… they may not be well placed to judge this risk.”
- the Report notes that Initial Coin Offerings (ICOs) have “exposed a regulatory loophole that is being exploited to the detriment of ordinary investors.” Although ICOs may be structured to fall outside the existing regulation, investors were clearly expecting financial returns in a similar manner to regulated investments.
- The Committee noted suspicions that crypto-exchanges are being used to facilitate money laundering and terrorist financing, since they enable anonymous transacting. The Report acknowledged conflicting views on how significant this criminal use is. The Fifth Anti-Money Laundering Directive will bring crypto-exchanges within the money laundering regulations by 10 January 2020, but the Committee urges the UK Government to implement the regulations more promptly.
Some limitations identified by the Committee are inherent. Others could be reduced and/or eliminated by effective regulation. Presently, the FCA has no powers to regulate crypto-assets themselves and only limited scope to regulate ICOs. This limits the FCA to issuing warnings drawing attention to the risks investors in these products face. The Report considered such warnings “a feeble corrective to advertisements…that only emphasise the upside opportunities of crypto-asset investing”. This led the Committee to conclude that:
“Given the scale and variety of consumer detriment, the potential role of crypto-assets in money laundering and the inadequacy of self-regulation, the Committee strongly believes that regulation should be introduced. At a minimum regulation should address consumer protection and money laundering.”
What might regulation look like?
There is currently a level of self-regulation within the industry, but the Committee considered this insufficient. The Committee’s recommended that in the first instance “The Regulated Activities Order should be updated to bring ICOs within the FCA’s perimeter… and bring investor protections into line with those in the United States”, where the Securities and Exchange Commission generally treats utility token issues as within existing securities laws. The Committee considered that this:
“…would be the quickest method of providing the FCA with the necessary legal powers to execute its duties of protecting consumers and maintaining market integrity. Designing a new framework of regulation would inevitably take much longer and given the growing risks surrounding crypto-assets and subsequent consumer detriment, the introduction of regulation should be treated as a matter of urgency.”
The Committee suggested that regulation should include, at least, issuing ICOs and providing crypto exchange services.
The Committee also considered that, whilst there didn’t appear to be a significant risk to market stability caused by crypto-assets, the Bank of England and FCA should continue to monitor this risk.
The Committee’s conclusions do not mean that regulation is sure to follow. But they do signal the clear direction of travel as far as the UK is concerned. As the Report itself highlights, regulation is urgently needed to prevent fraud and financial crime. Regulation also brings potential opportunities for crypto assets to become more widely adopted, increasing investment, liquidity, and price stability.