What are cryptoassets?
1.11 A crypto asset is understood to be a digital representation of value or contractual rights that can be transferred, stored or traded electronically, and which may (though does not necessarily) utilise cryptography, distributed ledger technology or similar technology.3 The term ‘token’ is used interchangeably with ‘cryptoasset’ hereafter.
2 Cryptoassets could fulfil a diverse set of functions, ranging from the trading of digital collectibles to raising capital for new projects. No internationally agreed taxonomy or classification of cryptoassets exists. In 2019 the Financial Conduct Authority (FCA) published its ‘Guidance on cryptoassets’ which described three broad categories of token in relation to how they fit within existing FCA regulation: e-money tokens, security tokens and unregulated tokens.
• e-money tokens meet the definition of electronic money in the Electronic Money Regulations 2011 (EMRs) – broadly, digital payment instruments that store value, can be redeemed at par value, at any time and offer holders a direct claim on the issuer
• security tokens have characteristics akin to specified investments, like a share or a debt instrument, as set out in UK legislation. 5 Broadly, these are likely to be tokenised, digital forms of traditional securities. As with emoney tokens, these are already within the UK’s regulatory perimeter and therefore subject to FCA regulation
• unregulated tokens are neither e-money tokens nor security tokens and include:
• utility tokens: tokens used to buy a service, or access a DLT platform – this could, for example, include access to online cloud storage; and
• exchange tokens: tokens that are primarily used as a means of exchange – this includes widely known cryptoassets such as Bitcoin, Ether and XRP.
1.13 The FCA’s guidance also makes clear that many tokens can take a hybrid form and fall into different categories at different points in time – for example, they may initially be used to raise capital, then later be used primarily as a means of exchange.
1.14 High volatility has been a notable characteristic of many widely known exchange tokens, making them less suitable for payment purposes and more attractive to some holders as a high-risk speculative investment. In March 2018 the UK’s Financial Policy Committee (FPC) noted that ‘their values are currently too volatile to be widely used as a currency or a store of value and, with transaction costs high and settlement times slow, they are an inefficient media of exchange’. The FPC also stated that ‘as assets, they establish no claim on any future income streams or collateral. They have no intrinsic value beyond their currently limited potential to be adopted as money in the future, and hence could prove worthless’.
1.15 So-called ‘stablecoins’ are an evolution of cryptoassets, which seek to minimise volatility in value. Depending on design stablecoins can currently fall into any of the categories set out above – though are currently more likely to be unregulated exchange tokens or e-money tokens. Stablecoins aim to maintain stability in their price, typically in relation to stable assets such as fiat currency. Examples include Tether, Paxos or USD coin.
1.16 Design features vary, including how the stablecoin is backed or stabilised (for example, with financial assets or using an algorithm to increase or decrease the supply as needed to maintain a stable price). Other design features include the existence and nature of the token-holder’s claims on any assets referenced (e.g. whether or not a holder has legal rights to assets in the reserve) and the population of users able to hold the coin. 1.17 A stablecoin arrangement can consist of a number of different entities in a chain, conducting activities in relation to the issuance of tokens, redemption and stabilisation of the stablecoin, the exchange of the token, and the interaction with users. Opportunities and risks vary depending on these design features, scale of uptake and intended use.
1.18 The FCA’s classification of tokens above aimed to provide guidance on which tokens may lie within the FCA’s regulatory perimeter and may be subject to its regulation. However different classification methodologies exist, for example by categorising tokens according to their economic function (for example, ‘payment tokens and investment tokens’), or other relevant characteristics, such as the rights they confer to users. Classifications have also evolved in line with the changing nature of the market.
1.19 To provide continuity and clarity for market participants, the government proposes to maintain the FCA’s broad approach to classification as far as possible. However, to reflect the proposal to bring additional tokens and associated activities into regulation (as set out in chapter 2) the government is considering whether a new category of regulated tokens may be needed – stable tokens.
1.20 The regulated category of stable tokens would refer to tokens which stabilise their value by referencing one or more assets, such as fiat currency or a commodity (i.e. those commonly known as stablecoins) and could for that reason more reliably be used as a means of exchange or store of value. The category would also include other forms of tokenised payment and settlement assets, as well as tokenised forms of central bank money. Further detail on tokens in scope is set out in chapter.
1.21 In considering this classification, the government and other Cryptoassets Taskforce authorities recognise that whilst cryptoassets are typically underpinned by DLT, stable tokens could be designed using other types of technology. This classification is therefore agnostic on the technology underpinning its use (e.g. whether it relies on DLT or not).
1.22 The government recognises that a more granular classification or taxonomy of tokens could have benefits, for example in providing clarity for consumers and businesses as to what type of cryptoasset they are using and the benefits and risks that derive from it. However, given the rapidly evolving market and hybrid (sometimes fluid) nature of many tokens it is also important that any classification is future-proof and sufficiently flexible. The government invites views and responses on this issue.
Cryptoassets and the current regulatory landscape Introduction
1.1 Financial innovation has seen rapid change over recent years, accelerated further by the impact of Covid-19. Cryptoassets, offering new ways to transact, invest and store funds, have been part of this trend and could play an increasingly important role in the future. However, as will always be the case with a rapidly changing technological landscape, they also present new challenges and risks.
1.2 New and emerging forms of cryptoassets, such as stablecoins, which seek to stabilise their value, could be used as widespread means of payment, and potentially deliver improvements in cross-border transactions. At the same time, depending on scale and nature of use, these developments could pose similar financial stability and consumer risks as traditional regulated payment systems.
1.3 At present a large proportion of cryptoassets fall outside or are likely to fall outside the regulatory perimeter. This means they may not be subject to the same consumer protections or safeguards found in other areas of financial services and payments. 1This may prevent benefits from being realised and exposes consumers to potential harms and, depending on prevalence and value transferred, could pose financial stability and consumer risks.
1.4 In light of this, and reflecting the pace of change, the Treasury’s March 2020 Budget outlined two measures as part of the UK’s response to cryptoassets: • consulting on bringing certain cryptoassets into scope of financial promotions regulation to enhance consumer protection; and • consulting on the broader regulatory approach to cryptoassets, including new challenges from so-called ‘stablecoins’
1.5 HM Treasury’s consultation on cryptoasset promotions concluded on 26 October. Further detail will be set out in due course.
1.6 This consultation relates to the second commitment. It seeks views on how the UK can ensure its regulatory framework is equipped to harness the benefits of new technologies, supporting innovation and competition, while mitigating risks to consumers and stability. It reflects advice from the Uk’s joint Cryptoassets Taskforce,2 which was established in 2018 with a mandate to consider the risks and benefits posed by cryptoassets and distributed ledger technology (DLT) in the UK, and to advise on the appropriate regulatory response.
1.7 The government proposes a staged and proportionate approach to regulation, which is sensitive to risks posed, and responsive to new developments in the market. This document represents the first stage in the consultative process and focuses on establishing a sound regulatory environment for stablecoins, where the government judges that risks and opportunities are most urgent. The government will strategically assess new and emerging risks as this market continues to mature. Future regulation of a potentially wider set of tokens and services will be informed by this analysis, taking into consideration the views of industry, consumers, and regulators.
1.8 The government invites views from a wide range of stakeholders, and particularly firms engaged in cryptoasset activities. If the proposals are adopted, further consultations and guidance will be issued by HM Treasury and relevant UK authorities on implementation, including specific firm requirements (see chapter 4 for further detail on next steps and how to respond).
1.9 The consultation element of the document is structured as follows: chapter 1 sets out the landscape for cryptoassets and their current status in UK regulation; chapter 2 outlines the government’s proposed policy approach; chapter 3 sets out specific proposals with respect to cryptoassets used for payments purposes.
1.10 Finally, the call for evidence (chapter 4) seeks stakeholder views on a broader range of questions in relation to cryptoassets used for investment purposes and the use of DLT in financial services. In particular, it asks about the benefits and drawbacks of adopting DLT across financial markets, whether there are obstacles to its adoption, and what further actions government and regulators should consider in this space.
