Latest regulatory challenges facing crypto businesses

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This article was originally published on 16 January 2024. 

New financial regulations affecting UK cryptoasset businesses have come into force in the past few months to address risks associated with cryptoassets, as highlighted by some controversies in the global crypto industry in recent years. Key examples include the high-profile collapse of crypto exchange FTX; the estimated $60 billion crash of the Terra/Luna network; and a sharp drop in the total market capitalisation of cryptoassets in what’s referred to as the ‘Crypto Winter’.

The regulatory transition has created challenges for some cryptoasset businesses, with some pausing UK operations due to new crypto promotion rules. Cryptoasset businesses have also had to reassess their operations to ensure compliance with new inter-cryptoasset business transfer requirements. With the UK’s Financial Conduct Authority (FCA) cracking down on the crypto industry, it’s important to understand what these new rules are and how they impact UK cryptoasset businesses.

Cryptoasset promotions

The FCA recently introduced new cryptoasset promotion restrictions to reduce harm to consumers from investing in cryptoassets that don’t match their risk appetite. In some cases, this required businesses to pause their operations to design and implement compliance programs, for example: PayPal temporarily halted its crypto purchasing service between 1 October and 1 November 2023; crypto exchange Binance halted the acceptance of new customers in the UK from 16 October 2023; and crypto exchange Bybit suspended its UK operations from 1 October 2023.

Generally, UK businesses are restricted from promoting financial products or services unless they:

• are authorised by the FCA,
• have their financial promotions approved by an FCA-authorised business; or
• are exempt from the regulations.

From 8 October 2023, this financial promotion restriction extends to cryptoasset businesses. Cryptoasset promotions, like other financial promotions, must now be clear, fair, and not misleading and must not inappropriately incentivise consumers to invest. A cryptoasset firm registered under the Money Laundering Regulations (MLRs) may also promote cryptoassets, in addition to the above three routes. The FCA has acknowledged that this is the first conduct regime for the UK crypto industry and that some cryptoasset businesses have had to significantly restructure their businesses to comply. The FCA therefore introduced the ability to apply for an additional three-month grace period to comply with ‘back end’ elements of the regime. However, this grace period ended on 8 January 2024.

Currently, FCA-authorised businesses can approve the financial promotions of unauthorised businesses. As of 7 February 2024, all FCA-authorised businesses must have FCA permission before doing this. Factors that’ll impact whether permission will be granted include whether the authorised business has sufficient relevant expertise in the type of financial promotion it’s looking to approve, and whether the authorised business has effective policies in place to ensure the promotions it approves comply with the rules.

The FCA has demonstrated that it’ll use its regulatory powers for those in breach of crypto promotion rules. For example, on 10 October 2023, the FCA announced that it had imposed restrictions on peer-to-peer lending platform rebuildingsociety.com, preventing it from approving the cryptoasset promotions of other businesses. This decision came days after the world’s largest crypto exchange, Binance, announced it was to have its cryptoasset promotions approved by the lending platform. The FCA also issued 146 alerts within 24 hours of the new regime coming into force, warning businesses that it’ll take robust action to remove illegal content. Cryptoasset businesses looking to operate in the UK going forward should be diligent in complying with the new regulations. They should apply for the relevant permissions and be prepared to justify their actions when promoting their products or services, or when approving the promotions of others.

Crypto Travel Rule

Since 1 September 2023, cryptoasset businesses in the UK have been required to comply with the crypto Travel Rule. The crypto Travel Rule derives from the recommendations of the Financial Action Task Force, which is an international standard-setting body that helps national authorities to tackle money laundering, terrorist financing and the financing of the proliferation of weapons of mass destruction. The crypto Travel Rule states that all cryptoasset businesses must verify, record, and communicate identifying information of both sender and recipient when making transfers between cryptoasset businesses. There’s also an obligation to report to the FCA where there’s a repeated failure by a cryptoasset business to provide information required by the regulations. Peer-to-peer transfers are outside the scope of these regulations. This new rule aims to make it harder for criminals to use cryptoassets for illegal activity by increasing transparency. The rule also brings cryptoasset transfers in line with existing wire transfer rules. The crypto Travel Rule poses a challenge as crypto transfers are pseudonymous by nature and transferred using distributed ledger technology, making it difficult in some cases to ascertain the identity or location of the sender. Implementing the new rule will require cryptoasset businesses to develop and test new systems to collect this information, as well as comply with data protection rules, and is therefore likely to present an additional significant expense. Furthermore, the borderless nature of crypto transfers makes enforcing the rule difficult where transfers come from jurisdictions that don’t have their own travel rule. In this event, the FCA recommends making a ‘risk-based assessment’ as to whether to facilitate the transfer, which poses an interpretive issue. While HM Treasury acknowledged in a consultation response that compliance with these new rules may be costly, it noted that the benefits to the crypto sector and the broader UK economy outweigh this cost.

What’s next?

The government and regulators have announced that they’ll be introducing a new financial services regime for cryptoassets in 2024. Phase 1 will see fiat-backed stablecoins brought into the regulatory perimeter, specifically where they’re used for payments. Phase 2 will introduce a regime requiring cryptoasset businesses to obtain authorisation from the FCA or rely on an applicable exemption or exclusion to operate. Cryptoasset businesses currently registered under the MLRs will not be automatically granted authorisation. The authorisation process will likely be resource intensive and authorised crypto businesses will need to comply with stricter regulations.

Concluding remarks

The UK crypto industry is currently in a transitional period, with cryptoasset businesses having to navigate the new regulations and align these with their business models. The new regulations, while potentially time-consuming to implement initially, also pose an opportunity for compliant cryptoasset businesses to capitalise on enhanced consumer confidence. Further guidance is still needed from the FCA as to how to navigate the crypto Travel Rule. However, as more countries around the world adopt their own crypto travel rules, compliance should become simpler over time. How the FCA enforces the new regulations in the coming months will need to be monitored, to help inform the approach that cryptoasset businesses should take to implementation going forward.

Victoria Cherrington is a trainee solicitor in the financial services regulation team at Taylor Wessing.