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Much has been written about the potential behind cryptoassets and associated technology such as distributed ledger technology (DLT): ‘crypto’ has captured the zeitgeist.
However, behind the headlines, there is still much foundational work to be done in terms of defining terms, scoping the opportunities, and balancing risks. All participants – from governments and regulators, to investors, fund managers and depositaries, are on something of a learning journey: the whole industry is trying to upskill – to seize competitive advantage and to avoid making costly mistakes. As the momentum builds, it is worth taking stock of where we are now, and what might happen next, from a regulatory and policy perspective.
Momentum and mainstreaming
In the past few years, cryptoassets have been making the move from niche to mainstream. This has been driven by a number of novel factors, such as the rise in FinTech apps, and a ‘bull run’ in the price of exchange tokens such as Bitcoin. Firms have also become increasingly aware of the potential efficiencies of blockchain, distributed ledger technology, and tokenisation.
For the funds industry, and its regulators, this is an inflection point at which the risks and opportunities are being carefully assessed. A number of firms have already started to move to compete in this space: some now boast dedicated blockchain units, intra-bank digital currencies, and crypto custody services.
While there are potential benefits, there are also significant uncertainties. These include price volatility, potential systemic risk, and concerns around money laundering and market manipulation. There is also something of a disconnect between understandable regulatory caution, firms’ duty of c are for consumers, and the more relaxed attitude of a sizeable number of retail investors: 47% say they actually bought cryptoassets as “a gamble that could make or lose money” ⁶.
The challenge of cryptoassets, and associate technology such as blockchain, is therefore not only one of education – simply understanding the key terms – but also one of navigating risks while acting on opportunities.
Cryptoassets have captured public attention, and firms are keen to tap in to consumer demand, where this can be done safely and in line with fiduciary responsibilities. The machinery of public policy is also moving at pace, and this will play a big part in setting the tone for “crypto” going forward.
For the UK government, crypto could become a competitive differentiator.
The UK government is in the process of firming up its own position on cryptoassets, which will ultimately set the ‘tone from the top’ for the funds industry as a whole. The Kalifa Review, published on 26 February 2021, set out a framework for how the UK can become a leading global cryptoasset centre, in terms of clearing, settlement, trading and exchange⁷. The report also emphasises the urgency of getting ahead in this space, concluding that “the time to act is now”⁸.
On 26 April the Chancellor of the Exchequer welcomed and supported the review, including its proposals on digital finance.
The UK government has also sought to clarify the practical applications of all the innovation in this space: a consultation on cryptoassets and stablecoins was issued by HMT in January, and later in the year a consultation on DLT-based ‘smart contracts’ is expected. A taskforce on central bank digital currencies is also being established.
This flurry of activity reflects a sense of urgency in terms of understanding the scale of the opportunity, and its practical, competitive, application.
For UK regulators, the task is to balance these opportunities with consumer protection.
UK regulators have already taken a series of actions on cryptoassets, with more to come. They have sought to deliver robust consumer protections whilst protecting financial stability.
Marketing cryptoderivatives to retail investors was banned by the FCA in October 2020 11. UK regulators have also sought to clarify the regulatory perimeter, and have consulted on bringing a broader subset of cryptoassets under the FCA Financial Promotions Regime⁹.
A key challenge for UK regulators has been to set standards that are robust enough to protect investors, while promoting growth and innovation. No mean feat, but critical to get right as demand continues to grow.
The view from Europe
European regulation has faced the same challenges as the UK, but with the added complexity of ensuring cross-EU regulatory alignment. On 24 September 2020 the Commission published its Markets in Cryptoassets (MiCA) proposal¹⁰. It aims to provide a harmonised approach to regulating cryptoassets across the EU, as there is no current crypto supervisory regime at EU level – different jurisdictions have started to set up their own policies. It will be implemented by 2024.
Some aspects of the cryptoassets zeitgeist have generated much more attention than others: there is wide awareness of cryptocurrencies such as Bitcoin and Ethereum, for example. However, for the funds industry, it may be that associated technologies such as DLT prove to be the most transformative, form an operational perspective.
DLT has been the most popular technology trialled within the FCA Sandbox 14, and the government’s cryptoasset taskforce has said that it has the potential to deliver significant benefits in future¹¹.
DLT enables a ledger or contract to be viewed and updated in real time by all parties to it (no single authority controls the network), presenting opportunities in terms of security and operational efficiency. DLT could facilitate accurate and time-stamped fund valuations, more stable trade settlement (with no single point of failure) and faster and more reliable AML and KYC monitoring, all of which would generate significant efficiencies.
While there has been much focus on the trading of cryptoassets (and their associated risks), firms are also increasingly experimenting with associated technologies like DLT, and these may prove just as transformational.
NatWest Trustee and Depositary Services view
- As the UK’s largest depositary, we have seen a range of perspectives from clients on this, reflecting the novel nature of the technology. We view cryptoassets and associated technologies first and foremost through the lens of investor protection, and are mindful of the risks and prohibitions.
- However, as an increasingly data-driven depositary, we are also aware of the opportunities presented by, for example, DLT, and the potential for the technology to transform the industry for the better if it is done correctly.
- We are therefore engaging with and monitoring policy and regulatory developments in this space very closely.
6 HM Treasury, UK Regulatory Approach to Cryptoassets and Stablecoins: Consultation and Call for Evidence, January 2021, Section 3.2, Page 13
7 Kalifa Review, February 2021, Page 30
8 Kalifa Review, February 2021, Page 13
9 HM Treasury, UK Regulatory Approach to Cryptoassets and Stablecoins: Consultation and Call for Evidence, January 2021, Section 1.23, Page 7
10 HM Treasury, UK Regulatory Approach to Cryptoassets and Stablecoins: Consultation and Call for Evidence, January 2021, Section 1.23, Page 8
11 HM Treasury, UK Regulatory Approach to Cryptoassets and Stablecoins: Consultation and Call for Evidence, January 2021, Section 1.23, Page 2