1. What are cryptoassets?

Cryptoassets are a digital representation of value, the ownership of which is cryptographically proven (using computer code). The most well-known cryptoasset is bitcoin, a digital currency. Bitcoin is based on blockchain technology, which removes the need for a central authority, such as a bank, to check for invalid transactions. Instead, individuals participating in the network solve computational puzzles to validate the transactions. The value of cryptoassets can be very volatile; this is discussed further below.

Stablecoins are a type of cryptoasset that is designed to be less volatile than other cryptoassets. Stablecoins are generally only created, or “minted”, once an individual deposits the equivalent amount in a national currency. The issuer of a stablecoin can use the proceeds of that currency to invest in other assets. However, the stability of these assets is not guaranteed; in May 2022, two linked stablecoins, Luna and TerraUSD, decreased sharply in value and lost their dollar equivalence.

‘Non-fungible tokens’ (NFTs) are another type of cryptoasset. These are digital assets that represent real-world objects. These can be digital, such as a piece of digital art, or physical, such as a bottle of whiskey. They are bought and sold online, frequently with cryptocurrency, and are often encoded with the same underlying software as many cryptocurrencies. However, many NFTs are digital creations that already exist in some form elsewhere, like securitised versions of digital art that is already widely available online. Twitter co-founder Jack Dorsey sold his first ever tweet as an NFT for more than £2mn. Finance magazine Forbes explains that buyers often value NFTs because proof of ownership gives them “bragging rights”, even if they do not have exclusive use of an item.

2. Why are cryptoassets considered high risk?

The value of many cryptoassets is very volatile. For example, the price of one bitcoin fluctuated from $67,567 on 8 November 2021 to $17,744 on 18 June 2022. In February 2023, global cryptoassets were worth an estimated $0.8tn. This was down 75% on the November 2021 value of approximately $3tn. Knock-on effects from failures of large companies, combined with highly leveraged lending, led to a large slump in the market in the first half of 2022.

‘Retail’ investors (people who are not professional investors) can lose significant sums of money by buying and selling cryptoassets. Recent research by the Bank for International Settlements found that approximately three-quarters of retail investors were likely to have lost money on their initial cryptoasset investment.

Many high value cryptoasset businesses have seen large falls in value or have declared bankruptcy, with customers and investors losing large sums. In November 2022, FTX Trading Limited, a cryptoasset business valued at $32bn, went bankrupt. Customers of its exchange lost assets it was holding on their behalf; the value of these assets is estimated to be in excess of $1bn. Individual investment firms have also lost hundreds of millions of dollars as crypto firms have defaulted on loans.

In January 2023, the International Monetary Fund (IMF) said that as cryptoassets become more deeply linked with the core financial system there could be “concerns about systemic risk and financial stability in the near future”. It argued that these risks could be addressed by strengthening financial regulation and supervision, and by developing global standards.

There are increasing concerns about cryptoassets’ potential links to economic crime because of the relative anonymity they offer and the speed at which transfers can be made. The government intends to use measures in the Economic Crime and Corporate Transparency Bill, currently before the Lords, to strengthen the UK’s regime for seizing cryptoassets.

3. How are cryptoassets regulated?

Generally, cryptoassets and activities relating to cryptoassets are not regulated in the UK. At present, the Financial Conduct Authority (FCA) has oversight to check that some types of cryptoasset firm have effective anti-money laundering and terrorist financing procedures in place, but cryptoasset businesses are not by default regulated by the FCA.

The UK Advertising Standards Authority regulates the promotion of cryptoassets to consumers by scrutinising social media, web pages and adverts. However, most cryptoassets are not currently subject to existing regulations restricting financial promotions enforced by the FCA.

Internationally, some countries, such as Japan and Switzerland, have amended laws or introduced new legislation covering cryptoassets and their service providers. Others, including the EU and US, are developing legislation in this area.

The international Financial Stability Board has made high-level recommendations for the regulation, supervision and oversight of “global stablecoin” arrangements. It said that while stablecoins have the potential to bring efficiencies to payments and promote financial inclusion, a widely adopted stablecoin used in multiple countries could become systemically important.

4. What is the UK government’s policy on cryptoassets?

The government has announced it intends to make the UK a global hub for cryptoasset technology. As part of this, it said it would create “a dynamic regulatory landscape which works for everyone”. The Financial Services and Markets Bill, which would make wide-ranging changes to financial regulation, contains measures relating to cryptoassets.

In 2021 the government ran a consultation on the UK’s regulatory approach to cryptoassets. It sought views on the UK’s regulatory framework and how to mitigate risks to consumers and stability. In the outcome document, published in April 2022, the government said that measures in the bill would focus on stablecoins and the promotion of cryptoassets.

In February 2023, the government published a further consultation paper, this time on its regulatory approach to cryptoassets, to be implemented following the passage of the bill. It said cryptoassets and the activities underpinning their use “should follow the standards expected of other similar financial services activities, commensurate to the risks they pose”. These standards include prudential requirements, data reporting, consumer protection, location policy and rules on operational resilience. The government said that having the regulatory framework in place should stimulate growth and innovation in the sector by “giving responsible actors the regulatory certainty and confidence to participate in cryptoasset markets, and investors the confidence to invest in the UK for the long-term”.

5. What impact would the Financial Services and Markets Bill have on cryptoasset regulation?

The bill would provide for establishment of a regime to regulate the use of ‘digital settlement assets’ (DSAs) for payment. The definition of digital settlement asset in the bill would include stablecoins and other cryptocurrencies that meet the definition; however, it would not be limited to cryptographically secured assets. The bill would not introduce this regime, but would allow for its creation by secondary legislation. The government has stated that it intends initially to use the powers to regulate stablecoins that are used for payment.

The bill would also amend the Financial Services and Markets Act 2000 to clarify that the government could use its existing powers in that act to regulate cryptoassets and would insert a definition of cryptoassets into that act. The government said that before using this power it would “consult on an approach which enables firms to innovate, while maintaining financial stability and clear regulatory standards so that people can use new technologies both reliably and safely”. The government published this consultation paper on 1 February 2023.

The Lords Library has produced a briefing on the Financial Services and Markets Bill.

Cover image by Kanchanara on Unsplash.