Crypto assets businesses - Risks, security & anti-money laundering rules

The Financial Conduct Authority (FCA) announced on June 3 that the expiry date of its temporary registrations regime (TRR) for crypto asset enterprises would be extended from 9 July 2021 to 31 March 2022. This delayed deadline permits crypto asset companies to continue trading while the FCA assesses their operations. At first sight, this might seem helpful to those operating in the sector. However, the FCA announcement came with a sting in the tail.

The fact that regulatory law does not regulate some of the riskiest forms of investing is a paradox of regulatory law. This is mostly due to the fact that the regulatory structure was designed to regulate the mainstream and conventional. It governs activities connected to ‘specified’ investments, to use the legislative wording (which most crypto assets are not). Investments falling outside the regime may be inherently risky because they are novel or esoteric but then become doubly risky as a result of the absence of regulation.

Does crypto customer have access to the Financial Services Compensation scheme?

The FCA not only observed that crypto assets are considered very high risk speculative investments but also pointed out that it does not have consumer protection powers for the crypto asset activities of firms in this sector. Nor is it likely that consumers will have access to the Financial Ombudsman Service or Financial Services Compensation Scheme. It should not be forgotten that, as various commentators have observed, the very purpose of crypto assets is to form part of a financial counterculture.

There is a long history of uncontrolled enterprises being brought under the broader regulatory structure. In the case of crypto asset firms, however, this is not the case. Instead, they’ll be subjected to a more restrictive system. It’s difficult to interpret this as an indication of anti-sector hostility.

Crypto assets and anti money laundering laws

To understand the FCA’s latest announcement, it is necessary to place it in context. On 10 January 2020, the FCA became the anti-money laundering and counter terrorist financing (AML/CTF) supervisor for crypto asset firms. This includes those firms which exchange money to and from crypto assets or safeguard their customers’ crypto assets. Crypto asset businesses existing at that date were required thereafter to comply with the Money Laundering, Terrorist Financing and Transfer of Funds (Information on the Payer) Regulations 2017. They also needed to become registered with the FCA by 10 January 2021.

Firms wishing to start a new crypto asset business after 10 January 2021 were required to be registered with the FCA before starting to trade.

The TRR was announced on 16 December 2020. It enables those crypto asset businesses which had existed on 10 January 2020 and had applied for registration by 16 December 2020 to continue to trade between 9 January 2021 and 9 July 2021 pending the assessment and determination of their applications. It was necessary because the FCA had been unable to assess and register all firms which had applied for registration. This was partly a result of the complexity and standard of the applications received and partly a consequence of pandemic related restrictions on the FCA’s ability to conduct the visits to firms which it had planned.

The sting in the tail of the FCA’s announcement was the revelation that a significantly high number of businesses were not meeting the required standards under the AML regulations. This, in turn, had resulted in an unprecedented number of businesses withdrawing their applications. Whilst compliance with AML/CTF legislation is not the only element assessed by the FCA in relation to an applicant, the FCA will only register firms where it is confident that processes are in place to identify and prevent unlawful activity.

This widespread failure to achieve the basic criteria has the potential to erode public trust in the industry. Furthermore, the FCA had stated that enterprises that had not submitted an application by 15 December 2020 would be ineligible for the TRR and would be required to refund crypto assets to clients and cease trading by 10 January 2021. Firms which did not do so would be operating illegally. The FCA is continuing to advise customers of those crypto asset firms which should have applied for registration but have not done so, to withdraw their crypto assets or money.

The enormous number of applications that have been withdrawn emphasises the importance for consumers interacting with crypto asset enterprises to check whether the company they are working with is listed on the FCA Register or in the TRR. Nor can business users (for example, those accepting payment in crypto assets) be oblivious to the risks. Whilst business users may not themselves be subject to regulatory requirements, prudence suggests that they should be wary of the possibility of dealing, even inadvertently, with firms which have been unable, or proved unwilling, to comply with even the limited regulatory regime to which crypto asset businesses are now subject.

How many people in UK hold crypto assets?

 An estimated 2.3 million adults now hold crypto assets and awareness has increased but risks are still high for investors, warns the Financial Conduct Authority (FCA), as there is no protection if a vendor goes bust.

 The consumer research shows that as holding crypto assets has become more common attitudes to them have changed. Although they are appear to be gaining more acceptance, a significant 38% of crypto users still regard them as a gamble (down from 47% last year), while increasing numbers see them as either a complement or alternative to mainstream investments. 

By contrast, the level of overall understanding of cryptocurrencies is declining, suggesting that some people who have heard of crypto may not fully understand, with only 71% correctly identified the definition of cryptocurrency from a list of statements.

Enthusiasm for crypto assets is growing with over half of crypto users saying they have had a positive experience so far and are likely to buy more (rising from 41% to 53%). Fewer people also regret having bought cryptocurrencies, down from 15% to 11%.

The amount of understanding about the risks of investing in this category, on the other hand, was extremely low. Only one in ten people who had heard of cryptocurrencies were aware of the FCA’s consumer concerns. Of those surveyed, 43% stated they were discouraged from purchasing cryptocurrency. Most consumers recognise that crypto investments are not protected, although 12% of crypto users believe otherwise.

Sheldon Mills, FCA’s executive director, consumers and competition said: ‘The research highlights increased interest in crypto assets among UK customers. The market has continued to grow, and some investors have benefited as prices have risen. However, it is important for customers to understand that because these products are largely unregulated that if something goes wrong they are unlikely to have access to the FSCS [Financial Services Compensation Scheme] or the Financial Ombudsman Service. If consumers invest in these types of products, they should be prepared to lose all their money.’

The FCA recently extended the registration deadline for the temporary registrations regime (TRR) for existing crypto asset businesses from 9 July 2021 to 31 March 2022. This follows low level of registration across the sector.

A significantly high number of businesses are not meeting the required standards under the Money Laundering Regulations, according to the FCA. This has resulted in an unprecedented number of businesses withdrawing their applications.

How many crypto asset firms have completed the registration checks and authorized by the regulator?

So far the public FCA register only lists five crypto asset firms which have completed all registration checks and have been authorised by the regulator. This leaves 90 firms on the temporary register awaiting FCA approval.

During that period the FCA issued further consumer warnings, stating that investing in crypto assets is high risk and that investors should be prepared to lose all their money.

The FCA will continue working closely with the Treasury and other regulators, including through the UK Crypto asset Taskforce, to tighten regulations and create an oversight framework for crypto assets.