Can cryptocurrencies handle the spotlight?

12 April 2018

On 22 February 2018 the UK Parliament announced it will be launching an inquiry into cryptocurrencies to examine the role of digital currencies in the UK; both the risks and opportunities.

The inquiry follows a heightened global focus on digital currencies as their popularity escalates. In September 2017, China banned the sale of new digital tokens; South Korea recently prohibited anonymous crypto-trading; and the US Cyber Unit (a new division of the Securities and Exchange Commission dedicated to Initial Coin Offerings (ICOs)) filed its first charges in December 2017 against Plexcorps in relation to an ICO scam. Closer to home, the EU recently agreed to revise anti-money laundering rules to encompass cryptocurrency exchanges and wallet providers. The UK’s support of these amendments was evidenced in a speech by Mark Carney, the Bank of England Governor, at the Scottish Economics Conference on 2 March 2018 in which he promised: “The time has come to hold the crypto-asset ecosystem to the same standards as the rest of the financial system”.

However, whilst the UK Government accepts cryptocurrencies need to be subject to more rigorous controls, there is awareness that the underlying distributed ledger technology (DLT) offers a number of important opportunities, including improved financial stability. As Nicky Morgan MP, chair of the Treasury Committee, explained: “Striking the right balance between regulating digital currencies to provide adequate protection for consumers and businesses, whilst not stifling innovation, is crucial”.

A key area of focus for the inquiry will likely be ICOs, a low-cost, time-efficient type of crowdfunding facilitated using DLT. Similar to an Initial Public Offering, an ICO issues transferable tokens to investors in return for cryptocurrency such as Bitcoin. Rights attaching to tokens can vary widely. Some may represent shares or debt securities whilst others may give the right to access future services. ICOs are mainly being used by early stage companies to fund the development of projects and services, as tokens can be issued and funds raised quickly and without intermediaries. The benefit of reduced regulation is also attractive.

ICOs are clearly an important means of raising funds that can support commercial innovation. However, investing in early stage development is extremely risky; in addition to price volatility, ICO investors are at risk of being victims of fraud. Action Fraud, the UK’s national fraud and cybercrime reporting agency, said crimes linked to Bitcoin increased to 999 in 2017, compared to 320 in the previous year. The level of scrutiny of ICOs is therefore an increasingly hot topic.

Currently, the UK regulatory framework does not specifically deal with cryptocurrencies or ICOs but if the underlying activity falls within the existing securities legislation (e.g. if it is akin to an IPO) it will apply. However, many ICOs fall outside the regulatory framework, for example if tokens representing an asset or a right to a service are issued, which leaves investors with limited protection.

The UK Government seems to consider that cryptocurrencies and DLT offer exciting opportunities and are here to stay. It will therefore be interesting to see how it balances providing necessary consumer protection with preserving the benefits the technology provides.