UK: “Wild West” crypto-assets should be regulated

The Treasury Committee publishes a unanimously-agreed Report on crypto-assets for its Digital Currencies inquiry.

Key findings

• Regulation needed for "Wild West" crypto-asset market
• Problems include volatile prices, hacking vulnerabilities, minimal consumer protection, and anonymity aiding money laundering
• Blockchain is currently slow, costly and energy-intensive, but there is potential for data storage uses
• The ambiguity of the UK Government and regulators' position is clearly not sustainable
• Regulation could improve customer outcomes, enable sustainable growth, and reduce certain risks
• In deciding the regulatory approach, Government should decide if growth should be encouraged
• Proportionate regulation could see UK as well placed to become global centre for crypto-assets

Report summary

• Crypto-assets, and most Initial Coin Offerings (ICO), are currently not within the scope of Financial Conduct Authority (FCA) regulation. Crypto-asset investors are currently afforded very little protection from the litany of risks, namely there are no formal mechanisms for consumer redress, nor compensation.
• Self-regulating bodies in the crypto-asset industry, which set out codes of conduct and best practice for the industry, are wholly voluntary. Inevitably, there are firms that will ignore them. This is clearly insufficient. As the Government and regulators decide whether the current Wild West situation is allowed to continue, or whether they are going to introduce regulation, consumers remain unprotected. The Committee strongly believes that regulation should be introduced. At a minimum, regulation should address consumer protection and Anti-Money Laundering (AML).
• In deciding the regulatory approach, the Government and regulators should evaluate the risks of crypto-assets, and assess whether their growth should be encouraged. If growth is favoured, regulation could lead to positive outcomes for the crypto-asset market, including the move toward a more mature business model and increased liquidity. If the UK develops a proportionate regulatory environment for crypto-assets, the UK could be well placed to become a global centre for this activity.
• Currencies act as a medium of exchange, a store of value, or a unit of account. There are currently no cryptocurrencies that perform these functions. As cryptocurrencies are being used widely for speculation, well-functioning cryptocurrencies exist only as a theoretical concept. Accordingly, this Report uses the term 'crypto-assets' as it's more helpful and meaningful in describing Bitcoin and many other 'altcoins'.
• A prominent feature of crypto-assets is the volatility of their prices. For example, the price of a Bitcoin increased from $6,472 in November 2017 to $17,629 in December 2017, and fell to $7,208 in February 2018. Investors are exposed to large potential gains, but correspondingly a greater risk of loss. Accordingly, investors should be prepared to lose all their money.
• Several crypto-asset exchanges, which are used to convert crypto-assets into conventional currency, have been hacked and customers' crypto-assets have been stolen. As there is no collective deposit insurance scheme to compensate investors in the event of a hack, the risk of hacking associated with crypto-assets may not be something that investors in conventional assets have experience of. Therefore, they may not be well placed to judge this risk. This constitutes further evidence that crypto-assets are particularly ill-suited to retail investors.
• An additional risk that consumers may not be aware of is that some customers who have lost their passwords to a crypto-asset platform have been told by the firm that runs their account that their password cannot be restored. Thus, there is no recourse for customers who have lost their password, and they are locked out of their account permanently. This often-unexpected outcome for investors is a stark contrast against how customers of banks, and other regulated financial services firms, are treated.
• The advertisements of both ICO issuers and crypto-asset exchanges are not regulated by the FCA. One-sided adverts imply that the crypto-asset market will only go up, and that anyone can make a lot of money easily. The FCA’s consumer warnings are a feeble corrective to such misleading adverts. The regulator needs more power to control how crypto-asset exchanges and ICOs market their services.
• Crypto-asset exchanges are not currently included in AML regulations. Owing to this, and their inherent anonymity, crypto-assets can facilitate the sale and purchase of illicit goods and services and can be used to launder the proceeds of crime. The Committee recognises that the EU's Fifth AML Directive, which will require crypto-asset exchanges to comply with AML regulations, is a step forward. However, the Government’s consultation on transposing the EU’s Fifth AML Directive into UK regulation is not expected to finish until the end of 2019. The Committee has urged the Government to prioritise and expedite the transposition.
• Blockchain is an electronic ledger that records and verifies transactions made using crypto-assets. Moving away from its origins with Bitcoin, blockchain has more recently been described as a database that works as a decentralised way of storing large amounts of data. A fundamental drawback of decentralised blockchains is the slow, costly and energy-intensive verification process for transactions. This may ultimately limit the extent to which crypto-assets and blockchain can replace conventional money and payment systems. But the Committee does recognise that blockchain technology may have the potential to be a more efficient method of managing certain types of data in the long-term.

Chair's comment

Commenting on the Report, Rt Hon. Nicky Morgan MP, Chair of the Treasury Committee, said:

"Bitcoin and other crypto-assets exist in the Wild West industry of crypto-assets. This unregulated industry leaves investors facing numerous risks. 

Given the high price volatility, the hacking vulnerability of exchanges and the potential role in money laundering, the Treasury Committee strongly believes that regulation should be introduced. 

It's unsustainable for the Government and regulators to bumble along issuing feeble warnings to potential investors, yet refrain from acting. 

At a minimum, regulation should address consumer protection and anti-money laundering. If the Government decides that crypto-asset growth should be encouraged, appropriate and proportionate regulation could see the UK become a global centre for this activity."