update 11 October 2021

Understanding the Role of FCA in the Regulation of Crypto-Assets

Financial Conduct Authority (FCA) is considered relatively new in the financial service sector. It has been less than a decade since the regulator took over from its predecessor Financial Services Authority (FSA) in 2013. Such a transition is bound to cause some confusion on the scope of the regulatory measures in place.

The broad and complex world of crypto assets and its evolving market is critical in the confusion of what falls under FCA regulations. As a consumer, you need to be aware of the parameters of protection provided by the authority. This is especially important when purchasing crypto assets as some of them are unregulated under the FCA and aren’t covered by their compensation scheme.

This article simplifies what the FCA does and its policies on the different crypto assets in the market.

What’s the FCA?

The Financial Conduct Authority (FCA) is a UK-based financial regulatory body that maintains the financial market’s integrity by protecting consumers and reducing financial crimes. The organization operates independently of the UK government and is responsible for the conduct of around 58,000 businesses. This comes to approximately 2.2 million employees and a contribution of about £65.6 billion in annual tax revenue to the economy.

FCA’s regulation roles include supervising financial firms through regular assessment and ensuring that rules and regulations protect consumers. The organization considers itself a champion of consumers and takes measures to protect themselves against fraud. Furthermore, it has the power to enforce fines, withdraw a firm’s authorization, and even bring criminal prosecutions against firms or individuals.

 The FCA and Crypto Asset Regulation

Crypto assets in the UK have attracted significant attention from consumers and markets in recent years. However, even as this interest grows, the number of firms carrying out crypto assets activities remains small in the UK compared to the global market. Even so, the crypto assets market and the underlying DLT technology are growing fast, and consumers need to be aware of the scope of FCA’s regulatory remit.

The FCA aims to provide extra clarity to these firms and crypto-asset owners on the market regulations and working. As a technology-neutral regulator, the FCA’s roles include ensuring that the consumer is protected from harm and fraud by enhancing the financial systems’ integrity. The technological aspects of crypto assets create equality and diversity issues that the organization tries to cater to in its regulations.

The FCA recognizes the complex nature of crypto assets and how broad the scope of these assets is. Therefore, in their guidelines, they use the term ‘tokens’ to denote different crypto assets. This allows the organization to use a neutral term that doesn’t directly compare to fiat currency. Without a general definition of crypto assets, the FCA considers crypto assets to be cryptographically secure digital representations of value powered by DLT and can be stored, transferred, and traded electronically.

Crypto assets vary depending on what rights they give their holder. They are typically used as a means of exchange, for investment, and to support the creation of decentralized networks.

The FCA categorize crypto assets into three types of tokens:

  • Exchange tokens

These are the crypto assets that are not issued by any centralized authority and are designed to be a means of exchange. As decentralized tools, these tokens are used to buy and sell goods without intermediary involvement on a peer to peer basis. These tokens include Bitcoin, Litecoin, Ethereum, etc. and are generally referred to as cryptocurrencies.

Exchange tokens are used independently of any platform and aren’t limited to any specific network. As much as they are used in the same way as fiat currency, these tokens are much more volatile and therefore are not widely accepted as a means of exchange. They are not considered currency or money because the UK does not recognize the tokens as legal tenders.

Exchange tokens do not grant their owner the rights associated with Specified Investment in the FCA. This is because their decentralized nature means they have no central issuer to honor the specified contractual rights. Therefore, exchange tokens fall outside the FCA regulatory parameters, and FCA does not currently regulate their exchange.

  • Security tokens

Security tokens are crypto assets with characteristics that make them akin to traditional instruments like shares, debentures, or units in a collective investment scheme. These tokens include those that grant their holders all or some rights as shareholders or debt holders. It also includes tokens that give rights to other tokens.

The FCA uses security to refer broadly to an instrument. This record shows an entity’s ownership position, a creditor’s relationship with an entity, or other ownership rights. They are called security tokens because they grant certain rights associated with traditional securities. Security tokens meet the definition of a Specified Investment and therefore fall within the FCA regulatory perimeters.

  • Utility tokens

These are crypto-assets that grant consumers access to a prospective service or product. These tokens usually allow rights similar to pre-payment vouchers. In some instances, they are just like reward-based crowd-funding. Much-like exchange tokens, utility tokens can be traded in the market and used for speculative investment purposes.

Utility tokens do not exhibit features that make them the same as securities or meet the definition of e-money. Therefore, these tokens do not constitute the FCA’s Specified Investment and aren’t captured in their regulatory regime.

Endnote

Crypto assets pose a range of substantial risks to the consumer varying from fraud to purchasing unsuitable products. The adoption of FCA regulations to the crypto assets market protects both the businesses and the customers from being victims of these crimes. The FCA is still doing extensive research to improve the crypto-market infrastructure and include more tokens under its regulations.

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The organization further plans to reduce legal uncertainty dealing with DLT and help firms develop legitimate crypto assets. This will ultimately increase participation and create healthy competition on the platform in the consumer’s best interest.

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