On 6 September 2021 the Chair of the Financial Conduct Authority (FCA) and Payment Systems Regulator, Charles Randell, gave a speech to the Cambridge International Symposium on Economic Crime about the risks of token regulation.
In this wide-ranging speech, the Chair commented on cryptoasset scams, the role of the FCA in combatting financial crime online and the need for new legislation and FCA powers to address consumer harms associated with online paid-for cryptoasset promotions and scams.
Cryptoasset Promotions and Scams
The Chair noted that a Kim Kardashian post where she asked her 250 million Instagram followers to speculate on tokens by “joining the Ethereum Max Community” may have been the financial promotion with the single biggest audience reach in history.
Whilst Kim Kardashian did disclose that her post was an advertisement, she did not disclose that Ethereum Max – not to be confused with Ethereum – was a speculative digital token created a month before by unknown developers. The Chair did not express a view as to whether Ethereum Max was a scam but he did state that social media influencers are now routinely paid by scammers to help them pump and dump new tokens on the back of pure speculation. Some influencers promote tokens that turn out simply not to exist at all.
This type of hype create a powerful fear of missing out from some consumers who may have little understanding of the risks. Despite the FCA’s warnings, around 2.3 million Britons currently hold a speculative token. According to research undertaken by the FCA, around a quarter of a million people mistakenly believe that they will be protected by the FCA or the Financial Services Compensation Scheme if the investment goes wrong.
DLA Piper has written about this FCA research on FinBrief.
The FCA’s Current Role
The FCA’s current role is limited to registering UK-based cryptoasset exchanges for anti-money laundering purposes. According to the Chair, some businesses have applied for registration but have fallen short of the acceptable standards so have had to withdraw their applications.
Whilst the Chair does not mention it expressly, the FCA has recently warned consumers that Binance Markets Limited is not registered or permitted to undertake any regulated activity in the UK. Binance has recently complied with the requirements of an FCA’s Supervisory Notice including via an online clarification.
The FCA has also published guidance on which tokens are within the UK regulatory perimeter, banned the sale of crypto-derivatives to retail consumers and published a list of unregulated crypto exchanges that the FCA suspect are operating in the UK.
The FCA does not, however, have a remit from Parliament to regulate the issue or promotion of speculative tokens that are outside the current scope of the regulatory perimeter.
The Chair does note that bringing these tokens within scope could have unintended consequences such as making investors think these are good faith investments (a “halo-effect”). The FCA does not regulate other highly speculative assets like art, foreign currencies or commodities like gold.
Any effective system of regulation would require a business seeking registration or authorisation by the FCA to be firmly within the FCA’s reach – including having sufficient people and resources in the UK. Given the decentralised, online and cross-border nature of speculative tokens, this may not be the most effective way of addressing consumer harm.
New Legislation to hold gatekeepers accountable
The Chair noted that Google has committed to stop promoting advertisements for financial products unless an FCA authorised firm has cleared them. According to the Chairman, it is now time for other websites - Facebook, Microsoft, Twitter, TikTok - to do the right thing too. In his view, legislation is needed to address these harms.
The UK Government’s proposed legislation about online harms now includes some financial harms but paid-for online advertising remains out-of-scope. The Chair believes this should be included in-scope of the Online Safety Bill.
According to the Chairman, legislators need to consider 3 issues:
- how to make it harder for digital tokens to be used for financial crime;
- how to support useful innovation; and
- the extent to which consumers should be free to buy unregulated, purely speculative tokens and to take responsibility for their decisions to do so.
Additional FCA Powers
In the meantime, the Chair identified two areas where the FCA should have new powers to take action to reduce the potential harm to consumers from purely speculative tokens.
The first is to address online cryptoasset promotions. Her Majesty’s Treasury has recently been consulting on the case for the regulation of some cryptoasset promotions. According to the Chair, it is absolutely imperative that any regulation of cryptoasset promotions require risks to be clearly highlighted and ensure that they do not give the impression that the token itself is subject to regulatory supervision and/or approval. Since these promotions are nearly all online and often made by promoters in other jurisdictions, the Chair also considers it imperative that any regulations in this area cover paid-for advertising on online platforms.
The second is to limit the risk of contagion from the unregulated activities of digital tokens to the regulated business of authorised firms. The Basel Committee is consulting on a proposal which would ensure that speculative digital tokens attract a full capital charge for banks. According to the Chair, it is important that all FCA authorised firms (not just banks) show how they address the risks from any digital tokens involved in their business: both in respect to their conduct risk and their prudential soundness.
The Need for Balance
The Chair concludes by acknowledging that any new legislation must not impede the development of the promising use cases for the technology that underlies certain tokens to flourish – especially the potential to make payments and financial infrastructures more efficient and accessible.
It is essential that policy makers find the right balance between protecting consumers/markets and encouraging useful new ideas in this area.
Those new ideas include the use of digital tokens as a means of payment (so-called “stablecoins”), security tokens providing a feasible alternative to more traditional investments and distributed ledger technology which has the potential to make settlement and custody more efficient.