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What Is Virtual Currency? Is my business legally compliant?
The legal and regulatory framework for crypto-assets in the UK is complicated, leaving many prospective businesses in this industry unsure of how to comply.
If you are looking for a Cryptocurrency or Ingame Token Act of Parliament, you would be disappointed as there is no specific Cryptocurrency law. This is because cryptocurrencies are regulated largely through regulation and licensing, including laws that cover other activity related to the cryptocurrency business.
This article will now address critical compliance questions asked by entrepreneurs focused on the UK market.
Does my cryptocurrency business need to be authorised?
Under the Financial Services and Markets Act (FSMA) 2000, all financial activities within the UK must be regulated by the Financial Conduct Authority, and to be regulated, the FCA or the Prudential Regulation Authority (PRA) must authorise your business (including not for profit and sole traders).
Businesses involved in crypto-assets includes the operation of cryptocurrency ATMs and cryptocurrency exchanges. The FCA has released further guidance on whether your business requires authorisation here.
In summary, you will need to register a cryptocurrency exchange in the UK with the FCA but whether it requires authorisation will depend on whether its activities fall under the FCA's scope for financial activity.
As of January 2020, the financial activity mentioned above includes businesses involved in crypto-assets under The Money Laundering, Terrorist Financing and Transfer of Funds (Information on the Payer) Regulations 2017 as amended by The Money Laundering and Terrorist Financing (Amendment) Regulations 2019.
Money Service Business
A Money Service Business is defined by the FCA as:
carrying on by way of business the activity of:
(a) operating a bureau de change; or
(b) transmitting money, or any representation of monetary value, by any means; or
(c) cashing cheques which are made payable to customers. Any gambling business wishing to offer gambling facilities/virtual currencies that can be exchanged for cash or traded for items need to hold an operating licence
If your business is a Money Service Business, then you need to register with HMRC. To register with HMRC – costs £110 and you have to complete a fit and proper person test. If you are already supervised by the Financial Conduct Authority (FCA), you do not also need to register with HMRC.
Any Money Service Businesses with a credit licence issued under the Consumer Credit Act 1974 must be supervised by the FCA.
Payment Services Business
If you are a Payment Services Business, then FCA authorisation will be necessary under the Payment Services Regulation 2017. Payment services are listed in Schedule 1 to the Payment Services Regulations 2017 (PSRs 2017). Any payment of fiat currency into or withdrawn from an account is a payment service. Examples of payment services include e-money issuers and money remitters.
How do you apply for authorisation?
Businesses seeking authorisation for their financial activities can apply to the FCA here.
Typically, applications take between 6 and 12 months, and businesses must pay a registration fee. Once provided with all relevant application material, the FCA will assess an application within three months.
Compliance officers can find further guidance on applying including what the application entails and the associated registration fees on the FCA website here.
Do I need authorisation if I am a financial business owner in the European Economic Area (EEA)?
Before the 31 December 2020 – which marked the end of the Brexit transition period –, EEA financial businesses could operate within the UK via a branch or provide UK clients services without authorisation from the FCA PRA. Now, any cryptocurrency business that meets one of the following criteria must seek permission from, and register with, the FCA:
A registered or head office in the UK
Continuation of the day-to-day management of activities from a UK office, irrespective of where, geographically, the crypto-asset activity is conducted
Operation of one or more ATM(s) in the UK
A UK presence that is engaged in or facilitates crypto-asset activities
In circumstances whereby a business has no UK-based office or undertakes no regulated activities within the UK – beyond merely having UK-based clients – the business does not need to register with the FCA.
What if I already operated in the UK as an EEA firm before 31 December 2020?
To facilitate the continuation of financial services from EEA operators to the UK, a Temporary Permissions Regime (TPR) is currently in place. Firms that notified the FCA before 15 December 2020 of their intention to utilise the TPR can continue to operate as before. However, such businesses covered by the TPR must actively seek formal authorisation through the application process, as mentioned above.
EEA businesses that did not enter into the TPR will also need to seek authorisation from the FCA and PRA but may not continue their activities in the interim. Specifically, cryptocurrency businesses that did not apply for the TPR before 15 December 2020 are not eligible to continue their services and must return all assets to their customers and cease all trading by 10 January 2021. Such businesses, along with any new cryptocurrency businesses, must now seek authorisation from the FCA before commencing with any activities.
Businesses who are unsuccessful in gaining authorisation may enter into the Financial Services Contract Regime (FSCR). Through an FSCR, EEA firms can service any UK contracts entered into before the 31 December 2020, with the view of bringing the services contract to a close in an orderly fashion.
Through the FSCR, businesses are not able to procure new contracts within the UK. They are authorised to undertake activities relating to their duties from pre-existing agreements. FSCR's are time-limited and will apply for a maximum of five years for businesses involved in cryptocurrency services.
What are the consequences of not complying with regulations or rules?
Within its power, the FCA can issue several penalties for non-compliance with regulated activities. The FCA's enforcement powers include financial penalties, suspensions, restrictions, conditions, limitations, disciplinary prohibitions, and public censures.
Though the specific sanction is typically at the FCA's discretion, in circumstances where the FCA upholds the MLR or other relevant laws, they are likely to take a harsh disciplinary approach to businesses. The FCA's strict compliance approach is to uphold public confidence in the FCA and act as a deterrent for further financial crime.
What contracts do I need in place for my Cryptocurrency business?
Internal Contracts
Legal internal contracts are required to establish a cryptocurrency business. Legal, and internal agreements include:
Company's Articles of Association
Directors' Service Contracts
Shareholders Agreements
Nonetheless, understanding crypto-assets as legally recognised assets (despite its intangibility) is still a poorly understood area of law. As such, businesses should obtain specialist advice to ensure that contracts appropriately reflect crypto-assets legal status.
External Contracts
With most organisations that use cryptocurrencies, 'smart contracts' are considered the norm for providing a contractual relationship between the business and the customer. Smart contracts denote an automated, self-executing agreement generated at the point of a transaction between both parties.
In principle, the status of smart contracts should not differ significantly from conventional contracts in UK law. However, several factors that comprise the basis of UK contract law are missing with smart contracts, namely:
· An agreement – usually evidenced by a written contract, signed by both parties
· An intention to be legally bound
· The certainty of terms
As such, it is strongly advised that businesses involved with cryptocurrency resolve potential disputes and regulatory compliance through Terms & Conditions, Privacy Policies and any further agreements relating to investments.
Again, such contracts should be procured by specialist legal support who can demonstrate a clear understanding of crypto-assets' unique legal status.
Which virtual currencies need to be authorised?
The UK regulates some but not all virtual currencies. The FCA distinguishes between broad categories of virtual currencies with the following features:
Security tokens are regulated. Security tokens have the characteristics of regulated shares or debt instruments, that means they can provide liquid rights and obligations. Utility tokens are not always regulated because they only grant access to a product or a service.
E-money tokens: virtual currencies that meet electronic money's definition – these fall within the regulatory perimeter (Electronic Money Regulation 2011). These tokens are a medium of exchange for buying goods and services on and outside an exchange.
The FCA defines electronic money as follows:
Electronic money (e-money) is electronically (including magnetically) stored monetary value, represented by a claim on the issuer, which is issued on receipt of funds for the purpose of making payment transactions. It must be accepted as a means of payment by a person other than the electronic money issuer. Types of e-money include: pre-paid cards and electronic pre-paid accounts for online use
Exchange tokens or unregulated tokens: are virtual currencies that are not issued by a central authority and are intended to be used directly in exchange for products or services. Exchange tokens may also be used outside the platform or could potentially be a form of shares or investment. Calling Exchange Tokens unregulated tokens is problematic since they could be regulated depending on how they are used.
Game tokens: a token is not issued by a central authority and is used solely to exchange products or services within a gaming platform. An example of an Ingame token would be Pixelmatic, a studio based in Shanghai and Vancouver, currently using a Blockstream featuring a cryptocurrency for an in-game medium of exchange.
These above broad categories of crypto-assets or tokens are not the only ones. FCA states that each token needs assessment on a case-by-case basis depending on its functionality.
For sources: see this document from the FCA dated June 2019. Chapter 2 'Unregulated Tokens', contains a comprehensive discussion about whether tokens are regulated or not, however on page 10, a section titled 'A regime for exchange tokens' states:
The 5AMLD will bring in an AML regime for crypto-assets, including exchange tokens. The Government has announced that the FCA will be the supervisor for this regime, and the FCA will consult later this year on our approach.
The 5AMLD was transposed into UK law on 10 January 2020 as the Anti Money Laundering regime.
Further to this, a House of Commons Briefing Paper Number 8780 dated 19 February 2020 states:
The Financial Conduct Authority (FCA) regulates types of crypto-assets that function like shares or investments. They now refer to cryptocurrencies as "exchange tokens" or "unregulated tokens". Cryptocurrency exchanges must register with the FCA and follow anti-money laundering regulations
(see- Page 4, paragraph titled 'Political and Regulatory Response').
Consumer Laws
As of 06 January 2021, there is now a total ban on the sale of crypto-based derivatives and exchange-traded notes to consumers in the UK. The changes were proposed back in October 2020 by the FCA.
Consumer Rights Act Section 44(4) – a trader is to provide any refund due to the consumer without undue delay, and within 14 days from when the trader agrees, the consumer is entitled to it. Subsection 5 – makes it clear that it must be given using the same means of payment as the consumer used to pay for the digital content unless the consumer expressly agrees otherwise. An exclusion states that when a consumer uses digital currencies (cryptocurrencies) to pay for digital content, the trader can repay the consumer in the digital currency.
What's next? How can I become legally compliant, and what sort of budget will I need?
As a rapidly developing area of law, entrepreneurs and businesses should regularly check the FCA website for updates on crypto-asset regulation to ensure that any existing or planned activities are compliant with UK law. Businesses must also look to safeguard themselves against potentially costly consumer disputes through a comprehensive suite of compliance documents from dedicated cryptocurrency legal specialists.
This practice area is continually developing so you do not want one-off advice but require an ongoing retainer for legal advice. The advice given in December 2020 may no longer be applicable this week. For example, the latest legal developments in crypto-assets have been as recent as last week, including the ban on crypto-based derivatives and exchange-traded notes to retail customers.