Decrypting the crypto regulatory landscape – What lies ahead in 2021
By Ryan Cartmill, BlueCrest Capital Management (UK) LLP
Published: 22 March 2021
With a 2020 performance of almost 300%, the allure of Bitcoin (and other cryptoassets) to both retail and institutional investors is plain to see. Whilst it is argued that investor gravitation to cryptoassets (particularly Bitcoin) has largely been driven by the coronavirus pandemic, there is nonetheless a clear turning of the tide in terms of wider adoption for many reasons, not least as an inflation hedge against the devaluation of fiat currencies as a result of central bank stimulus packages. In fact, in a scarcely believable statistic, 25% of all U.S. Dollars in circulation today were printed in 2020 alone. It is hardly surprising, therefore, to see the proliferation of institutions concerned with the potential erosion of cash on their balance sheets, reallocating to Bitcoin in order to guard against what is widely perceived as excessive use of QE by central banks. The most widely publicised institutional investment occurred last month, when Tesla revealed in its SEC filing that it invested in $1.5 billion of Bitcoin. But what about the regulatory environment? This article aims to explain some noteworthy aspects of the regulatory landscape in this rapidly evolving space, from a UK and U.S. perspective.
In terms of market development in the U.S., there are numerous crypto exchanges which have opened up to institutional investors and several crypto derivative products have proliferated the market – CME and CBOE first launched Bitcoin futures in 2017 and ICE has also launched Bitcoin futures and options products of its own. The launch of such products was facilitated by the CFTC’s order in 2015 in its order against Coinflip Inc., in which the CFTC classified Bitcoin as a commodity (under the Commodity Exchange Act) and thus allowed for its entrance into derivative markets (like any other commodity). Therefore, any U.S. exchange offering Bitcoin derivatives must comply with the CFTC regulations. The CFTC decision has not been immune to criticism, particularly in that it allows crypto derivatives to be listed on futures exchanges when the underlying spot market of crypto is beyond the CFTC’s regulatory purview. Nevertheless, the unregulated spot market has not put off large asset managers from investing in these synthetic products and joining the bandwagon. In its January filing to the SEC, a leading fund manager stated that it “may” invest in Bitcoin futures, however custody risk remains a deterrent to wider interest in these futures contracts. For physically settled Bitcoin futures contracts, the exchanges are required to hold physical Bitcoins. Given that there is no federal-level investor protection for cryptoassets, Bitcoin held by the exchange (or its appointed custodian) is not subject to FDIC protection. Therefore, if cryptoassets are lost or stolen, it is likely that they will be lost forever with no recourse or insurance fallback. It doesn’t appear that there are any immediate proposals to extend FDIC or SIPA protections to cryptoassets.
As mentioned earlier, the CFTC regards Bitcoin as a commodity and, although it has been determined not to be a security, the SEC also plays a role in regulating cryptoassets when, for example, they are offered to retail investors through an investment fund. To this end, there have been calls to develop comprehensive federal cryptoasset legislation to remediate the current patchwork of state and federal regulation in the U.S. Standardising the fragmented regulation in the U.S. will be key in order to provide a clear regulatory regime for market participants, although the timeline is unclear.
Across the pond in the UK, there is arguably a more coordinated approach than the U.S. in tackling regulatory reform in this space. In January, HMT published its consultation on the UK regulatory approach to cryptoassets and stablecoins (the “HMT Publication”). This was in furtherance to commitments announced in the UK Government’s March 2020 Budget to consult on the broader regulatory approach to cryptoassets, including new challenges from so-called ‘stablecoins’ and follows earlier publications regarding the UK’s approach and guidance on cryptoassets from the FCA, HMT and the Bank of England. As noted in the HMT Publication - at present a large proportion of cryptoassets fall outside or are likely to fall outside the regulatory perimeter. Of particular importance was the determination that ‘exchange tokens’ (i.e. unregulated tokens/assets/coins that are primarily used as a means of exchange – this includes Bitcoin, Ethereum and XRP) are currently not within its regulatory perimeter and therefore not subject to FCA regulation. This means they may not be subject to the same consumer protections or safeguards found in other areas of financial services. However, clearly this is of more relevance to retail investors.
One of the primary considerations of the UK Government outlined in the HMT Publication is whether a new category of regulated tokens may be needed – ‘stable tokens’ and whether to bring stable tokens into the regulatory perimeter in line with the Financial Policy Committee’s expectations as set out in its 2019 Financial Stability Report. By all accounts this would not include Bitcoin, Ethereum or other similar cryptos because they are not pegged to a particular fiat currency (an inherent characteristic of stablecoins). Therefore, BTC, ETH and XRP would remain outside of the FCA’s regulatory purview (for now), although that’s not to rule out the possibility that they may be subject to regulation in the future. The first proposed legislative changes would therefore cover firms issuing stablecoins and firms providing services related to them (custodians, exchanges etc.). The HMT Publication notes that the UK Government is “proposing to take an incremental, phased approach to regulatory adjustments”, meaning the exact timeline with respect to legislative changes remains unclear, as is the case with the U.S. timetable. It also states that the UK government’s broader approach is to harmonise with the legislative measures of other jurisdictions vis-à-vis cryptoassets.
Aside from the proposals for future regulation, the UK authorities have already taken actions to address risks of cryptoassets (e.g., implementation of the Fifth Anti-Money Laundering Directive) – bringing custodians and cryptoasset exchange providers into AML and CFT regulation and more recently, banning the sale of derivatives that reference certain types of cryptoassets to retail consumers. No such measures are currently envisaged for fund managers and other institutional investors.
With the current frenzy surrounding cryptoassets and the parabolic rise of Bitcoin and other so-called ‘Alt coins’ (essentially any alternative to Bitcoin), it seems inevitable that they will attract increased scrutiny of both governments and regulators globally in 2021. Evidently the current framework in both the U.S. and UK is a hotchpotch which requires significant surgery in order to keep up with innovation in cryptoassets and the blockchain technology underpinning it. There are also broader legal hurdles not discussed in this article that will drive legislative reform globally, for example – legal status of cryptoassets, data privacy, enforceability of smart contract and governing law issues. Whilst all of this is currently on the radar of governments and regulators, non-crypto priorities may take precedence, specifically the pandemic as well as other local issues (post-Brexit affairs in the UK, for example) which could delay any meaningful regulatory reform in 2021. Furthermore, as seen in the UK, bringing unregulated cryptoassets such as Bitcoin into the regulatory perimeter does not appear to be the immediate concern, rather the primary focus is on stablecoins and protection of retail investors. However, whilst all signs point towards a phased-approach which may lead to some incremental introduction of legislation later this year, policy makers appear to be ready to step in at any time. As the HMT Publication notes– ‘Should new risks emerge or if presented with evidence of significant consumer harm, the government will take further action’.
Disclaimer: these are the views of the author and not BlueCrest Capital Management
 Dominic Frisby, ‘Bitcoin is coming of age: make sure you own some’ MoneyWeek (29 January 2021)
 Sangita Gazi, ‘Regulatory Responses to Cryptoderivatives in the UK and the EU: The Future of Cryptoderivatives in the U.S.’ <https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3737947>
 See the October 2018 ‘final report’ published by the UK Cryptoassets Taskforce (which comprises the FCA, HMT and the Bank of England)
 See the Financial Conduct Authority (FCA) publication ‘Guidance on cryptoassets’ (2019) which described three broad categories of token in relation to how they fit within existing FCA regulation: e-money tokens, security tokens and unregulated tokens. Similar assessments have taken place in the US; the Senate proposed a new Cryptocurrency Act 2020. The draft bill categorized cryptocurrency or digital tokens into three main groups based on its decentralized nature and/or use of cryptographic ledger
 Bank of England, ‘Financial Stability Report’ (December 2019) <https://www.bankofengland.co.uk/-/media/boe/files/financial-stability-report/2019/december-2019.pdf>