With the British government collapsing over the last few days, culminating in the Prime Minister’s resignation yesterday, we’re taking a slightly different approach this week.
Alongside the political manoeuvring, there has also been a number of developments for crypto regulation. So we’re going to focus on whether the UK could become the home of crypto, and what the new leadership will need to do to deliver this ambition.
In this light, I spoke on a panel at CogX last month on “Regulation: Crypto's sword of Damocles”. You can watch the conversation in the link below.
You might have missed it while desperately refreshing twitter to check on the next round of resignations, but there has been lots of regulatory activity over the last week.
- The EU struck political deals on a) the Markets in Crypto-assets (MiCa) regulation, although the final text has yet to be tied down and b) the Transfer in Funds Regulation (TFR) that surrounds the Financial Action Task Force’s (FATF) ‘travel rule’ for crypto transactions, which are related to KYC/AML compliance.
- In the UK, also in relation to the travel rule, HMT issued its response to a consultation saying it would require crypto businesses to collect customer information on unhosted wallets only for transactions identified as posing an elevated risk of illicit finance. A tweet thread on which below…
- The UK Treasury launched a consultation into taxing DeFi, requesting responses by the end of August.
- In its July Financial Stability Report, the Bank of England called for “enhanced regulatory and law enforcement frameworks” for crypto markets and stablecoins in particular.
It is worth pausing to look at the details of the EU’s MiCa and TFR rules, texts of which are set to be finalised and voted on in the next few months, with implementation expected to follow in the next couple of years. In high level terms, the regulations cover the following issues.
- Consumer protection/AML: Cryptoasset Service Providers (CASPs) such as exchanges will have to undergo stress testing, prove they will safeguard customer funds and meet significant KYC/AML requirements as part of the TFR. The TFR, which is aimed at bringing crypto assets into the Financial Action Task Force (FATF’s) Standards with respect to the travel rule, means that CASPs will have to hold information on the originator and beneficiary for all crypto transfers between CASPs regardless of transaction value (which goes beyond even the FATF standards and seems somewhat inconsistent with GDPR); there will be a risk based approach for transfers between CASPs and wallets; and no requirements on transfers between private wallets. The European Securities and Markets Authority (ESMA) and European Banking Authority will have powers to prevent certain CASP activities where requirements are not met.
- Stablecoins: Stablecoin issuers will need EU authorisation to operate and be required to disclose how they will be fully backed by 1:1 reserves (e.g. by issuing 1 USD stablecoin, have 1 USD in reserves in the bank). Stablecoin products will not be allowed to charge interest and there will be a limit on their size.
- Environment: CASPs will be required to declare information on their environmental and climate footprint.
- Passporting: CASPs that gain authorisation in one Member State will be able to operate across the EU.
- DeFi and NFTs: Were largely excluded from the regulations, but the Commission has 18 months to consider whether further action is needed.
A helpful thread on these and other aspects is below.
This is the first comprehensive framework for digital asset regulation anywhere in the world. The EU has put down a marker. As Mark Leonard has long said, the EU’s power comes from exporting its rulebook. Its size means that anyone that wants to do business in the EU will have to fall in line:
Europe's obsession with legal frameworks means it can transform the countries it comes into contact with.
This was true for the General Data Protection Regulation (GDPR), which continues to influence data protection standards globally, and will be for MiCa too.
In the US, a draft bipartisan bill was recently published by Senators Gillibrand and Lummis. While little of the bill, if any, will be adopted this year given the midterms, it nevertheless takes a similarly broad approach to the EU. There’s a good summary here for those interested.
So what does this all mean for the UK?
In a statement in April, the now former Chancellor Rishi Sunak said:
It’s my ambition to make the UK a global hub for cryptoasset technology.
This was wrapped up in a broader set of announcements, including an intention to legislate for stablecoins as part of the Financial Services Bill later this summer and the release of a Royal Mint NFT – pure gimmickry, but a helpful signal that the UK was getting on board with the new technology.
However, to date, the UK hasn’t backed up its positive political rhetoric with action. As Ian Taylor of CryptoUK said to the FT recently:
How is it that 12 firms that were on a temporary register have been fully authorised by the FCA to trade for the foreseeable future, while the rejected 160 will have to cease trading immediately or relocate offshore? This looks arbitrary. Many in the industry believe it shows a lack of a fair and consistent approach. It bodes ill for the future.
Given the recent turmoil in the crypto markets, it’s hard to argue that sensible regulation and consumer protections are not required; in fact, such regulation is likely to help the sector mature and grow. However, there are also reasons why the UK would be wise to take a long-sighted view of web3’s potential and ensure an open and permissive approach to policy.
Why would the UK want to become a crypto hub?
There are different parallels that can be made for where web3 is in its evolution. It’s reasonable to think that it could be at a similar phase to the internet in the late 90s when most people said: “it’s too slow and expensive to be useful” (and it was, then) or “it’s too complicated and unsafe to send money over the internet” (and it was, then). You get the idea…
But as we know, from those early days there has been enormous growth in tech. Around a third of the S+P 500 is made up of tech stocks today. And we rely on the internet for just about everything we do in our daily lives.
So to extrapolate the trend for web3, it’s not implausible to think that a meaningful amount of global economic activity will take place using crypto/web3 infrastructure in the future. To take a few data points…
- The rate of crypto adoption is faster than that of the internet. That is an extraordinary thought. Real Vision’s Raoul Pal suggested that a conservative estimate would be 1.2bn users by the end of 2025, while a reasonable but more aggressive estimate would be 2.8bn.
- Venture capitalists that invest in early stage companies have taken note of these trends and the potential use cases, and invested over $32bn in web3 in 2021. Despite the current market downturn, new £billion funds seem to be announced every week.
- Talent is flying into crypto at a rate of knots. A 2021 report from Electric Capital suggests that there has been a flood of new developers into web3 and importantly, history suggests that they do not leave the space even if prices fall (as they currently are). So if you are a hub for crypto, despite remote work meaning that the market is far more global than it was pre-covid, you’re also likely to attract some of the most ambitious software engineers.
States are competing for capital, talent and influence. The more they have, the greater their economic strength and weight in the world. Europe largely missed web1 and web2. Of course there are a few major players: Spotify, Klarna etc. But the majority – including Google, Meta, Amazon, Apple, Tencent – are American or Chinese. Some in Europe are focussed on breaking these companies up. More people should be focussed on building the next generation of European companies.
The UK had much success in the past by controlling the rules of the game, particularly in relation to trade. In the post-war era those rules have been established by the US and the major international institutions like the IMF or OECD. As discussed above, the EU has done the same, creating a community of laws, standards and regulations that shape the global economic environment, including via GDPR. If web3 does become an important feature of our digital lives in future, as we expect that it will, international standards will matter. There will be value in being ahead of the game (or at least not falling behind).
So if web3 is going to play a major role in our futures, there are going to be enormous companies built, thousands of jobs created and significant wealth created. Becoming a global hub for that activity could therefore mean reaping financial and social rewards.
If the thesis is wrong, and web3 plays a much smaller role in our futures, then the downside is limited. We still might have attracted smart people, carried out interesting research and created an innovative environment. These should all be welcome anyway.
A bet with outsized potential returns and only limited downside risk seems like one that is worth taking. It’s surprising that more countries aren’t lining up to be the home of web3.
But what would it take to become the home of web3?
When the political dust settles, a new British Prime Minister and Chancellor should take the lead. A web3 plan would consist of three parts:
The UK’s announcement about becoming a crypto hub was a good first step. But this should be followed by the publication of a comprehensive web3 strategy. This would send a real signal of intent, going beyond warm words and rhetoric.
Other initiatives could also help – for example, Silicon Roundabout/Tech City was a marketing exercise in trying to replicate some parts of Silicon Valley in Old Street in London, but had an interestingly galvanising effect on the tech sector in London since it launched in 2010. A UK city could take the lead – perhaps Manchester, linked to the new GCHQ cyber centre and Manchester University’s Computer Science Dept, following the example of crypto friendly cities that have started to spring up in parts of the US, including Miami, which launched the MiamiCoin (with mixed results) and a series of conferences to attract developers to the city.
The US’s approach will still take some time to settle. And the EU’s latest rules haven’t been welcomed by everyone.
The UK has a short window to take the lead and set out a sensible and compelling approach to regulation. A few areas where the UK could differentiate itself from the MiCa and TFR rules in particular.
- Transform the FCA authorisation process. The process is opaque and difficult to navigate for firms. The FCA could be clear what its requirements are and speed the process up 10x.
- Continue to take a sensible risk based approach to AML rules. In a response to its recent consultation on the travel rule, the UK said that firms needed to collect customer information on unhosted wallets only for transactions identified as posing an elevated risk of illicit finance. The EU’s TFR rule takes a far more stringent approach for CASPs.
- Announce the simplest tax system for crypto possible. Clarity is king. One idea that has been floated is a ‘Crypto Exit Tax’ which would tax any gains made by individual actors at the point at which the crypto-assets are converted to fiat currency via a UK financial institution.
- Announce a pilot on DeFi regulation, which would last for 12 months and consider whether the FCAs existing objectives could be met through different means as a result of the way that DeFi works and the nature of the data available. This would build on the existing sandbox approach in asking more pointed questions about whether some crypto activity could be regulated in a different way altogether.
- Create a standalone web3 regulatory body that could sit within the FCA, but be tasked with drawing together a new supervisory and regulatory regime for digital assets.
Rules and regulations governing digital assets are a critical element in providing clarity to entrepreneurs and giving confidence to consumers. But as with any other sector where the government might want to see growth, there are a number of tools that could be deployed.
- Capital → Europe is a long way behind the US in terms of venture capital funding in general, and this is no different for web3. While there are a few crypto focussed funds, there is a role for the British Business Bank in particular to support emerging fund managers and stimulate capital allocation in an area that may be beyond more traditional LPs risk matrices.
- Talent → The most important component is people. Enabling people with skills in blockchain – whether Solidity developers or community builders – to come to the UK and start companies will be critical. The UK’s new Global Talent Visa is a positive change and it should be made explicit that web3 is one of the areas that is in scope.
- Training → Programmes to support training within government and regulators, but also in the private sector. These could be designed in partnership with industry and subsidised for greater take up.
- Research → With funding for new blockchain based research via PhD programmes and research institutions.
- Innovation → Providing funding and environments for innovation – whether through initiatives like the FCA sandbox, within institutions like NESTA or a new web3 Catapult.
- Security → Ensuring that there is adequate focus on the security aspects of web3 growth, including through different agencies like the National Crime Agency and National Cyber Security Centre.
- Pilots → For instance, in areas where web3 tools and protocols could help with public policy problems like tax efficiency, humanitarian aid, property rights and privacy.
This is a non-exhaustive list, but it highlights that for any country looking to become the home of crypto, there are multiple dimensions to consider. It is really about setting out a framework and getting the incentives right.
With the government in disarray and an opposition entirely absent of policy ideas, maybe web3 could provide one forward looking platform to drive growth. It is also one area where there may be a genuine brexit opportunity, with space to take a meaningfully different approach to regulation relative to the EU.
But as the FT quite rightly said, with Rishi Sunak gone, the UK will need a new crypto champion…
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