Written by Grace Kung, an Associate at the law firm Ontier LLP
Research from the Financial Conduct Authority (FCA) shows that estimated crypto ownership more than doubled from 2021 to 2022, with 10% of those surveyed stating that they own crypto.
Although investing in this arena is not without risk, there is little doubt that some investments have seen remarkable growth in recent years and investing in the blockchain and crypto space continues to be attractive. Indeed, many see opportunities arising from Rishi Sunak’s ambitions for the UK to become a global hub for digital asset technology.
One way for high net worth clients to gain exposure to the asset-class without buying crypto directly is through, for example, investing in digital asset-linked financial products (such as ETFs and trusts). However, those who want to potentially gain more control over their investments may prefer to invest directly in a blockchain business by buying shares in publicly listed or privately held companies that are dedicated to blockchain technology and digital assets.
Either way it is important to do thorough research into what the blockchain means and how the products linked to them work. There are then five legal questions to ask before putting a signature on the dotted line:
1. What are the preparatory works?
Each form of investment comes with its own unique set of legal considerations with consequent risk related implications. Clients should consider how much time and resources they can devote to doing their own due diligence on the opportunity or to what extent they want to rely on an intermediary. It is important to understand what legal documentation will be required to complete the investment. Critically, investors need to understand their rights and liabilities in the event the investments go wrong.
2. Has the blockchain company been authorised/registered?
While there is currently no specific regulatory framework for blockchain companies either in the UK or globally, authorisation may be required from the FCA where the company falls within its traditional regulatory perimeter. If the activities carried out fall under Part 4A of the Financial Services and Markets Act 2000 (FSMA), for example, the company needs to be authorised under the FSMA. The Financial Services Register can be checked to see which companies the FCA authorises and what they are authorised to do.
If clients are investing in cryptoasset exchange providers or custodian wallet providers, they may also need to ensure that the business has been registered with the FCA pursuant to the Money Laundering and Terrorist Financing (Amendment) Regulations 2017, which sets out obligations of private companies exposed to the risks of money laundering. The FCA’s Registered Cryptoasset Firms Register shows the cryptoasset firms that have been registered for these purposes.
Carrying on regulated activity without authorisation has serious consequences and is a criminal offence. An investor risks losing some, or even all, of their money if the company is found to be unauthorised.
3. What are the future regulations in this area?
As with any business, before getting involved with investments in blockchain related companies, it is important to be aware of any potential regulatory changes when assessing an opportunity.
While there is still ongoing debate as to the extent to which the UK Government wants to regulate blockchain businesses, it has already committed to a number of steps to bolster the UK regulatory framework. For example, in its January 2021 consultation paper, HM Treasury proposed new regulatory regimes for cryptoassets, including introducing a new definition of “cryptoassets” and formally including them within the scope of the regulated activities under the FSMA. These initiatives are taken further in the more recent Financial Services and Markets Bill 2022-23, which is approaching its final legislative stages at the time of this article.
Earlier this year, HM Treasury also published several papers about introducing more specific regulations, such as the financial promotions of cryptoassets and their use within the financial services. The FCA then announced in June that from 8 October 2023, those promoting crypto must put in place clear risk warnings, ensure adverts are clear, fair and not misleading, and introduce a 24-hour cooling-off period for first time investors.
It is expected that the regulatory landscape will continue to mature and grow in future.
4. Is there any protection if the company goes out of business?
Notwithstanding the above authorisation regimes, many crypto-related activities are not yet regulated in the UK. This means that unlike with other conventional investments, once a client’s money has entered the crypto ecosystem, there are limited rules to protect it.
It may not be possible to access the Financial Services Compensation Scheme, which provides compensation under certain circumstances if an authorised firm cannot pay claims against it, or the Financial Ombudsman Service, which settles complaints concerning authorised firms. If a company is not on the Financial Services Register of those firms authorised by the FCA, investors are likely to miss out on these statutory protections if the company goes out of business.
5. Should investors get legal advice?
Depending on the size of an investment, it may be worthwhile to retain a lawyer specialising in blockchain and cryptoassets to deal with the complexities and technicalities of investing in blockchain companies. From due diligence to contract negotiations to regulatory compliance, a blockchain legal professional can help avoid legal pitfalls and navigate the evolving regulatory landscape for any virgin crypto investors.
