The Financial Conduct Authority (FCA), the institution responsible for financial services regulation and consumer protection in the UK, is currently consulting on cryptoassets. To help us understand this article in respect of the consultation, these two (2) key concepts, Cryptography and Distributed Ledger Technology (DLT), will be very helpful. In the view of The Economic Times, “Cryptography is associated with the process of converting ordinary plain text into [coded] text and vice-versa. It is a method of storing and transmitting data in a particular form, so that only those for whom it is intended can read and process it. Both the sender and receiver share a single key. The sender uses this key to encrypt plain text and send the coded text to the receiver. The receiver, on the other side, applies the same key to decrypt the message and recover the plain text”.
Distributed Ledger Technology (DLT), “makes it possible for a ledger (a record of anything of value) to be distributed among all those using it; putting the responsibility to maintain and validate it in the hands of those using it. The result is a decentralised system of data registry wherein transactions are instant, transparent, reliable and incorruptible”. We can therefore appreciate cryptoassets “as a cryptographically secured digital representation of value or contractual rights that is powered by forms of DLT (Distributed Ledger Technology) and can be stored, transferred or traded electronically”. Some of the examples of cryptoassets include Bitcoin and Litecoin.
Globally, the emergence of cryptoassets has attracted significant attention from many financial services regulators, governments and their people. There has been a growing divergence of opinions on the matter from different schools of thought. Regulators have therefore found the need to explore if they can define the parameters to contain them. In this regard, the Financial Conduct Authority (FCA) in January 2019 issued a 50-page consultation paper titled ‘Guidance on Cryptoassets’.
While acknowledging the usefulness of the Guidance to stakeholders in the UK, this article attempts to highlight some abstracts therein to shape public opinion in Ghana. The material is coming at a time when the Securities and Exchange Commission (Ghana) is reported to have started its own research into cryptocurrency-related activities in the country.
The Guidance intends to seek stakeholders’ opinions to enable the Financial Conduct Authority to provide regulatory clarity on cryptoassets. The Authority recognises that it is a technology-neutral regulator, and therefore the use of new technology alone does not alter how it should make judgements in relation to both regulated and unregulated activities.
“In particular, it looks at where cryptoassets would be considered ‘Specified Investments’ under the Regulated Activities Order (RAO); ‘Financial Instruments’ such as ‘Transferable Securities’ under the Markets in Financial Instruments Directive II (MiFID II); or captured under the Payment Services Regulations (PSRs), or the E-Money Regulations (EMRs).It also covers where cryptoassets would not be considered ‘Specified Investments’ under the Regulated Activities Order (RAO).”
It includes the following uses of Cryptoassets:
- As a means of exchange, usually functioning as a decentralised tool to enable the buying and selling of goods and services, or to facilitate regulated payment services.
- For investment, with firms and consumers gaining direct exposure by holding and trading cryptoassets, or indirect exposure by holding or trading financial instruments that reference cryptoassets.
- To support capital raising and/or the creation of decentralised networks through Initial Coin Offerings (ICOs) or other distribution mechanisms.
But these benefits do not come with the downsides. The Guidance clearly states that: “While cryptoassets can be used as a means of exchange, they are not considered to be a currency or money as both the Bank of England and the G20 Finance Ministers and Central Bank Governors have previously set out. They are too volatile to be a good store of value, they are not widely accepted as a means of exchange, and they are not used as a unit of account”.
Harm to consumers
Even though the Authority also identified the potential benefits such as increased speed and the possibility of reduction in the cost of cross-border money remittances, it has not lost sight of the potential harm to consumers.
- Cryptoassets pose a range of substantial risks to consumers, which stem from consumers purchasing unsuitable products without having access to adequate information. This can include fraudulent activity, as well as the immaturity or failings of the market infrastructure and services.
- Consumers may experience unexpected or large losses. While this is true of many types of investments, cryptoasset investors should be particularly aware of the volatility that many tokens experience, and the limited information available on how these tokens work. Consumers can overestimate their knowledge of cryptoassets and the underlying technology, with some believing that due to language such as ‘mining’ and ‘coins’, they are investing in tangible assets.
- The potential to misunderstand the nature of these assets can be compounded by poor practices in relation to advertising. Adverts often overstate benefits and rarely warn of volatility risks – the fact consumers can lose their investment, the absence of a secondary market for many offerings, and the lack of regulation. These often play on consumers’ aspirations for ‘easy money and wealth’ and ‘fear of missing out’. Often, social media plays a significant role in influencing consumers’ behaviour.
- Poor cyber security can also lead to hackers taking advantage of systems and stealing cryptoassets through cybercrime. Cryptoassets are now viewed as high-value targets for theft. Both users, and service providers like custodians/wallet providers and exchanges are increasingly being targetted by cybercriminals to obtain the private keys which enable consumers to access and transfer their cryptoassets.
Harm through financial crime
Cryptoassets can sometimes offer potential anonymity and the ability to move money between countries and individuals. This lack of transparency and regulatory oversight for certain cryptoassets means that there are risks from financial crime, including money laundering and the financing of terrorism.
Harm to market integrity
Market volatility and the lack of transparency and oversight may also heighten the potential risk of market manipulation and insider-dealing on exchanges and trading platforms. This can be further exacerbated by exchanges and trading platforms not having adequate systems and controls to protect against market manipulation and insider dealing.
In the wake of the benefits and the harms, the Financial Conduct Authority (FCA) is therefore consulting stakeholders for the following reasons (extenso).
- The FCA recognises that the cryptoasset market is developing quickly, and participants need to be clear on where they are conducting activities that fall within the scope of the FCA’s regulatory remit and for which they require authorisation. It may be a criminal offence to carry on regulated activities without the relevant authorisations.
- To support consumers to understand the cryptoasset market and implications for the types of protections they are afforded depending on the product.
- To help market participants to understand whether the cryptoassets they employ are within the regulatory perimeter. This will alert market participants to pertinent issues, and should help them better understand whether they need to be authorised and what rules or regulations apply to their business.
Based on the foregoing, the Authority identifies the following interested stakeholders to whom the consultation is relevant. These include firms issuing or creating cryptoassets, firms marketing cryptoasset products and services, firms buying or selling cryptoassets, and the firms holding or storing cryptoassets. Other stakeholders are professional advisers, investment managers, recognised investment exchanges, consumers and consumer organisations.
Stakeholders have up until 5 April 2019 to submit their inputs. The consultation process in the UK is welcome and gives us much insight. Though we are in a global village and need to learn from developments, our recent experiences in which people have fallen victim to predatory scammers should guide us to adopt a conservative inclination to cryptoassets. While recognising that sandbox provides an incubator for product development and innovation, we need to tread cautiously to prevent scammers from using the space as a conduit to exploit the innocent public. God Bless!
This script was written by a Chartered Banker with a flair for feature writing. Apart from his work schedules, he edits or proof-reads corporate material for his colleagues, executive managers – including distinguished professionals working in various fields outside Banking. Through this column, his articles feature on third-party online media platforms in Ghana and outside.