Keyword: EU and Other Overseas Regulatory

European Crypto Regulation on the Verge of Enactment

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The EU’s Markets in Crypto-Assets (MiCA) regulations are now all but final and may take effect this year. MiCA will provide new regulatory frameworks, including licensing and disclosure obligations, for participants in the cryptocurrency ecosystem, including token issuers, financial intermediaries (exchanges, brokers, etc.) and custodians.

What Happened

The Economic and Monetary Affairs Committee of the European Parliament gave its approval to MiCA on October 10, 2022, the latest step in a process that has lasted more than two years.

What’s Next

This paves the way for the larger European Parliament plenary to approve the regulations, a step that often is merely procedural. Once the plenary approves MiCA, it will become effective and mark the beginning of 18 months in which firms must become compliant, with the regulations coming into full effect in the second or third quarter of 2024.

While the text of MiCA helps provide regulatory certainty for crypto-asset businesses and consumers in the EU, additional practical guidelines for implementation will also be drafted to further elaborate MiCA.

MiCA’s Goals

MiCA’s main objective is to provide a level of regulatory and economic harmonization to crypto-asset businesses and consumers across Europe. Guiding principles of MiCA include:

  • Providing legal certainty through clear definitions of crypto assets and activities in relation to those crypto assets that are in scope;
  • Providing for consumer protection and market integrity alongside financial stability of crypto-asset businesses; and
  • Encouraging innovation and fair competition in the European crypto-assets markets and avoiding regulatory arbitrage between member states.

Businesses engaged in activities that are within the scope of MiCA will, at a minimum, be required to register with the competent regulatory authorities and produce a detailed white paper for their business, in a form and content specified by MiCA.

MiCA will not apply in the United Kingdom or Switzerland as they are not member states of the European Union. While similar principles of regulation may apply in these two jurisdictions, separate analysis is needed to understand what crypto-asset businesses must do to achieve compliance with local regulation.

What MiCA Missed

The final text of MiCA omits treatment of Non-Fungible Tokens, Decentralised Finance, Decentralized Autonomous Organizations and Proof of Work consensus mechanisms. European regulators are expected, however, to treat fractionalized NFTs as utility tokens governed by MiCA.

How Will MiCA Impact the U.S. Market?

MiCA reflects the EU’s acknowledgement that digital assets are a persistent part of a modern financial system. Whether the EU’s steps to define and regulate digital assets will influence U.S. regulators remains to be seen.

The Biden Administration’s March 2022 Executive Order on Ensuring Responsible Development of Digital Assets remains the most comprehensive U.S. policy statement on the topic. While there are numerous proposed legislative efforts in the U.S. Congress, the U.S. has yet to produce comprehensive legislation or regulatory guidance. Instead, regulators have relied on enforcement actions and individual agency guidance to inform market participants. We expect the U.S. regulatory regime to continue, at least in the short term, to take coordinated but separate action aligned with the Executive Order’s primary objectives of protecting consumers and investors.

The Orrick fintech team takes an international approach to digital asset markets. We will continue to monitor regulatory developments in both the U.S. and Europe to support our clients and innovation in crypto.

English High Court Recognizes Cryptoassets to be a Form of Property: Considerations Following AA v Persons Unknown

On January 17, In AA v Persons Unknown [2019] EWHC 2556 (Comm), the Commercial Court held that a cryptoasset such as Bitcoin is a form of property capable of being the subject of a proprietary injunction. Although this is not the first case before the English courts that considers whether cryptoassets might be property, it is the most detailed and effectively confirms the position set out in the Legal Statement of the UK Jurisdictional Taskforce (UKJT) on cryptoassets and smart contracts from November 2019. The decision is likely to be a matter of importance in a variety of commercial contexts from taxation and sale of goods legislation to the taking of security and insolvency scenarios.

Cryptoassets as Property

In a co-authored piece published in Thomson Reuters’ Practical Law, Orrick’s Jacqui Hatfield and Rebecca Kellner recently considered whether cryptoassets can constitute property by analyzing the issue through the lens of taking security over cryptoassets. In it, the pair note that “security may only be taken over property, and the type of security that can be taken over a particular cryptoasset, and the process for doing so, will depend on the type of property that cryptoasset amounts to or represents. Therefore, in order to establish whether security may be taken over a cryptoasset, the type of property (if any) which that cryptoasset represents will need to be considered.”

To work out what type of property a cryptoasset represents, they suggest this would be looked at by the courts in the same manner with which the Financial Conduct Authority analyzes cryptoassets – by looking through the “crypto” label to consider what the token represents underneath. The court would effectively consider the underlying function of that token and the rights it confers on its owner.

The authors then set out the law as it stands as it applied to classifying cryptoassets as property:

“under English law, only (i) real property (land) and (ii) personal property (choses in possession (property that is possessed, i.e. goods or equipment) and choses in action (rights enforceable against a third party, e.g. money in a bank account or shares in a company)) are considered property.

“Cryptoassets are not real property, nor may they be physically possessed. Therefore, they can only be considered property to the extent they are choses in action. Cryptoassets that represent a right that may be enforced against a third party may be treated as choses in action and therefore, fall within the definition of property. Examples of such cryptoassets include the following:

  • Security tokens that represent shares or debentures.
  • Asset backed tokens that represent property.
  • Tokens that have been issued under terms which are enforceable against a third party.

“If a cryptoasset does not give the person holding those tokens any rights against a third party, it cannot be treated as falling within the definition of a chose in action. It would also not fall within the definition of real property, nor could it be possessed, so in this scenario, it is difficult to see how such a cryptoasset would amount to property under this strict definition of property, which enables security to be taken over it. Examples of these types of cryptoassets include the following:

  • Bitcoin, Ether and other cryptoassets that are fully decentralized and not issued by a central issuing authority. These give no rights to the holder which are enforceable against a third party.
  • Certain tokens issued by a central party for fundraising purposes (as in the case of initial coin offerings) that do not attach any claim against the issuer.” (emphasis added)

Despite the speed with which cryptoassets have infiltrated the financial system, the fact is that in England and Wales, what a cryptocurrency is in legal terms (a right, property or otherwise), owing largely to this somewhat anachronistic categorization of what constitutes property, remains unclear and unresolved.

In noting that there are already futures and exchange-traded notes in Bitcoin, Marc Jones of Stewarts Law LLP draws a comparison with conventional securities to highlight how the legal framework regarding what constitutes property in England and Wales is behind the curve when it comes to cryptoassets: “imagine a scenario where shares in a public company are regulated by a legal system in terms of how they can be promoted to the public; what information must be provided; to whom they can be promoted; in which jurisdictions, and so on. But the same legal system provides no answer as to how legal title in a share passes; whether and how security can be given over a share; what happens to a share in the event its owner becomes insolvent; whether a share can be trust property; and whether a share can be subject to a proprietary freezing order in the hands of an alleged fraudster.”

In November last year, the UKJT published its analysis of the status of cryptoassets and smart contracts under the law of England and Wales and concluded that cryptoassets are capable of being a form of property in law. It also determined that the novel features of cryptoassets (i.e. intangibility, distributed transaction ledger use, and decentralization) did not disqualify them from being property.

With regard to ownership, the legal statement declared that a person can acquire knowledge and control of a private key, and therefore become owner of the associated cryptoasset. This is considered to be the same as a person lawfully being in possession of a tangible asset and therefore being presumed to be the owner. In much the same way, a person can hold the key on behalf of another (e.g. an employer or client or on trust); and ownership can be shared through multiple keys. A person who unlawfully acquires a key through hacking is not the lawful owner, in the same way as someone who steals property is not the legal owner of that property.

The Legal Statement emphasized the ability of the English common law to adapt to new technologies and to rise to the challenge of applying existing law to new and unexpected situations. However, the Legal Statement is not legal advice, nor is it law. It is not a considered ruling from judges by way of case law, nor is it a legislative change. Therefore, while it provides (i) a potentially valuable analytical framework against which to understand the application of existing law and regulation and (ii) clarity in relation to the availability of existing legal remedies, the conclusions in the Legal Statement are not definitive and are subject to challenge.

AA v Persons Unknown

The case of AA v Persons Unknown concerned a private application for an injunction by a UK insurer. The UK insurer had insured on of its clients, itself an insurance company (albeit a Canadian one), against cyber crime attacks.

The client was the subject of an attack, where a hacker managed to encrypt all of the client’s computer systems and then subsequently sent a ransom request for payment in Bitcoin in exchange for the decryption tool. The insurer agreed to pay the ransom on behalf of the client. The insurer then hired a company to track the Bitcoin, which were placed on an account held by an exchange, Bitfinex. The insurer was seeking, among other things, a proprietary injunction in respect of Bitcoin held with Bitfinex.

Bryan J in AA v Persons Unknown noted that cryptoassets meet the four criteria set out in Lord Wilberforce’s classic definition of property in National Provincial Bank v Ainsworth [1965] 1 AC 1175 as being definable, identifiable by third parties, capable in their nature of assumption by third parties and having some degree of permanence.

The judge identified that traditionally, English law views property as being of only two kinds: choses in possession and choses in action, and that cryptoassets do not sit neatly within either category.

However, the judge considered that on a detailed analysis, it is “fallacious” to proceed on the basis that English property law does not recognize other forms of property. A cryptoasset might not be a chose in action on a narrow definition of the term, but that does not mean it cannot be treated as property. As a result, the Bitcoin (and by implication, other cryptoassets) were considered to be property and thus could be the subject of a proprietary injunction. Further, the judge noted his view that the Legal Statement was an accurate statement as to the position under English law.

Bryan J also noted that there are two English authorities where crypto currencies have been treated as property, albeit that those authorities do not consider the issue in depth. These are:

  • Vorotyntseva v Money-4 Ltd (T/A Nebus.com) and others [2018] EWHC 2596 (Ch), where there was no suggestion that crypto currency could not be a form of property, or that a party amenable to the court’s jurisdiction could not be enjoined from dealing in or disposing of it, and the High Court granted a freezing order against a company (and its directors) in respect of an amount of crypto currency which the claimant had given to the defendants. On the evidence before the court, there was a real risk of dissipation.
  • Robertson v Persons Unknown (unreported), 16 July 2019, (Commercial Court), where, following a theft of a number of Bitcoins, the judge accepted the argument that the Claimant had a proprietary claim over the Bitcoin and proceeded on the basis that Bitcoin could be personal property before making an asset preservation order in relation to Bitcoins which were stolen. By granting this order, the High Court treated the Bitcoin as property, which would allow for security to be taken over it. The Court also considered the UKJT analysis as ‘compelling’ in granting the order.

Implications

This is the first reported judicial consideration of the UKJT’s analysis of cryptoassets (otherwise a non-binding statement) and provides some further legal certainty over the classification of cryptoassets. Classifying cryptoassets as property has far-reaching implications that can have a real impact on how the asset can be dealt with. It enables (i) the law to recognize the legal rights of crypto currency investors, (ii) cryptoassets to sit more comfortably within the existing legal framework on property, which governs how they can be owned, used and transferred, as well as whether they can be charged and whether they would form part of insolvency/bankruptcy procedures, and (iii) courts to impose freezing and proprietary injunctions over them in cases of cyber attacks and theft.

It should be noted that the case considers the question of whether cryptoassets could be property only in the context of proprietary injunctions and therefore it is possible that alternative views could be reached in the context of other areas (e.g. corporate insolvency). Although this judgment is a helpful indication of how the law could apply in those circumstances, it would not be a binding precedent in matters beyond the context of proprietary injunctions. Nevertheless, the analysis relating to the definition of “property” did not solely rely on the definition of “property” in the context of injunctions but was drawn from broader sources, which may prove instructive for the application of this analysis in other contexts. Further, the alternative interpretation (i.e., that cryptoassets can never be property) could lead to unfair and unexpected results.

With the crypto currency market continuing to grow exponentially, this increased legal certainty will likely serve to shore up market confidence. However, while the judgment is a helpful confirmation that cryptoassets could be considered property, it remains to be seen whether the other conclusions of the Legal Statement of the UKJT will be confirmed in the English courts – e.g., the recognition of a valid granting of security over cryptoassets. In fact, the City of London Law Society’s submission to the UKJT suggests it prefers to wait for a dispute to work its way to the Supreme Court before the fundamental legal status of cryptoassets is clarified – an obviously unsatisfactory result for interested parties such as investors, insolvency practitioners and trustees.

As Sir Geoffrey Vos, Chancellor of the High Court, remarked in a speech at the University of Liverpool in May 2019, when considering why smart contracts had not become ubiquitous yet: “mainstream investors are unwilling to part with real money without the assurance that there is a legal foundation for their engagement. Thus far, the legal uncertainty that pervades the use of so-called crypto currencies and cryptoassets for financial transactions has meant that the starting line has not been crossed. It will be crossed at some stage soon.”

While the relative legal certainty offered by Bryan J in AA v Persons Unknown does not represent a crossing of the proverbial starting line for smart contracts and cryptoassets to become more mainstream in financial transactions envisaged by Sir Geoffrey, it does bring this moment one step closer.

HMRC’s New Approach to Cryptoassets – Tax First, Define Later

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The UK tax authority, Her Majesty’s Revenue & Customs (HMRC), has taken a further step towards tackling perceived tax avoidance in transactions involving cryptoassets. Specifically, according to press reports, exchanges such as eToro, Coinbase and CEX.IO have received letters from HMRC requesting customer and transaction data.

The move follows HMRC’s most recent policy paper, “Cryptoassets for Individuals,” published in December 2018, which in turn built on the brief general guidance published by HMRC four years earlier in 2014. The 2018 policy contains the statement that HMRC will apply the relevant income or capital gains tax provisions by looking at the factual details of each circumstance rather than by reference to terminology.

While the policy paper does distinguish between exchange tokens, utility tokens and security tokens, in practice we expect HMRC to focus on a transaction’s factual elements, rather than the description of the cryptoassets.

In contrast to HMRC’s approach, the UK financial regulator, the FCA, has recently revamped its classification of cryptoassets, clearly defining which ones among them would not fall within the scope of its regulatory regime, the Financial Services and Markets Act 2000. HMRC is yet to comment publicly on this development, but it is hoped that HMRC will follow suit and provide taxpayers with more certainty in determining their tax obligations in relation to cryptoassets.

Interestingly, on the other side of the Atlantic, the U.S. Internal Revenue Service (IRS) was also reported to have sent compliance letters to holders of cryptocurrency, warning them of the consequences of their potential non-compliance with relevant tax obligations. It is not clear whether the letters are limited to those taxpayers identified in the Coinbase Summons in 2016. The IRS believes that in 2017 up to $90 billon in cryptocurrency gains went unreported. On the Chain authors have written on the topic previously here, here and here.

While the IRS confirmed in 2014 that virtual currency ought to be treated as property for tax purposes, HMRC has, so far, used the word “property” only to describe cryptoassets for inheritance tax (IHT) purposes. Whether a similar approach will be taken for other UK taxes is yet to be confirmed and cannot be assumed.

The Financial Committee of the City of London Law Society published a paper that provided a potential framework for legal classification of cryptoassets. According to the Committee, exchange tokens could constitute a new category of personal property that is neither a “chose in possession” nor a “chose in action,” subject to the Supreme Court extending the notion of personal property to such assets.

In order to tap into the value generated by cryptoassets, HMRC’s approach has been to treat cryptoassets as property in relation to IHT and as “assets” in relation to other taxes. This approach is potentially quite unclear for taxpayers if we consider that, at the time of writing, there is no legislative basis (judicial or statutory) for the classification of cryptoassets as property. The fact that HMRC has recognized cryptoassets as property only in relation to IHT, and not for other UK taxes, adds to the uncertainty.

This uncertainty, coupled with the fact that most taxing legislation was drafted before digital assets even existed, means there is an urgent need for clarification on their legal status.

This is relevant to all value-generating actions involving cryptocurrencies, including the UK tax treatment of:

  1. options on tokens – will this mirror the taxation of options over shares?
  2. ICOs – will these be taxed in the same way as IPOs? and
  3. the transfer of tokenized shares – will these fall within the scope of stamp duty?

At the moment, there is no clear answer.

One thing does seem certain, however – blockchain is a harbinger of a new way of generating value and its potential will be fully leveraged only when the tax and legal frameworks around it have reached a serviceable level of cohesion. How and when this will be achieved is difficult to say.

The FCA Reclassifies Cryptoassets, But Is It Moving Away From Its Technology Neutral Approach?

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The Financial Conduct Authority (FCA) has released final guidance on cryptoassets in a policy statement that includes feedback from their January consultation paper. It is important to note that the policy statement is of a limited scope and focuses on whether different types of cryptoassets fall within the regulatory perimeter of the Financial Services and Markets Act 2000 (FSMA) and Electronic Money Regulations 2011 (EMRs). While the policy statement does touch upon the use of cryptoassets for payment services, prospectus requirements and anti-money laundering issues, it does not provide much new guidance on these areas.

In terms of whether cryptoassets fall within the regulatory perimeter, there is not much new or groundbreaking in the FCA’s approach – which is a good thing. The guidance closely follows the FCA’s views that it had set out in the consultation paper, and the FCA is aware that regulation outside its purview would require legislative changes. This being said, the guidance is useful in assisting token issuers and market players to classify whether the cryptoassets they deal with are subject to, or could potentially be subject to, the regulatory regime.

The guidance confirms that cryptoassets will fall within the regulatory regime, if they meet the definition of specified investments, under the FSMA (Regulated Activities) Order 2001 (RAO), the definition of transferable securities under the Markets in Financial Instruments Directive (MiFID) or the definition of e-money in the EMRs. The guidance notes that the most relevant specified investments for cryptoassets are:

  • Shares
  • Debt instruments
  • Warrants
  • Certificates representing certain securities
  • Rights and interests in investments

The guidance deviates from the consultation paper in classifying the different types of cryptoassets. The previous categories had been security tokens, which were regulated, and exchange tokens and utility tokens, which were unregulated unless they met the definition of e-money under the EMRs. The new categories are:

  • Security tokens
  • E-money tokens
  • Unregulated tokens

The definition of security tokens remains the same, that is, those tokens that meet the definition of specified investments under the RAO and fall within the regulatory perimeter. The previous categories of utility tokens and exchange tokens have been reclassified as e-money tokens, which are those tokens (either utility or exchange tokens) that meet the definition of e-money, and unregulated tokens which, as the name suggests, fall outside the regulatory sphere. This new approach is far clearer from a regulatory standpoint and acknowledges that utility and exchange tokens did not need to be classified separately when considering whether they were regulated.

Less obvious, and potentially more interesting, the policy statement also indicates a change from the FCA’s previous technology-neutral approach. This is not spelled out, and we suspect the FCA would still claim to be technology-neutral; however, the guidance notes that the use of particular technology may raise operational issues unique to that technology and the FCA will consider this as part of its ongoing regulation.

The policy statement also notes the transposition of the 5th Anti-Money Laundering Directive (5AMLD) into UK law by January 2020, although separate guidance on this will be issued. The policy statement confirms that the UK’s approach goes beyond that required by the 5AMLD with regards to cryptoassets, and the Government proposes to extend the Anti-Money Laundering regulations to all cryptoasset exchanges, cryptoasset transfers on behalf of another person and issuance of new cryptoassets, for example an ICO.

This shift towards a less technology-neutral approach is also shown in the FCA’s recent consultation on banning contracts for difference (CFDs) and CFD-like products that reference cryptoassets to retail investors. This consultation comes on the heels of the FCA imposing restrictions on the sale of all CFDs and CFD-like products to retail investors. We would argue, and suspect a technology-neutral approach to support, that CFDs and CFD-like products that reference cryptoassets should be treated in the same way as CFDs and CFD-like products that reference other assets. Given that the ban which is being consulted on only targets those products that reference cryptoassets, is it possible that the FCA is moving away from its technology-neutral approach and towards specific cryptoasset regulation?

FCA Proposes Guidance on Cryptoassets, but Questions Remain

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In January, the UK’s Financial Conduct Authority (FCA) released a consultation on potential guidance on cryptoassets that provides useful direction on how cryptoassets fall within the current regulatory regime. This consultation, one of the publications resulting from the Cryptoasset Taskforce’s October 2018 final report, does not drastically alter the current regulatory landscape, but rather provides clarity on the FCA’s current regulatory perimeter. The consultation also references a consultation by Her Majesty’s Treasury (HMT) that is expected in early 2019, which will explore legislative changes and potentially broaden the FCA’s regulatory remit on cryptoassets.

The FCA consultation on guidance asks for responses to the questions it poses by April 2019. The FCA does not intend to publish its final guidance until this summer; the guidance noted in this consultation paper is subject to change and should not be considered the FCA’s definitive position. However, subject to the feedback that is received, the consultation gives a good indication of the FCA’s thinking with regards to the regulation and classification of cryptoassets. Some of the points highlighted in the consultation are discussed below.

Exchange Tokens / Anti-Money Laundering

The FCA has confirmed that exchange tokens, such as Bitcoin, Litecoin or Ether, do not fall within the regulatory perimeter. This had already been expressed in the Cryptoasset Taskforce’s report, but it is useful to have it repeated here.

However, exchange tokens will be caught (along with other cryptoassets) by the 5th Anti-Money Laundering Directive (5AMLD), which will be transposed into UK law by the end of 2019. HMT will formally consult on this, but the FCA expects that 5AMLD will catch exchange between cryptoassets and fiat currencies or other cryptoassets, transfer of cryptoassets, safekeeping or administration of cryptoassets and provision of financial services related to an issuer’s offer and/or sale of cryptoassets. Being caught by the 5AMLD does not, by itself, mean the cryptoasset will be subject to FCA regulation.

Security Tokens

The FCA’s discussion on the classification of security tokens is arguably the most anticipated part of its guidance on cryptoassets. The discussion makes clear that cryptoassets that fall within the definition of a security will be treated as such. However, given that cryptoassets can provide a range of rights and other characteristics, it can be difficult to determine whether they do fall within such definition. While noting that it can be difficult to categorize tokens, the guidance describes the most relevant traditional forms of specified investments that security tokens may fall into. The guidance also notes that products that derive their value from or reference cryptoassets, such as options, futures, contracts for difference and exchange-traded notes, are likely to fall within the regulatory perimeter, even if the underlying cryptoasset does not.

The FCA states in its guidance that tokens that are issued in exchange for other cryptoassets, and not for fiat currency, will not necessarily be exempt from the regulatory regime if they are considered security tokens.

Issuing of one’s own security tokens does not require the issuing company to have a regulatory licence, in the same way that issuing one’s own shares does not require a licence. However, authorization must be obtained by any exchanges in which the tokens are traded, advisers and brokers, and the financial promotions regime will need to be complied with.

Shares / Debt instruments

According to the consultation, if a cryptoasset has the features of a share then it will be considered a specified investment and certain activities involving it will require authorization or exemption. In determining whether a cryptoasset is classed as a share, the FCA has noted that a separate legal personality, and a body which survives a change of member, are significant but not determinative factors in classifying the cryptoasset. Other factors include whether the cryptoasset provides voting rights, control, ownership, access to a dividend based on the performance of the company or rights to distribution of capital on liquidation. Interestingly, the FCA has noted that the definition is dependent on company and corporate law.

There is a trend for token offerings to be packaged as “security token offerings” and promoted in accordance with security requirements, as ICOs are no longer attractive to investors. However, many of these “security token offerings” do not give equity rights. Calling a token a “security token” will not change the nature of the token itself. The FCA has not been clear on this subject, but arguably a security token that does not meet the company law and corporate law definition of a share can be treated as a utility token and not require the trading platform, broker or advisers to be licensed.

A cryptoasset that represents money owed to the token holder will be considered a debt instrument, and therefore will be considered a security token.

If the cryptoasset is considered a share or debt instrument, and is capable of being traded on the capital market, it will be considered a transferable security under the Markets in Financial Instruments Directive (MiFID), and the MiFID regime will apply. As with traditional securities, this does not require the security to be listed. If the cryptoasset is able to be transferred from one person to another in such a way that the transferee will acquire good legal title, it is likely a transferable security. It is important to note that a cryptoasset may be considered a share under the UK law, but not a transferable security under MiFID.

Warrants, certificates representing certain securities and rights and interests in investments

Warrants may be issued as cryptoassets in situations where an issuing entity issues A tokens, which will provide the token holder the right to subscribe for B tokens at a later date. If the B tokens represent shares or debentures (or other specified investments), then the A tokens will be considered warrants and therefore specified investments. It is important to note that for the A tokens to be warrants, the B tokens will need to be new cryptoassets issued by the issuing entity. If the A tokens provide a right to purchase B tokens from a secondary market, the A tokens will not be considered warrants.

Similarly, A tokens that provide the token holder with a contractual or property right over other investments (either in cryptoasset or traditional form) will be considered certificates representing certain securities. Cryptoassets which represent a right to or interests in other specified investments are also classified as securities.

Units in collective investment schemes

Certain cryptoassets may be considered units in a collective investment scheme, notably tokens that allow investors to invest in assets such as art or property. Provided the investments in the cryptoassets are pooled, and the income or profits that the cryptoasset holders receive are also pooled, it will likely be considered a unit in a collective investment scheme. Importantly, if the token holders have day-to-day control of the management of the investment, it will fall outside this definition.

Utility Tokens

Tokens that represent rewards, such as reward-based crowdfunding, or the access to certain services, will be considered utility tokens. Utility tokens do not have the features of securities, and therefore fall outside the regulatory perimeter. The FCA has noted that the ability to trade utility tokens on the secondary market will not affect the classification of the token – even though this may mean individuals purchase these as investments.

Payment Services and Electronic Money

The guidance confirms that the use of cryptoassets is not covered by the payment services, unless the cryptoasset is considered electronic money. However, where cryptoassets act as a vehicle for money remittance (i.e. the transfer of money from one account to another, perhaps with a currency exchange) then the fiat sides of the exchange will be caught by the payment services regulations.

While cryptoassets do not fall within the payment services regime, they may fall within the e-money one. To the extent that the cryptoasset is issued on receipt of funds (i.e. fiat currency, not other cryptoassets) and the cryptoasset is accepted by a person other than the electronic money issuer, it may be considered electronic money (unless it is excluded). This would include cryptoassets that are issued on receipt of GBP and are pegged to that currency, as long as the cryptoasset is accepted by a third party. Therefore, stablecoins that meet the definitions set out above may fall within the definition of electronic money.

Issues Outstanding

None of the guidance’s declarations is new, but the guidance does provide useful clarification. What is not clear is how utility or payment tokens wrapped in a security token wrapper but not containing traditional security/equity rights will be treated. In our view, if the token is a utility token dressed in a security token wrapper, it should not necessarily be treated as a security, for UK regulatory purposes including requiring an authorized multilateral trading facility (MTF) to carry out secondary trading. The FCA says nothing here conflicting with this, but it would be useful to have clarity in this regard.

HMRC Publishes UK Tax Guidance on Cryptocurrency for Individuals

On December 19, HM Revenue and Customs (“HMRC”), the UK’s counterpart to the US Treasury, published long-awaited (and arguably long overdue) guidance on the taxation of cryptocurrencies (which it refers to as “cryptoassets”), building on the UK government’s Cryptoassets Taskforce’s report that was published last year. This guidance is welcome in an area of law that needs to play catch-up to apply to income and gains on technology and digital assets. It is important to note that this guidance is limited to HMRC’s view in relation to individuals holding cryptoassets and does not extend to tokens or assets held by businesses. However, HMRC states its intention to publish further guidance in relation to the taxation of cryptoasset transactions involving business and companies sometime in the future.

The guidance confirms that HMRC does not consider cryptoassets to be currency or money for tax purposes and separates cryptoassets into three categories of “tokens”: exchange tokens, utility tokens and security tokens. This guidance focuses on the taxation of “exchange tokens,” a term encompassing assets such as Bitcoin, which presumably it considers to be the most prevalent and widespread. The approach is very similar to the IRS’ approach in this area in Notice 2014-21. HMRC considers that in the “vast majority” of cases, individuals hold (and acquire and dispose of) cryptoassets as part of a personal investment and will, therefore, be liable to capital gains tax. The analysis of whether the cryptoassets are held in the nature of a trade or an investment, and the consequential tax treatment, will largely follow the existing approach and case law but HMRC only expects individuals to be buying and selling cryptoassets with such frequency, level of organization and sophistication such that it amounts to a financial trade in itself in “exceptional circumstances”. If, following the application of the traditional analysis, the cryptoassets are considered to be held as part of a trade, then the Income Tax provisions will take priority over the capital gains tax provisions.

Individuals will be liable to Income Tax (and national insurance contribution, where appropriate) on cryptoassets which they receive from their employer as a form of non-cash payment (and which may be collected via withholding tax) and/or in return for “mining” the cryptoassets, “transaction confirmations” or “airdrops” The guidance describes these transactions and the applicable taxes. As discussed in the guidance, miners are the people that verify additions to the blockchain ledger. They may receive either cryptocurrency or fees for this function. An airdrop is where someone receives an allocation of tokens or other cryptoassets, for example as part of a marketing or advertising campaign in which people are selected to receive them. As pointed out in the guidance, while the receipt of cryptoassets is often subject to the income tax, appreciation will be subject to capital gains tax upon disposition.

In addition to the tax analysis, HMRC points out that cryptoasset exchanges might only keep records of transactions for a short period, or the exchange might no longer be in existence when an individual completes their tax return. The onus is, therefore, on individuals to keep separate and sufficient records for each cryptoasset transaction for the purposes of their tax records.

Cryptoassets Taskforce: Cryptoasset Regulation May Be Coming

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The regulation of cryptoassets is a question that has been troubling lawmakers and regulators across the globe. This new phenomenon has had a small but significant effect on how financial services function and facilitate new opportunities, but that has also brought risks and regulatory challenges. Currently, cryptoassets (a term preferred over cryptocurrency by regulators) are not, in themselves, regulated. Some cryptoassets will fall within the regulatory regime by way of representing or acting as traditional securities or other regulated financial instruments.

In October, the Cryptoasset Taskforce published its long-awaited report. The report sets out an overview of cryptoassets and the underlying technology before assessing their current, and potential future, role in the financial system as well as the risks and potential benefits. The report concludes with recommendations and ‘next steps’.

By way of background, the Cryptoasset Taskforce was launched by the Chancellor of the Exchequer in March 2018 and is made up of representatives from the Financial Conduct Authority (FCA), HM Treasury and the Bank of England.

In general, the report found that particular risks would need to be dealt with, but provides few concrete regulatory recommendations, and tends to focus on consultation, clarification of existing regulation and increasing awareness of the risks. It is important to note that this is not necessarily a bad thing and the overall message appears to be positive, particularly for those thinking about issuing cryptoassets (for example by way of an initial coin offering (ICO)). The Cryptoasset Taskforce seems less nervous of cryptoassets than other bodies, particularly the UK’s Treasury Committee (see our take on the UK’s Treasury Committee’s report here).

The report divides recommendations into distinct areas, explaining where regulatory action should be taken and where a ‘wait and see’ approach is more suitable.

Preventing financial crime

This is one of the few areas where action will be, and has been, taken. The concern over the use of cryptoassets for financial crime and in particular the transfer of criminal proceeds is often the cornerstone to any discussion on cryptoasset regulation. The report acknowledges that the use of cryptoassets for criminal activity is low, although increasing.

The Fifth Anti-Money Laundering Directive (5MLD) will require firms to bring certain activities relating to cryptocurrency within the scope of anti-money laundering regulation, for example fiat-to-crypto exchange firms. However, the UK government plans to go further and will consult on proposed actions in early 2019. Part of this consultation will be whether firms based outside the UK will be required to comply with AML obligations when providing services to UK consumers.

Regulating financial instruments that reference cryptoassets

From 1 August 2018, there has been a restriction on the sale of contracts for difference (CFDs) that reference cryptoassets. This is part of a European effort, led by ESMA. The restriction, although renewed on 1 November 2018, is only temporary until the FCA implements a domestic solution. The FCA is expected to consult on derivatives referencing exchange tokens and whether there should be a prohibition on the sale of these to retail investors by the end of 2018. This prohibition would not include those derivatives that reference cryptoassets that qualify as securities.

The FCA has also stated that it will not authorize or approve the listing of a transferable security or a fund that references exchange tokens unless it is confident in the integrity of the underlying market and that the other regulatory criteria are met. The FCA also confirmed that it has not approved the listing of any exchange-traded products with exchange tokens as the underlying asset.

Clarifying the regulation of security tokens

Tokens which represent securities or that have the same features of securities (‘security tokens’), fall within current regulation. However, it is not always clear whether certain tokens fall into this category, and there is not much guidance on this.

The FCA will consult by the end of this year on new perimeter guidance on the way regulation applies to security tokens. This additional clarity will be useful for helping token issuers understand whether, and to what extent, the tokens they issue fall within the regulatory regime and what, if any, authorization or permission is needed. However, it is important to note that this will not extend the regime. Security tokens are currently caught by regulation while other tokens remain outside it; this will not change. The FCA consultation will relate to further guidance on how to identify whether tokens are security tokens.

Consulting on extending the regulatory perimeter for ICOs

While the guidance noted above will not affect the regulatory status of any tokens, the FCA will also consider whether there needs to be any changes to the regulatory perimeter when it comes to cryptoassets. Notably, the FCA is concerned about when tokens may be comparable to security tokens but structured in such a way that they are not security tokens and therefore unregulated.

A consultation in early 2019 will consider whether such cryptoassets exist and whether an extension of the regulatory regime is required.

Addressing the risks of exchange tokens

Early 2019 will see a consultation on whether and how exchange tokens should be regulated. These tokens do not currently fall within the regulatory perimeter. It is not clear whether the clarification of the current regulatory regime, and how it applies to cryptoassets, or the extension of the regulatory perimeter for tokens which act like security tokens, will be sufficient to allay the regulators’ fears.

Ensuring a coordinated international approach

The Cryptoasset Taskforce acknowledges that an international approach is essential to mitigate the risks for consumers. There is continuous conversations with different international organizations, and the report outlines that the UK intends to take a role advocating for international bodies to address these issues.

Improving consumer awareness

The report reiterates messages from regulatory and governmental bodies that consumers should be cautious when purchasing cryptoassets. The authorities will continue to improve public awareness of the risks of purchasing cryptoassets.

Maintaining financial stability

The Cryptoasset Taskforce does not currently believe that cryptoassets pose a material threat to financial stability, either in the UK or globally. However, it acknowledged that this is a developing and growing area and that risks could emerge. This will continue to be monitored by the Bank of England.

In a subsequent speech, Christopher Woolard, Executive Director of Strategy and Competition at the FCA, hoped that ‘if someone in 10 years’ time was to pause on the world in 2018, they would see our taskforce work as a further step along our journey of encouraging beneficial innovation to thrive in the UK, but in a context in which financial crime is combatted, market integrity is safeguarded and consumers are adequately protected from harm’.

The important point to note here is that the taskforce is a step in the journey. While the report infers that regulation is coming, it does not have any immediate effect on the regulatory sphere. Assuming consultations are released in late 2018/early 2019, one can expect that any formal regulation is still a way off. However, this is no bad thing. The Cryptoasset Taskforce’s insistence on an international approach is encouraging; inconsistent regulation across jurisdictions will be less effective for an instrument which, by its very nature, is borderless. Nevertheless, guidance on the current regulatory regime, and how it applies to cryptoassets, will be welcomed as soon as possible by issuers and those who work in this world.

Learn more from this Blockchain alert.

Recent Reports Show UK and EU (Slowly) Progressing Towards Virtual Currency Regulation

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Currently there is no EU-harmonized approach for the specific regulation of virtual currency. In September 2018, the UK’s Treasury Committee released a report on crypto-assets as a part of its ongoing Digital Currencies Inquiry, in which the Committee strongly and unanimously recommended that the UK regulate virtual currencies and initial coin offerings (“ICOs”) as a matter of priority. It will be important for the UK not to be too restrictive as this could drive innovative business away from the UK. The EU Parliament’s All-party Innovation Group has drafted a proposal examining potential new rules that would bring ICOs within the scope of the EU-wide harmonizing crowdfunding regulation that is currently being drafted. While it is certain that any regulation needs to be carefully considered, the lack of a harmonized approach to regulation of ICOs will lead, as is happening currently, to a piecemeal approach across member states that will hamper blockchain developments.

Learn more from this recent Orrick-authored alert.

Virtual Currencies Fall Within Scope of EU’s Fifth Anti-Money Laundering Directive

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The fifth iteration of the Anti-Money Laundering Directive (MLD5) took effect in July 2018. In addition to several updates covering a wide range of anti-money laundering objectives, MLD5 extends its coverage to include certain cryptocurrency service providers.

Learn more about the updates under MLD5, including further details regarding the inclusion of cryptocurrencies within the scope of EU anti-money laundering and terrorist financing regulations, in this recent alert.