CryptoSprint outputs

Participants suggested applying a principles-based approach would help accommodate the pace of technology and market evolution. They also argued that technology neutrality was essential to avoid policymakers ‘picking winners’ in developing markets. Participants explained the many use cases for cryptoassets and that having a clear digital taxonomy (ideally internationally) would help in developing a regime for cryptoassets. Due to the digital nature of the taxonomy, it can be updated regularly, and would enable regulators to classify cryptoassets and apply relevant rules based on product types, relevant activities, and underlying technology. 

Participants emphasised the need to avoid ‘reinventing the wheel’ with new regulatory standards. They suggested that existing rules and tools should be used where possible, for example the Client Assets Sourcebook (CASS) rules around custody of assets or the Open Banking type model for transparency, rather than creating bespoke new standards. Participants also argued for a proportionate approach to regulating cryptoassets, balancing encouraging innovation with protecting consumers and markets.

Some participants suggested original solutions to the questions for example, using blockchain technology to assist with regulating cryptoassets. They argued that given the transparency of distributed ledger technology, regulators would have direct access to blockchains and transaction data which could assist in regulating the market.

Some participants also suggested that a self-regulatory organisation (SRO) could be used to provide greater clarity for firms, perhaps before formal regulation took effect. They thought this would allow issuers, firms, and protocols to adopt agreed standards, encouraging good practice where parties remain out of jurisdictional reach or have pseudo anonymity (where the user appears to be anonymous). 

Participants also suggested that regulators should prioritise key risks when developing any potential standards, and that regulation could be phased over time, with new rules implemented gradually to allow firms and consumers to adjust. 

What information should be provided to buyers of cryptoassets and how should cryptoassets be vetted before being traded on an exchange?

In traditional finance, there are various rules in place relating to issuance and disclosure and these rules are different for retail and institutional investors. When considering cryptoassets, there was a consensus from participants that a disclosure regime is needed to provide consumers and market participants with the information they need to assess risks and benefits. However, participants disagreed about the level of disclosure that would be most effective, and who could receive this. 
Examples of the types of disclosure suggested by the teams included:

• a white paper or a ‘plain language summary’ at the point of issue/creation 
• a document only containing objective information, e.g. circulating supply, project aim, token creation method 
• the inclusion of periodic material or subjective information to provide a fuller picture of risks. This could include risk warnings or volatility metrics. 

All these suggestions raised the question of who should be responsible for the compliance checks and ensuring accuracy of information. Many participants suggested an SRO.

Many participants also suggested that cryptoassets could be categorised, for example in reference to their level of risk, volatility or underlying technology used. They argued that disclosure requirements could then be tailored to the characteristics of each cryptoasset type and the consumers in question.

There was no clear consensus on whether the responsibility for providing information should fall on the issuer or exchange providers. Many favoured the issuers providing the information. However, in instances where there is no issuer, many thought the exchange should bear disclosure responsibility.

There was also no agreement on different disclosure requirements for retail and institutional investors, as some were keen to maintain the notion of ‘crypto is accessible to all’, whereas others noted the risks for retail customers and the benefit of having different rules.

How do we identify (and test) where regulatory obligations on centralised and decentralised cryptoasset models should be placed?

Regulatory obligations are traditionally placed on relevant persons according to the activities they conduct within the UK. Cryptoasset activities are often undertaken by persons with no obvious headquarters and often within decentralised systems. Therefore, it is important to consider where regulatory obligations should be placed to ensure regulators capture relevant activity that poses a risk to UK consumers and markets.

Participants agreed that fundamental differences between centralised finance (CeFi) and decentralised finance (DeFi) cryptoassets necessitate different regulatory and policy responses whilst seeking the same outcomes. Therefore, when determining where regulations should be placed, participants thought that an understanding of the level of decentralisation in a cryptoasset proposition is important. They noted there is a spectrum between these two categories, and that very few protocols and/or firms are fully decentralised currently.

Some participants proposed that risks associated with the governance of DeFi could be managed by focusing regulatory responsibility for mitigating risks on centralised on and off ramps like exchanges. On this view, parts of DeFi could be reconfigured, for example, giving decentralised autonomous organisations (DAOs) a UK legal status. Others suggested regulators could achieve similar outcomes using a principle-based approach alongside a clear taxonomy for digital assets. 

On the global nature of cryptoassets, many teams were concerned about the potential for regulatory arbitrage. Many participants suggested that this issue could be factored into regulation by creating a consistent global taxonomy and cross-border regulatory cooperation. They thought this would prevent a reduction in standards and encourage competition. However, there were significant differences of opinion on how to achieve this. Discussions highlighted the risk that an overly prescriptive taxonomy would soon be overtaken by changes in the market. In contrast, it was pointed out that excessive flexibility could be gamed by market participants or lead to unintended consequences. 

The sprints provided contrasting proposals on the use of existing regulation. Some participants argued that current standards could be adapted to account for how digital assets differ from traditional finance. They often suggested that this would provide a proportionate starting point, citing the important principle of ‘same risk, same regulatory outcome’. Other participants insisted that digital assets were unique and provided particular benefits and risks. As a result, they argued that a bespoke regime should be created.

A high number of participants wanted regulation to adopt a phased approach. Some participants suggested focusing on creating a regime to address the highest risks, and gradually extending this to other areas. Exchange providers were highlighted as the highest risk, due to the customer-facing nature. Others suggested having regulations at checkpoints e.g. custody, issuance and wallets.

However, some argued that DeFi should not be regulated due to the difficulty in regulating a decentralised entity and/or the philosophical ambitions behind its creation which are counter to central governance models. 

What gaps need to be addressed in the UK’s existing custody regulatory framework for custody of cryptoassets to help protect UK consumers and markets?

Whilst contributors identified gaps in applying the existing custody framework for cryptoassets, the key theme among the teams was that regulators should use existing regulation where possible, particularly the Client Assets Sourcebook (CASS) to build out a regulatory regime for custody of cryptoassets as a high priority. Many participants adopted and adapted CASS rules during their final presentations. 

The definition of ‘custody’ in this sector raised a particular challenge for many teams. Participants said that there was a wide range of business models, standards, and services among existing cryptoasset custodians, and that clear regulatory standards would help to create a uniform understanding of what custody of cryptoassets entails. 

Participants also highlighted the challenge of evidencing ownership of a cryptoasset in the case of a firm’s insolvency. They flagged that this is because, unlike traditional finance custody, there is no clear distinction between legal and beneficial ownership of a cryptoasset as these details are not recorded as such on the underlying distributed ledger technology and the pseudonymous nature of this technology means that an owner’s identity is not easily identifiable. Participants also noted that, in the event of a firm insolvency, investors’ rights are generally governed by contractual arrangements whereby they may be treated as unsecured creditors.

A further challenge was the bearer nature of the private key which provides access to the cryptoasset. Participants emphasised the need for custodians to apply robust operational and governance controls to help prevent loss and misuse of private keys. Participants also asked regulators to explore who should be liable for loss of private keys and assets. 

Finally, participants also highlighted the challenges with the global nature of cryptoassets and relationships between different jurisdictions in this problem statement. They noted that UK consumers may be serviced by a custodian based in another jurisdiction, and regulators should be ready to protect UK consumers from harm.