Dispute Resolution

Asim Arshad
September 2023

In the age of the Digital Revolution, terms such as ‘cryptoassets’, ‘cryptocurrency’, ‘tokens’, and ‘blockchain’ have become increasingly common in everyday conversations, as well as in financial, technological, and legal discourse. Despite their growing presence, adoption and relevance, misconceptions and ambiguity continue to surround this novel asset class.

Perhaps these misconceptions and ambiguity can be explained by the nuances in the terminology, which often amalgamate traditional financial and technological terms.

The terms ‘cryptoassets’, ‘cryptocurrency’, and ‘cryptotokens’ are often used interchangeably, yet each has its own specific implications and considerations.

Whilst ‘cryptocurrency’ is perhaps the most commonly recognised catch-all term for this group of assets, it is somewhat of a misnomer as they do not possess all of the properties of a traditional currency (also called ‘fiat currency).

Fiat currencies are typically used as a medium of exchange for goods and services. They can also be used as a store of value and as a unit of account. They are most often issued by central banks or monetary authorities.

In contrast, cryptocurrencies are not yet widely accepted as a medium of exchange, and their inherent volatility makes them unsuitable as a unit of account. Cryptocurrencies are said to be ‘decentralised’ as they are not issued by or subject to governments, central banks or monetary authorities. However, a point should be made to contrast this with Central Bank Digital Currencies (CBDC’s), which are digital forms of fiat currency issued by central banks, and are often mentioned in the same discourse as cryptocurrencies.

For these reasons, the term ‘cryptoassets’ is a more accurate catch-all term that we choose to adopt.

What are Cryptoassets?

Essentially, they are digital assets that use cryptography for security, and utilise a form of distributed ledger technology, such as a blockchain, to record and store transactions. The wide definition of ‘cryptoasset’ adopted in the UK also encompasses cryptoassets such as NFT’s.

Blockchain is the underlying technology that enables the secure and decentralised functioning of cryptoassets. A blockchain is a type of digital ledger that is distributed across a network of computers known as nodes, where no one single entity has control of the data.

Each block contains a list of transactions which are cryptographically linked to the previous block, which functions to create a secure and immutable record of transactions.

The decentralisation aspect of cryptoassets is one of their most appealing design features. It means that they are not subject to governmental or monetary policy interference, nor are they susceptible to any single point of failure, and it also enables a number of use cases for cryptoassets.

Popular and well-known cryptoassets include Bitcoin, Litecoin, Ether, and Cardano, although there are now tens of thousands of cryptoassets in existence.

Treatment of Cryptoassets in the UK

As the adoption of cryptoassets continues to grow, they have presented novel and unique challenges to governments, monetary bodies, and international regulators. One of the main challenges in regulating cryptoassets is that they are global in nature and exist without borders. As such, different national regulators have taken inconsistent approaches towards their treatment of cryptoassets, and it is very much a sector that is in a near-constant state of regulatory and legislative flux.

Cryptoassets are not subject to any blanket prohibition or ban in the UK, in contrast to what has been seen in other parts of the world such as China. Rather, the UK government and regulators have openly recognised the substantial benefit and use cases of cryptoassets and blockchain technology, which has made the UK a ‘friendly’ jurisdiction for start-ups and established companies alike, looking to develop, create, implement, and explore this space.

Aside from an outright ban on the marketing, distribution or sale of crypto-derivative products to retain consumers, there are no specific prohibitions on the use, purchase or trading of cryptoassets in the UK.

The legal status of cryptoassets in the UK is that they are treated and viewed as property. While there is continuing academic and legal discussion on this classification, which does not neatly fit with cryptoassets, the view that cryptoassets constitute property has been accepted several times by the High Court. This has provided much-needed legal clarity as to the status of cryptoassets, and how they are to be treated under existing laws and frameworks. This approach by the High Court has meant that England and Wales have emerged as a favourable forum for resolving cryptoassets disputes, as the legal clarity provided allows for the application for well-established laws to this emerging asset class.

Are Cryptoassets Regulated in the UK?

The UK has positioned itself as a key participant in shaping the regulatory landscape for cryptoassets, with bodies such as the Financial Conduct Authority (FCA) taking steps to define and further classify cryptoassets.

Broadly speaking, the current FCA regulatory regime refers to cryptoassets by way of a token taxonomy, which then dictate whether a cryptoasset is regulated or unregulated.

Security tokens and e-money tokens are regulated by the FCA, whereas exchange tokens and utility tokens are considered unregulated tokens.

  • Security Tokens: These are cryptoassets with characteristics causing them to meet the definition of a Specified Investment as set out in the Financial Services and Markets Act 2000 (Regulated Activities) Order 2001. An example of a security token is a cryptoasset that represents shares in a company or functions as a debt instrument.

A security token essentially grants the holder financial rights, akin to a share or a bond, and cryptoassets which exhibit characteristics and functions of a security token would be regulated.

  • E-money tokens: These are cryptoassets which meet the definition of e-money and are subject to the Electronic Money Regulations 2011, and fall within the scope of regulation.
  • Utility Tokens: These are cryptoassets which essentially act as digital coupons for the service, application or ecosystem they are associated with. They do not confer ownership rights (unlike security tokens) and nor do they represent an investment in the issuer. They are often used as a means of exchange for goods or services, or to acquire access to a particular service or application. Utility tokens are unregulated – examples include Basic Attention Token (BAT), Filecoin (FIL), and Axie Infinity (AXS).
  • Exchange Tokens: These include cryptoassets that are used in a similar way to traditional fiat currency as a means of exchange, although they do not meet the criteria to be considered a currency. Similar to Utility tokens, they do not grant the holder any ownership rights or rights associated with specified investments. They are often held as speculative investments, as well as a means of exchange. Exchange tokens are unregulated, and examples include Bitcoin (BTC) and Ether (ETH).

The FCA takes a substance over form view in relation to cryptoassets. In other words, if a cryptoasset has the substance of a traditional financial instrument, regardless of whether it is in digital form, it will fall under the FCA’s regulatory ambit.

Cryptoassets lacking the characteristics of a traditional financial instrument, including those like Bitcoin, Ether, and other various utility and exchange tokens, are not currently regulated. It is also prudent to note that even if a cryptoasset is unregulated by the FCA, certain activities relating to or involving those cryptoassets may trigger other regulatory regimes.

The prevailing sentiment appears to be indicating increasing regulation and oversight into the crypto sector, driven by concerns in relation to consumer protection, stability of the financial markets, and various financial scandals that have happened within the crypto sector in recent years. There is an ongoing consultation which proposes to bring cryptoassets within the scope of existing legislation by considering them as a specified investment under the Financial Services and Markets Act (Regulated Activities) Order 2001. The consultation process remains underway, and its outcomes will significantly influence the future regulatory framework for cryptoassets.

Conclusion

The landscape of cryptoassets and their regulation is complex, rapidly evolving, and varies across jurisdictions. The implications for individual investors and cryptoasset enterprises are substantial. The complexities of cryptoassets covered in this article only scratch the surface, and it is essential to seek out expert advice in order to ensure that guidance is tailored to one’s situation.