Crypto roulette
Like other jurisdictions, the UK is grappling with the issue of DeFi regulation. Existing and prospective legislation place cryptoasset activities within the domain of the Financial Conduct Authority (FCA) and related regulators and therefore in the same regulatory category as traditional financial services. However, other voices press for investment in crypto to be seen as no more predictable than a game of chance and to be regulated as gambling.
The House of Commons Treasury Committee has taken a crypto-sceptical stance in its latest report on regulating the cryptoasset industry. The Committee considers that ‘unbacked cryptoassets’ such as Bitcoin and Ether have ‘no intrinsic value’, and ‘consumer speculation in unbacked cryptoassets more closely resembles gambling than it does a financial service’. It ‘strongly recommend[s] that the Government regulates retail trading and investment activity in unbacked cryptoassets as gambling rather than as a financial service’.
Some of the evidence received by the Committee took a more absolute position. Charles Randell, former Chairman of the Financial Conduct Authority (FCA), said: ‘The social purpose of regulated financial markets is to facilitate economic growth by enabling people’s savings to be channelled to productive business ventures. The issue and trading of speculative cryptoassets serves no such social purpose.’
Later, his evidence continues, ‘Speculative crypto is gambling pure and simple. It should be regulated and taxed as such, with levies to support the debt advice and addiction services for which it will fuel demand. If the issue and trading of speculative crypto are instead treated as financial services, conferring the ‘halo’ of financial services regulation, then increased consumer loss and calls for compensation provided by taxpayers or financial services levy payers will inevitably follow.’
Criticisms of this kind have, of course, been made before and are becoming increasingly prevalent as commentators continue to reflect on recent events, which have been the most damaging yet to the cryptoasset industry’s reputation.
However, the question addressed by the Treasury Committee (investment v gamble) is particularly pertinent as cryptoassets enter their ‘regulated age’ in the UK and elsewhere. It concerns not only what the regulatory rules should be, but which regulator should have oversight. There is no question that being painted with the same brush as gambling would limit the expansion of crypto and investment in the digital economy.
It is surely going too far to say that trading in unbacked cryptoassets is gambling ‘pure and simple’. While features such as 24/7 trading and the promise of rapid returns should not be overlooked, cryptoasset trading is not a purely chance-based enterprise. Identifiable factors exist which may inform the speculator about their future value. The rules that govern blockchain properties and procedures vary by cryptocurrency type and this in turn can influence future uptake. Their value is also driven by market sentiment which, though expressed and developed through different channels (for example, social media) to those of traditional financial instruments, is also capable of being analysed.
A further element shifts the dial. Unlike in the vast majority of gambling activities, the speculator decides when to cash in his or her cryptoassets, and there are wide and varied examples of cryptoassets increasing in value in the long term. It is difficult to see how these interactions can be characterised as anything less than ‘investments’, even if many are quite possibly high-risk in nature.
A related (but not determinative) question is whether unbacked cryptoassets have ‘intrinsic value’. Even setting aside the problems with the concept of intrinsic value, the claim that unbacked cryptoassets have no such value may at least need to be qualified in light of such assets’ characteristics. Unbacked cryptoassets are said to offer fungible representations of value in a trustless, swift and pseudonymous payment system. To the extent that this is true, these characteristics offer value. These characteristics may be novel in comparison to those of assets thought traditionally to have intrinsic value (such as fiat currency, stocks and commodities), but it does not follow that their value is non-existent or not ‘intrinsic’.
Randell’s evidence also suggests that cryptoassets are not connected to “the real economy”, equating “speculative crypto” with spread betting. There are two reasons why this may not be the case. First, cryptoasset value is, of course, connected to the cryptoasset industry itself. Even in the dead of the “crypto winter”, it is increasingly difficult to maintain that none of it is part of the “real economy”. Secondly, cryptoasset value is also influenced by the traditional economy. TradFi’s provision of ancillary services (relating for example to payments, custody and market-making) is increasingly important to the crypto sector, and cryptoassets have lost value in the past when such services have been compromised. The performance of traditional financial instruments affects demand for cryptoassets; for example, investors (including DeFi devotees, such as DAOs) retreated from crypto positions in autumn last year when short-term US Treasury Bills were achieving better yields. The cost and supply of energy and computer hardware exerts a critical influence on cryptoasset mining, which in turn has potential to affect cryptoassets’ value.
Whether cryptoasset trading serves a ‘social purpose’ is unlikely to be a useful consideration. One may also ask whether it is part of Randell’s argument that the gambling industry serves no social purpose, and if so, on what basis it remains regulated and maintained.
In any case, the claim that the cryptoasset industry has no “productive business ventures” is a bold one. At the very least, even unbacked cryptoassets offer appreciable advantages as means of payment and financing. The cryptoasset industry also contributes to the development of blockchain technology more broadly, which has applications in further contexts, such as healthcare, media and logistics. In its report, the Treasury Committee recognises cryptoassets’ potential in the payment systems and finance space. While it observes that the extent of this potential “remains unclear”, this observation relates to its valid criticism of overstated government rhetoric about the technology’s promise.
By contrast, one of the most important factors in the shaping of the regulatory system is the associated risk. Randell clearly appreciated this, having been responsible for the conversion of the FCA into a data-led regulator, using big data to drive regulatory decisions. Similarly, with the regulation of crypto, it is clear that the extent and form of the headline must be thoroughly understood and monitored. This includes a strong data-driven understanding of consumer and firm behaviour. While the Treasury Committee referred to data about consumer behaviour in reaching its conclusion on the ‘investment v gamble’ issue, it is unclear whether its evidence base was sufficiently comprehensive.
One additional risk to consider is whether the application of financial services regulation (as opposed to gambling regulation) would in itself confer undue legitimacy upon cryptoasset products. This risk was cited by the Treasury Committee as support for its position. It bears note that, conversely, overly stringent financial services regulation could also have adverse effects on cryptoasset trading, delegitimising it in similar ways to the ‘gambling’ label. Whatever form of regulation is ultimately deployed, care should be taken to strike a balance between addressing regulatory risks and avoiding undue restrictions.
The government announced on 1 February that it will ‘seek to regulate cryptoasset activities, consistent with its approach to traditional finance’. Although any government response to the Treasury Committee’s report will be keenly awaited, financial services regulation is set, as matters stand, to be the regime that deals with cryptoasset trading in the UK (and in jurisdictions across the world). It is to be hoped that the FCA is led by an analytical approach that is not unduly crypto-sceptical.