Crypto View - Spring/Summer 2024

It’s been a while, and you have no doubt missed us, but Crypto View is back! It’s been a busy few months, both for us and in the crypto space, and so there are plenty of crypto-related legislative and regulatory developments to catch up on.

Since March, we have arguably seen increasing institutional acceptance of digital assets – following the US’s move to approve Bitcoin ETFs earlier in the year, we have now seen spot Bitcoin and Ethereum ETFs launched in Hong Kong, the first crypto-linked ETNs listed in the UK and the Securities and Exchange Commission (SEC) giving its approval for the eventual listing of Ethereum ETFs in the US. There has also been a slew of consultations published and concluded in the EU (for MiCA) and in the UK – we take a look at some of these below.

We also take a look at some regulatory enforcement and court cases that will impact the sector, including the eviscerating judgment handed down by Judge Mellor in the High Court on whether Dr Craig Wright really is Satoshi Nakamoto, the creator of Bitcoin, (spoiler: he is not). We also saw the sentencing and four month imprisonment of one of crypto’s most well-known and influential figures, Binance co-founder Changpeng Zhao. In the UK, the FCA continued its enforcement efforts and strengthened its rules surrounding financial promotions on social media.

Structured Products

Tokenisation of Funds

In March, the Technology Working Group of the Asset Management Taskforce published its second report, "Further Fund Tokenisation: Achieving Investment Fund 3.0 Through Collaboration." This report builds on its initial blueprint and paints a picture of a transformed UK funds industry through the adoption of Distributed Ledger Technology (DLT) and tokenisation. The group suggests a future where investment funds operate on a tokenised register, potentially revolutionising how assets are managed and owned. It is clear from discussions we are seeing that there is a growing interest in this area.

A key takeaway from the report is the potential use of digital money for settlements, pointing to an integrated digital financial ecosystem. It also discusses the innovative use of tokenised money market fund units as collateral where eligible under the UK regime for non-centrally cleared derivative contracts, highlighting the broader financial impact of tokenised assets on liquidity and collateral management. This highlights potential synergies between traditional financial services and the evolving blockchain ecosystem. The investment industry is encouraged to utilise both the content of the findings so far and collaborative working to further its innovation journey in fully achieving the aims of Investment Fund 3.0 for the benefit of investors and the UK. The Group will now focus on phase three and the impact of AI on the industry.

If you have any questions on fund tokenisation, please reach out to my colleagues Catherine Weeks or John Dooley.

First UK ETNs list

May and June saw the listing of some of the first crypto-backed exchange-traded notes (ETNs) in the United Kingdom. Following on from the FCA’s decision in March, the likes of WisdomTree, 21Shares, and Global X launched a variety of ETNs tracking Bitcoin and Ethereum. However, in contrast to a number of major European markets, the UK will still bar retail investors from purchasing crypto-related ETNs. It isn’t clear how long the regulator will be able to maintain the position that retail investors should be able to purchase Bitcoin, but not a regulated product that gives exposure to Bitcoin. Interestingly, ESMA published a consultation on extending the eligible assets for UCITS funds to include cryptoassets. This doesn’t seem like something the UK would be following. Our team have extensive expertise in cryptoasset structured products, and advised 21Shares on their ETN listing. Please do get in touch with Paul Browne and Oli Ward if you would like to discuss this area at all.

SEC approves first spot Ethereum ETFs

On the other side of the Atlantic, the SEC approved spot Ethereum ETF applications from eight asset managers for the first time. Although this represents a substantial development, the ETFs will not start trading on US exchanges until the SEC approves their S-1 registration statements. Speaking before the Senate Banking Committee in June, SEC Chair Gary Gensler indicated that such approval could take place as quickly as summer 2024. While the Bitcoin ETF launches led to price spikes in BTC, it is thought that there will not be similar spikes in ETH as a result of any ETH ETF listings. We will wait and see.

Muted enthusiasm for Hong Kong crypto-ETFs

Hong Kong also joined the rush to allow Bitcoin and Ethereum ETFs. However, enthusiasm for these products proved to be muted especially in comparison with the US. Instead of the $100m trading volume expected, the six ETFs launched in Hong Kong garnered only $11m. This contrasted significantly with the $655m worth of first-day volume enjoyed when almost a dozen Bitcoin ETFs started trading in the US on January 11.

FCA’s ‘Name and Shame’ Game Sparks Debate

We hosted a webinar on 25 March, featuring Therese Chambers, the FCA’s Joint Executive Director of Enforcement and Market Oversight to discuss the FCA’s proposed new approach to publicising enforcement investigations outlined in CP24/2.

The key point of the consultation is a proposal to “name and shame” firms that are being investigated, with one justification being that there is greater political and public scrutiny of the FCA than in the past. Whilst we note the need for transparency, in our view, the potential benefit of this policy and the burden it would impose on firms is neither defensible nor proportionate. Reports suggest that the FCA ends up not enforcing against more than 60% of the firms it investigates, so publishing names on this basis seems to go beyond what is reasonable. Further, having seen the approach the FCA has sometimes taken to regulating the crypto industry, there is clearly a concern that the FCA would look to use these powers in relation to the industry.

If you wish to watch this session on demand, please click the button below.

FCA’s Consultation Paper CP24/2 - discussion with Therese Chambers, or speak to Emma Sutcliffe or Tom Makin.

BoE and FCA’s Digital Securities Sandbox

The consultation period for the FCA and BoE’s DSS closed at the end of May. The DSS regime will grant companies access to emerging technologies, such as distributed ledger technology, in the issuance, trading, and settlement of securities. The sandbox hopes to promote innovation in the financial system, while protecting financial stability and market integrity.

We worked with UK Finance, a trade association for the UK banking and financial services sector, on its response to the Sandbox’s consultation. It praised the BoE and FCA’s “commitment to innovation” and supported the intention to make the DSS “emblematic of the UK’s leading global position in financial markets.”

Specifically in regard to cryptoassets, which are excluded from the scope of the sandbox, UK Finance asked for the DSS to take a more holistic and relaxed approach to the use of permissionless blockchain systems. It also warned that the attractiveness and commercial viability of the DSS market infrastructure could be damaged if participants dealing in digital assets are subject to punitive capital requirements.

The DSS did receive praise from one of the most pro-crypto regulators in the US. SEC Commissioner Hester Peirce wrote that the project will generate real-world insights about the possibilities afforded by DLT. Peirce even proposed the creation of a cross-border sandbox to increase collaboration between the US and the United Kingdom.

The FCA and BoE will respond to feedback from the consultation period in the Summer. The first cohort of DSS applicants will become participants in the Autumn.

The Meme Police? FCA Steps up Financial Promotion Efforts

FinProms on Social Media

In March, the FCA published its long-awaited Finalised Guidance for Financial Promotions on Social Media – following the original consultation published in July last year. This recognised the increasingly important role that social media now plays in the marketing and communication strategies of firms – and perhaps crypto firms most of all.

The FCA has regularly emphasised that poorly designed financial promotions communicated over social media can cause substantial consumer harm because of their wide reach and the potential complexity of the products and services in question.

There are no real deviations from the initial consultation, but key takeaways from the guidance include:

• Clarification that the rules for financial promotions apply to all media, including social media. Any communication, even on private channels like Discord and Telegram or public forums like Reddit, can be considered a financial promotion if it invites or encourages investment activity. This includes posts by unauthorised 'finfluencers' and even memes, which are especially common in the cryptoasset sector.
• Each communication must individually adhere to the FCA's rules, ensuring that it is fair, clear, and not misleading. Advertisements must present a balanced view of risks and benefits and include the necessary risk warnings to help consumers make informed financial decisions.
• Firms are expected to proactively ensure that their affiliates, who help communicate financial promotions, comply with regulations. This means having effective monitoring and oversight systems in place.
• Influencers who are not authorised by the FCA and promote regulated financial products or services without approval may be committing a criminal offence. Influencers must also comply with the Advertising Standards Authority's (ASA) guidelines, which require them to clearly label promotional content as an advertisement, especially when receiving any form of payment.

As several respondents to the initial consultation pointed out, social media platforms continue to evolve rapidly, but this guidance does seek to be relatively tech and platform neutral. One important point is the confirmation that having a UK specific handle for a firm’s social media will help mitigate the impact of having global handles.

As if to emphasise the point, and maybe to show they have bite as well as bark, the FCA brought charges against nine individuals in relation to an unauthorised forex trading scheme promoted through social media. The ‘finfluencers’ had a combined Instagram following of 4.5 million followers and are set for trial in July.

FinProms and UK’s Future Authorisation Regime

In April, Simmons met with the FCA. The regulator emphasised the importance of compliance with the Financial Promotions Rules for Cryptoassets. The FCA also stressed that adherence to this regime will be a significant factor in their assessment process of the UK’s future cryptoasset regulatory regime. The FCA has emphasised that firms seeking authorisation must demonstrate a clear understanding of the crypto financial promotions regime and show evidence of compliance. Given the importance that the regulator has given this matter, firms operating in this space should therefore prioritise their understanding and adherence to the FCA's rules and guidelines to ensure they are well-positioned for the future authorisation regime in the UK.

Please let us know if you have any questions on this.

FCA targets Illegal Crypto Exchange

Earlier this month, the Metropolitan Police, in conjunction with the FCA, arrested two individuals on suspicion of running an illegal cryptoasset exchange. The press release suggested that over £1bn of unregistered cryptoassets (note: there is no register of cryptoassets) are thought to have been bought and sold through the business. At this time, the name of the exchange and the identities of those arrested have not been disclosed.

Singapore Payment Services Act Gets a Facelift

A $1bn crypto-related money laundering scandal in Singapore in 2023 prompted the amendment of the country’s Payment Services Act 2021. The Monetary Authority of Singapore (MAS) started to enforce the amended act and accompanying Regulations and Notices on 4 April.
Here are the key highlights you need to know:

• New Regulated Activities: Activities including custodial services for digital payment tokens (DPT), facilitation of DPT transactions with no possession of funds, and cross-border money transfers even where money is not accepted/received in Singapore will now come under regulatory purview.
• Transitional Measures: Entities must notify MAS within 30 days and apply for a license within 6 months from the commencement date.
• Enhanced Protection: From October 4, 2024, DPT service providers must segregate customer assets into trust accounts and bolster systems to safeguard asset integrity.

Not wanting to let its guard down, despite the new legislation, the MAS recently stated that digital and virtual payment token service providers operated in “a higher risk sector of note” and vowed to closely monitor the risks associated with the industry.

If you have any questions, please get in touch with my colleagues Yingyu Wang or Ashleigh Low.

From C-Suite to Cell Block – An Update on Prominent Crypto Court Cases

Changpeng Zhao Begins Prison Sentence

At the end of May, Binance founder Changpeng Zhao began his four-month sentence in a California low-security federal prison. The billionaire pled guilty to violating US laws against money laundering whilst at the helm of the prominent cryptocurrency exchange.

The sentence was shorter than the three years sought by prosecutors and substantially shorter than the 25-year sentence handed down to Zhao’s erstwhile rival Sam Bankman-Fried. Unlike the former FTX Chief, Zhao broadly co-operated with authorities.

COPA V Craig Wright Concludes

In May, a longstanding question that had become a feature of the crypto industry for over a decade was conclusively resolved. Judge Mellor of the UK Business & Property Courts published his written judgement. This included the resounding statement - Craig Wright is not Satoshi Nakamoto.
The Crypto Open Patent Alliance (COPA), which brough the action against the Australian computer scientist, wanted to confirm that:

(i) Dr Wright is not the pseudonymous creator of Bitcoin;
(ii) does not own copyright in the Bitcoin White Paper (the “White Paper”); and
(iii) COPA members’ use of the White Paper will not infringe any copyright (or other intellectual property rights) owned by Dr Wright.

Judge Mellor’s judgement, which followed a statement in March that Wright was not Satoshi, is likely to have significant legal ramifications. Not only will it allow the individual members of COPA to obtain injunctive relief against Dr Wright (preventing him from asserting authorship of the White Paper and/or commencing legal action against others on the basis of being Satoshi Nakamoto), but also Dr Wright’s positions in other proceedings are likely to be affected. These include actions against:

• Coinbase and Kraken, in which Dr Wright claims the exchanges are misusing the term “Bitcoin” and infringing his intellectual property rights;
• Coinbase and 26 other defendants, where Dr Wright is seeking to enforce database rights in the Bitcoin blockchain, as well as copyright in the Bitcoin file format and the White Paper; and
• a group of 12 Bitcoin developers, concerning alleged ownership of 111,000 BTC that Dr Wright lost following a hack in 2020.

For the crypto industry, a decision in Dr Wright’s favour had the potential to undermine the decentralised and open-source nature of Bitcoin. The decision should instead help volunteer programmers and developers to continue their work without the looming spectre of litigation. It also ensures that Bitcoin is not “gatekept” or restricted by an individual, which should facilitate innovation in the blockchain space.

Judge Mellor’s official judgement noted 47 instances of proven forgeries and described Wright’s attempts to prove that he was the creator of Bitcoin as “a most serious abuse” of the High Court’s process. He added that Dr Wright is “not nearly as clever as he thinks he is.”

This Quarter in MiCA

A Rush of MiCA Final Reports and Consultation Papers

Several final reports relating to the technical standards of MiCA have been published by the European Securities and Markets Authority (ESMA) in the last three months.

Final Report: Draft technical standards specifying requirements for cooperation, exchange of information - This report covers various topics related to crypto-asset service providers (CASPs). It included how financial entities should notify their intent to provide crypto-asset services, what information is necessary for the authorisation application as a CASP, how CASPs should handle complaints, and how to assess the acquisition of a significant stake in a CASP. Another key point involved ESMA’s reasonable method for requesting information from potential indirect acquirers of significant stakes, which was generally agree upon.

Final Report: Draft technical Standards specifying certain requirements of MiCA – first package - This report addressed the development of draft Regulatory Technical Standards (RTS) and Implementing Technical Standards (ITS) to facilitate efficient information exchange and cooperation between competent authorities, ESMA, and the European Banking Authority (EBA). The technical standards are built upon existing financial legislation precedents, aiming to streamline communication processes.

Consultation Paper: Draft technical standards and guidelines specifying certain requirements of MiCA on detection and prevention of market abuse, investor protection and operational resilience – third consultation paper - This consultation, which closed for comments on June 25, asked for input on official guidelines for policies and procedures, including the rights of clients, for crypto-asset transfer services per Article 82(2) MiCA. It also asked for advice on suitability requirements for certain crypto-asset services and the format of the periodic statement for portfolio management per Article 81(15) MiCA. Finally, it sought feedback on the maintenance of systems and security access protocols in conformity with appropriate EU standards and the detection and reporting of suspected market abuse in cryptoassets per Article 92(2) MiCA.

Final Report: specifying certain requirements relating to conflicts of interest for CASPs under MiCA - This clarifies aspects relating to the vertical integration of CASPs and updated requirements for conflict of interest identification, prevention, management and disclosure to be managed with consideration to the nature, scale and breadth of cryptoasset services provided.

EBA publishes regulatory products under MiCA.

In June, the EBA published its package of technical standards and guidelines under MiCA on several areas. The package included a Final Draft ITS on reporting obligations of CASPs and of issuers of asset-referenced tokens (ARTs) and electronic money tokens (EMTs). It also contained Final Drafts RTSs on the use of ARTs and EMTS as means of exchange and specifying the general conditions for the functioning of supervisory colleges. Finally, the package outlined guidelines for the parameters and risks to be considered in liquidity stress testing.

Regulators brace for MiCA implementation

As well as at an EU level, local regulators have also started making moves in relation to MiCA. The Dutch Authority for the Financial Markets (AFM), for instance, has updated its licence application form page for cryptoasset service providers. It now requires the completion of four forms, a declaration, and several suitability matrices, among other measures. With almost 9,000 words worth of questions stretching to 30 pages in length, the license application form for CASPs is certainly detailed. However, the AFM’s completion checklists that accompany its forms will help to ensure that all questions are answered fully.

The regulator advised applicants to focus on clear argumentation on how they comply with MiCA rules and to “include specific references (page numbers) to supporting documentation” to evidence their claim.

In Ireland, the CBI has updated its page on the Impact of Markets in Crypto Assets Regulation on Virtual Asset Services Providers in relation to the granting of any further VASP registrations in Ireland. In short, on the basis that it takes at least ten months to conclude the assessment of a VASP application, and that MiCA will apply in Ireland from 30 December 2024, any firm which is considering providing CASP services should focus its efforts on preparing for a CASP application rather than seeking a VASP registration. In addition the Central Bank has provided some clarifications on the commencement of MiCA:

• any applicant firm not registered and operating as a VASP by 30 December 2024 cannot avail of the MiCA transition period and will not be permitted to operate as a CASP until authorisation has been granted under MiCA;
• firms which are registered and operating as VASPs prior to 30 December 2024 will be permitted to avail of the transitional period, which will allow them to continue to operate for up to 12 months or until their CASP authorisation is granted or refused, whichever is sooner;
• a VASP availing of the transitional arrangements that does not apply for a CASP authorisation, or whose application is refused, will be required to cease VASP operations by 30 December 2025 or when their CASP application is refused, whichever is sooner; and
• the CASP authorisation assessment will be significantly broader and more substantial than a VASP registration, and therefore a VASP registration provides no indication of the outcome of a CASP assessment. In addition, a VASP registration will not lead to a simplified CASP assessment.

Finally, the CBI has stated that it will issue further communications regarding the authorisation and notification processes under MiCA in due course.
Our Irish team has been actively engaged with the Central Bank on these matters. For more information please contact Derek Lawlor.