14/09/2023 Alexander

Digital asset regulation and compliance in the UK

CEO Pawel Kuskowski is joined by Nick Andrews to talk about the UK landscape for digital assets.

Nick started his career in project finance for traditional banks and ended up running credit risk management functions in a commercial bank which then led him to the capital market side of the business running credit, legal and other risks apart from market risk. With this background, Nick became a compliance and money laundering reporting officer and subsequently founded a compliance regulatory consultancy firm. In early 2016, Nick and his friends started a crypto lending business at an institutional level which they found quite difficult to fund because of how large the project was so it didn’t launch. However, this showed Nick what the crypto risks were and eventually led him and another colleague to start a crypto proprietary trading company. According to Nick, there are quite a few parallels between traditional finance and crypto, it’s just a different pace.


Are there any jurisdictions better than the UK for cryptocurrency?

According to Nick, things are grindingly slow in the UK despite the government announcing that it wants to be the center for crypto. The reason is because the UK has always analyzed each step before taking the next one. With crypto being the fastest changing market in the modern world, it has become difficult for regulators and legislators to keep up-to-date with this matter.

The original requirement was the 5th Anti-Money Laundering Directive (5AMLD) or the Virtual Asset Service Provider (VASP) registration, similar to the registration system in the UK under the Payment Services Directive which was managed for Anti-Money Laundering purposes by His Majesty’s Revenue and Customs (HMRC). According to Nick, that was rather quick because all the firms that were registered had to be regulated for financial crimes and/or money laundering by the HMRC. However, the moment that the Financial Conduct Authority (FCA) became involved, registration became a very expensive and time consuming one size fits all authorisation process, making it extremely slow. The FCA has also been affected by the pandemic and their ability to not risk failure.

Nick believes that although it may be good to set up in London, it is very hard as the FCA puts the companies on a very long 12-18 month application waiting time. Therefore at this stage, it may be more convenient to set up in another jurisdiction like Switzerland. However, as the industry is changing and the category of participants are changing, jurisdiction will eventually become an important factor when the corporates and investors get involved.


Consumer protection and regulation

The Financial Services Compensation Scheme (FSCS) protects customers when authorized financial services firms fail. It is usually there for retail clients but not for professional clients. In the crypto space, we need to differentiate what falls into a regulated activity versus a derivative. The problem is that there is an expectation that anybody who touches a company will get compensation if something goes wrong just because the company is regulated by the FCA even if it doesn’t fall under the FSCS.

When the financial sector comes up with something innovative with greater rewards, it starts to have more risks. What is intended in the UK is to provide a greater return on customer investment, but as soon as there is a little bit of risk, it is discouraged to invest in these products. The risk has now moved offshore which doesn’t fall under the UK FSCS compensation scheme.


Who is your operator and where they are located?

For Binance, the ambiguity regarding where the operator is done on purpose. There is one engine at the end which is covering all different jurisdictions but the onboarding body could be in Switzerland, BVI, Korea, or Malta etc. It is not even sufficient to know where the entity is located because the entity could be different. That model is similar to what most CFD and retail operators have where the face is in the UK but the B-Book that they are transacting with is in a jurisdiction with crazy high risks because of high returns on capital.


How can this industry tackle these longstanding problems?

As usual, the good guys will do the good thing and display where they are and the bad guys will pay a better rate and will ultimately cause problems. So many people have fallen for scams that are not crypto but are just Ponzi schemes or Pyramid schemes. Therefore, one needs to understand who are the good guys and who are the bad guys. Those who are regulated and registered are good ones but the ones who have left the country because they chose not to be registered are more likely than not, bad.


Watch the whole discussion:


An element of gambling involved

Pawel says that from his 10 year experience in crypto, there is an element of gambling involved. While stablecoins may be a safe place in crypto, Tether/USDT are arguable. A recent banking closure in the USA for example led to the USDC devaluing by 10% in one day.

Stablecoins make sense in that they remove the friction out of how things are handled around the world as long as the good guys run it, but if this system is put into the wrong hands, it gives people control over other people. If someone has hands on your wallet, then they have the power to keep you quiet. There is also the bigger issue of global politics. The US Dollar (USD) is the reserve currency around the world and oil is valued in USD only. Imagine if oil starts to be valued in Renminbi, would that not reduce the influence of the US on the world? Does it mean that some of the parts or tools the government can use for sanctions are weakened?


What about Non Fungible Tokens (NFT) or property wrapped in NFTs?

NFTs are useful for the purpose of membership cards. For example, if Picasso’s painting was purchasable in NFTs, then one could have a share in that. It does not mean that one could have it on the wall, but one can have a share in it. Nick is a believer of digital assets such as tokenized real estate. However, the government needs to be careful in these areas as the problem with this is the abolishment of Stamp Duty Tax which will create a large hole in the UK economy. Eventually therefore, this sort of model will be skewered out by the government.


Why has property tokenisation not happened yet?

There are three main reasons why property tokenization has not yet happened in the UK:

  • Nearly everyone has a mortgage on their house so banks would not allow one to tokenize property 
  • No bank wants to be the first one trying it as a house would be a very expensive gamble for them to roll their dices for
  • Regulations and/or tax


Understanding crypto properly

The thing about crypto is that there are many great ideas that do solve a problem, but these ideas are rarely implemented. People need to understand that it is just a different representation of rights wrapped into crypto and it is already under proper licensing. The big public relations hurdle that needs to be overcome is to stop treating crypto as money laundering. They are entirely different aspects.