TerraLex Cross-Border Guide to Crypto Assets

There is currently no single definition in law. The UK Jurisdiction Taskforce on Crypto Assets (UKJT) established by the UK Government and comprising the Financial Conduct Authority (FCA), the Bank of England and HM Treasury, was tasked with preparing a legal statement on the status of crypto assets and smart contracts under English law, which may assist with establishing the likely position under Scots law. The UKJT has defined cryptoassets as "cryptographically secured digital representations of value or contractual rights that use [that is, are built on] some type of DLT [distributed ledger technology - this includes blockchain] and can be transferred, stored or traded electronically."

Scotland has no specific legislation governing crypto assets. It is generally considered that crypto assets are recognized as having legal status under the laws of Scotland, but there are potential questions in relation to what type of property they comprise. The Scottish Government has convened an Expert Reference Group to consider the status of digital assets under Scots law.

In respect of financial regulation, the term "cryptoasset" is not defined in the FCA Handbook but is adopted in the FCA Glossary definition of "unregulated transferable cryptoasset" which was introduced in the context of the ban on certain investment products referencing cryptoassets.

The Money Laundering, Terrorist Financing and Transfer of Funds (Information on the Payer) Regulations 2017 defines a crypto asset as a "cryptographically secured digital representation of value or contractual rights that uses a form of distributed ledger technology and can be transferred, stored or traded electronically."

Regulation of crypto assets is primarily led by the UK financial services regulator, the FCA. Firms carrying on a specified activity, by way of business in the UK, involving a crypto asset which is a specified investment may require FCA authorisation and the relevant permission. The types of investment which are regulated – known as specified investments - are set out in the Financial Services and Markets Act 2000 (Regulated Activities) Order 2001 (RAO). Specified investments include shares, debentures, and units in collective investment schemes.

Whether or not a crypto asset falls within the FCA's regulatory perimeter and is subject to financial regulation in the UK will turn on whether or not it falls within the definition of a specified investment in the RAO. As we discuss below, typically, crypto assets which fall within the FCA classifications of security tokens and e-money tokens will be subject to financial regulation in the UK.

The FCA regulates those crypto assets which provide rights (such as voting rights or access to dividends or the distribution of capital on liquidation) and obligations akin to specified investments, like a share or debenture or unit in a collective investment scheme, as set out in the RAO, but excluding e-money. These crypto assets are likely to be tokenised, digital forms of traditional securities. Firms carrying on specified activities involving security tokens must ensure that they have the correct FCA permissions and are following the relevant FCA rules and requirements.

The FCA also regulates those e-money tokens which meet the definition of e-money in the Electronic Money Regulations 2011. Firms issuing e-money must ensure they are appropriately FCA-authorised or registered. E-money tokens are, generally, digital payment instruments that store value, can be redeemed at par value at any time, and offer holders a direct claim on the issuer.

Tokens which are neither e-money tokens nor security tokens are not regulated by the FCA. These unregulated tokens include utility tokens (tokens which are used either to purchase a service or to access a DLT platform) and exchange tokens (which are primarily used as a means of exchange, including Bitcoin and Ethereum). The transferring, buying, and selling of these unregulated tokens, including the commercial operation of crypto asset exchanges for exchange tokens, are not FCA-regulated currently (but may be subject to the requirement for FCA registration under the Money Laundering Regulations).

While exchange tokens are not FCA-regulated, firms using them to facilitate regulated payment must consider the requirements of the Payment Services Regulations 2017 (PSRs), which would apply to each side of the remittance.

For regulated crypto assets, the FCA is responsible for financial regulation and enforcement. As noted above, firms carrying on a specified activity, by way of business in the UK, involving a crypto asset which is a specified investment may require FCA authorisation and the relevant permission.

Under the Financial Services and Markets Act 2000 no person may carry on a regulated activity unless they are FCA-authorised or exempt (the "general prohibition"). A person contravening this rule is guilty of an offence and may face up to two years' imprisonment or an unlimited fine or both. For example, if a person who is neither authorised nor exempt gives advice on a security token which amounts to the regulated activity of advising on investments they may be in breach of the general prohibition. Likewise, the issuing of e-money without the correct authorisation or registration is an offence which carries a penalty of up to two years' imprisonment or a fine, or both under the Electronic Money Regulations 2011 (EMRs).

FSMA also restricts the financial promotions of crypto assets. The financial promotion restriction provides that a person must not, in the course of business, communicate an invitation or inducement to engage in investment activity or claims management activity. This includes invitations or inducements to engage in certain activities which are not regulated activities. The financial promotion restriction does not apply if the communication is made by an FCA-authorised person, the content of the communication is approved by an FCA-authorised person, or the financial promotion otherwise meets the conditions of an exemption within the Financial Services and Markets Act 2000 (Financial Promotion) Order 2005 (FPO).

The promotion of engaging in investment activity is restricted under the FPO, which relates to agreements constituting a controlled activity, or exercising any rights conferred by a controlled investment. Controlled investments under the FPO currently include government and public securities, options, and futures. Controlled activities include dealing in securities and contractually based investments, arranging deals in investments, and managing investments.

Whether or not the financial promotion restriction applies to activities relating to a particular crypto asset will therefore turn on whether the activities involve a controlled activity or a controlled investment within the definitions set out in the FPO.

The UK Government intends to expand the definition of “controlled investment” to include “qualifying cryptoassets”, to bring them within the financial promotion regime.

Communicating a financial promotion in breach of FSMS is a criminal offence on the part of the unauthorised person. The FCA has wide ranging enforcement powers to require a financial promotion approved by an authorised person to be withdrawn, and to take enforcement action against the authorised person where serious misconduct is found.

The FCA’s Handbook contains rules on financial promotions which authorised persons must comply with when communicating or approving financial promotions. Financial promotions must be ‘fair, clear and not misleading’.

Unregulated crypto assets (utility tokens and exchange tokens) are not currently subject to similar financial promotions regulation. Proposed regulatory reforms would expand the scope of the FPO to capture qualifying crypto assets, to bring most of these unregulated crypto assets into financial promotions regulation.

Regulatory reforms are also proposed to ensure that in the future only authorised persons with FCA consent to provide such approval will be able to approve financial promotions communicated by unauthorised persons.

In 2020, crypto asset exchange providers ("CAEPs") (defined broadly to include crypto asset ATMs, peer-to-peer providers and entities issuing new crypto assets) as well as custodian wallet providers ("CWPs") which are based in the UK were brought within the scope of the UK's money laundering regime.

CAEPs and CWPs based in the UK therefore need to register with the FCA for anti-money laundering supervision (even if the FCA would not otherwise have a regulatory role in relation to the relevant CAEP or CWP). A failure by a CAEP or CWP to register for anti-money laundering is a criminal offence and exposes the entity to enforcement action, and potentially prosecution. Whether a CAEP or CWP is "based" in the UK, and therefore subject to FCA supervision, will be case-specific and significantly affected by the entity's business model.

CAEPs and CWPs based in the UK need to identify and assess the risks of money laundering and terrorist financing they are subject to and keep that assessment under review on a regular basis. They need to have proportionate systems in place to mitigate the risk of them being used for money laundering or terrorist financing. This will include an appropriate suite of policies, procedures, and records, as well as top-level commitment and adequate staff training. In addition, whenever they enter a business relationship, or carry out an occasional transaction, CAEPs and CWPs need to undertake customer due diligence, which involves verifying the identity of the customer and assessing their risk profile and seeking to verify the identity of any beneficial owner(s). CAEPs and CWPs need to report suspicious activity to the National Crime Agency.

The FCA has been given specific powers as part of its anti-money laundering supervisory function in respect of CAEPs and CWPs. The FCA can appoint a skilled person to report to it on any CAEP or CWP in relation to money-laundering compliance. In addition, the FCA can require CAEPs and CWPs to make regular reports to it. The FCA has used this power to institute a requirement for CAEPs and CWPs to submit annual financial crime reports. The FCA can also direct any CAEP or CWP to take (or refrain from taking) certain actions in relation to MLR compliance.

Currently blockchain (as the underlying technology that enables the existence of cryptocurrency) itself is not regulated in the financial services sector in the UK. However, to operate in the UK, crypto exchanges must register with the FCA, or alternatively, apply for an e-money licence.

The FCA has statutory objectives of financial system integrity and consumer protection and key to achieving these objectives is the operational soundness of FCA-regulated firms. To the extent that blockchain technology usage could affect firms' exposure to operational risk (for example due to a consequential reduction in firms' control over people, processes, and systems) firms must implement appropriate systems and controls to ensure that they are operationally sound. Although the FCA does not regulate the blockchain technology itself or its usage, firms are required to identify and manage the operational risks associated with their activities, including their technology usage and their use of third-party providers, and to put in place appropriate systems and controls.

Whether or not a given cryptocurrency is subject to financial regulation in the UK depends on whether it falls within the general financial regulatory perimeter established under FSMA or within the UK AML regime or the payment services and electronic money regime established under the PSRs and the EMRs. The FCA guidance splits crypto assets into regulated (i.e., security tokens and e-money tokens) and unregulated (i.e., exchange tokens / utility tokens) crypto assets. Activities related to Bitcoin, Litecoin and Ethereum are currently unlikely to trigger licensing requirements in the UK.

The UK Government is currently consulting on potential changes to the UK financial regulatory framework to establish a "sound regulatory environment" for stable coins (crypto asset which seeks to maintain a stable market value). The consultation is however limited to defining the scope of the regulatory perimeter with respect to such stable coins, rather than seeking to regulate blockchain technology itself.

There is no specific cryptoasset tax in Scotland. Cryptoassets are treated as property and gains or profits are taxed on normal UK tax principles either as capital gains (subject to capital gains tax) or income profits (subject to income tax) depending upon the nature of the transaction.

Generally, the UK tax authority expect individuals to hold cryptoassets as a personal investment subject to capital gains tax on disposal, unless the nature of the transaction is such that the individual is treated as trading for tax purposes.

Where crypto assets are earned e.g., from mining or from working for a decentralised autonomous organisation, it is likely that income tax and national insurance contributions will arise on receipt.

Any transaction involving "swapping" of cryptoassets will be treated as triggering a taxable disposal and potentially crystallising a taxable gain. Different types of cryptoassets are treated as separate assets for capital gains tax purposes.

For UK tax purposes, the situs of assets is important in establishing whether any disposal could give rise to a chargeable gain. The UK tax authority treats an exchange token as being located wherever the beneficial owner is resident and therefore any disposal would be treated as subject to UK capital gains tax for UK tax residents. However, that is a controversial view and has not been legislated nor (at the time of writing) tested in the courts. This treatment can be problematic for UK tax resident non domiciled individuals, as the acquisition of cryptoassets can result in them being treated as remitting untaxed foreign income to the UK.

While it is generally considered that crypto assets are a type of property under Scots law, there is no legislation or case law on the point. The Scottish Government has convened an Expert Reference Group on Digital Assets to consider the status of crypto assets under Scots law.

Transactions and disputes involving intangible property follow choice of law rules developed in statutes and European legislation, such as Rome I and II.

These rules traditionally apply the law of the country where the property is situated at the relevant time. This is also the case for intangible property. The law allocates an artificial location to certain types of intangible property, often the place in which some form of control might be exercised over the property.

Difficulties are likely to arise when applying these rules to crypto assets, as many crypto assets will be decentralised systems and so incapable of pointing to a location, artificial or otherwise. Within the UK there are further complications as there are different legal systems in each of England and Wales, Scotland, and Northern Ireland with notable differences in relation to the law of property, which may create conflict over which legal system applies.

In Scotland, these issues are being considered by the Scottish Government's Expert Reference Group.

There has been no definitive answer to this question as at the date of this guidance. However, we anticipate that based on the basic rules of contract, smart contracts are, in principle, capable of giving rise to binding legal obligatinos and therefore enforceable on their terms.

The possibility of taking security over crypto assets, although technically possible for certain types of crypto assets, under Scots law remains an area of uncertainty in practice.

Security can only be taken over property, and the form of security which can be taken over a crypto asset would depend on the type of property (if any) which that particular crypto asset falls within.

In Scotland, as it is uncertain what category of property type they fall within, the validity of any purported security would also be uncertain. If crypto assets were to be recognised as corporeal property, then the usual forms of non-possessory security (for example a bond and floating charge) and quasi security may be taken.

The taking of possessory forms of security (such as a pledge) would require legislation to be passed to recognise digital control over crypto assets as equivalent to possession. If crypto assets were to be considered incorporeal assets, then those crypto assets and the rights attached to those crypto assets would be capable of being secured by way of assignation in security. Such assignation in security would require (i) intimation of the assignation in security and (ii) the rights attached to the crypto asset to be transferred to the security holder. If the assignation in security is not intimated and the rights are not transferred, the effect of this would be to render the assignation in security incomplete whereby a contractual right only would be created and not a right in security.

Yes. Crypto assets will be treated by the UK tax authority (HMRC) as property for inheritance tax purposes, and so will be liable to IHT on the date of death value in the same way as non-crypto assets. Loss on sale of share relief offers relief against inheritance tax ('IHT') where 'qualifying investments' are sold at a loss within 12 months of the date of death. If net losses are made on the sale of all qualifying investments, then the sale proceeds can effectively be substituted for the date of death value.

Qualifying investments are shares and securities quoted on a "recognized stock exchange" (not including AIM); holdings in unit trusts; and certain other investments – none of which are crypto assets, but some of which could conceivably have some indirect exposure to crypto assets. Crypto assets will be treated by HMRC as property for inheritance tax purposes, and so will be liable to IHT on the date of death value in the same way as non-crypto assets.

Yes. The FCA is working with HM Treasury, the Bank of England, and the Prudential Regulation Authority to develop a regulatory regime for crypto assets. HM Treasury is considering extending the scope of crypt assets covered by the Money Laundering, Terrorist Financing and Transfer of Funds (Information on the Payer) Regulations 2017 as part of a wider consultation on increasing regulation of crypto assets. Additionally, HM Treasury have proposed legislation to bring activities that issue or facilitate the use of stablecoins used as a means of payment into the UK regulatory scope.

While not strictly legislation, it is also worth noting that the Advertising Standards Authority has published detailed guidance tightening the restrictions on advertising cryptocurrencies by introducing new requirements in relation to providing all material information in relation to cryptocurrency, the fact that they are unregulated and to make clear that the value of cryptocurrency can fluctuate. The guidance has been released to protect consumers from being taken advantage of due to inexperience or credulity.

The Scottish Government's Expert Reference Group on Digital Assets may also lead to recommendations for legislation under Scots law.

None. As the UK is no longer part of the European Union it would not be subject to any EU rules on digital assets though UK businesses operating in the EU may well be subject to those rules.

No.