Why the UK joined the race to woo the crypto industry

Bitstamp launched its first effort to set up a London headquarters in 2013. The fledgling Slovenian cryptocurrency exchange was seeking a new base for its global expansion and Europe’s financial capital was developing a reputation as a hub for investment and talent in financial technology.

Part of the appeal was the opportunity to strike up an early relationship with the UK’s Financial Conduct Authority, one of the world’s most respected regulators. The company reasoned that regulation of the nascent cryptocurrency industry was inevitable, and wanted to get ahead of its rivals.

But the plan was cut short. The FCA said it had no mandate to oversee crypto, and just two years later the exchange decamped to Luxembourg, where it remains. The impression that the UK was not receptive to the fast-emerging digital asset world was reinforced in 2019 when the regulator banned crypto derivatives for retail investors, warning that trading them was “akin to gambling”.

In 2021, after growing into one of the top 15 cryptocurrency exchanges in the world by volume, Bitstamp tried again, when the FCA launched a UK registration scheme for companies offering crypto assets. Again, it was unsuccessful, eventually dropping its application.

Julian Sawyer, the exchange’s chief executive, says Britain needs “a long-term road map that allows us to think about where we want to invest our money and our resources . . . I think it’s a great opportunity for the UK. It’s one of our biggest markets.”

That plea, echoed by many in the cryptocurrency industry, has found a receptive audience at the top of the UK government with the finance ministry in April laying out its ambitions post-Brexit to make the country “the very best place in the world” to start and scale crypto companies.

At an event in London’s medieval Guildhall John Glen, treasury minister, appealed to offshore digital asset firms at the forefront of finance to put down roots in London. “If there is one message I want you to leave here today with, it is that the UK is open for business — open for crypto businesses.”

His speech — which was short on detail about the plan — marked the UK’s entry into a global beauty contest, featuring among others the United Arab Emirates and Switzerland. All are trying to persuade the fast-moving, moneymaking machines of the crypto industry — exchanges, infrastructure providers and fund managers — to settle in their jurisdictions. It is a race that has intensified since global authorities realised the extent of capital flows pouring into crypto-related technologies that could bring cheaper, quicker transactions for consumers and replumb deeply-embedded relationships in the financial system.

Global investment in the crypto and blockchain sector soared to more than $30bn in 2021 up from $5.4bn in 2020, according to KPMG, the consultancy. But the industry brings with it some hefty baggage, from concerns about money laundering controls to speculative trading products sold to retail investors. That potentially puts the UK government’s “open arms” approach to the industry at odds with the FCA.

Up to now UK regulators have only been asked to focus on narrow issues within the sector. But as the country moves towards a full suite of standards for digital assets, the question will be whether these rules will create a welcoming environment for crypto companies or whether they will deter businesses. Early clashes between the FCA and some of the companies, over money laundering rules, have contributed to scepticism in the industry that Glen’s vision of a UK hub will ever become a reality.

Traditional financial institutions such as commercial and central banks and fund managers are just as keen on exploring the possibilities of the emerging technologies and digital money.

Many see the UK plan as much broader than attracting people trading assets named after dogs or depicting bored apes. “They’re seeking to make the UK a leading place for crypto technology within financial services,” says Jonathan Master, a partner at law firm Eversheds Sutherland. “I didn’t read [Glen’s remarks] as seeing Bitcoin and Litecoin as the future of investment.”

Lagging behind rivals

There is no consensus on how widespread the use of crypto will become and its use in mainstream financial services is still limited, yet Britain feels the need to act. The importance of the financial services sector — which contributed £165bn to the UK economy in 2020 producing 8.6 per cent of the country’s total gross domestic product — helps explain that.

“Crypto asset technology has huge potential,” says Rishi Sunak, the UK chancellor, “and I want to harness this as part of our plan to ensure that our financial services sector is at the forefront of innovation.”

Yet in the eyes of many British politicians, the country already lags behind others in the race to woo crypto business. Singapore, for instance, bid to win the loyalty of companies fleeing China’s crypto crackdown last year, offering a regulatory regime tailored to the industry rather than shoehorning it into existing finance rules.

Regulators have come to accept that digital assets do not easily sit in the traditional banking and markets rules covering most aspects of financial services from shares to bonds, derivatives and loans. President Joe Biden issued an executive order in March providing direction to US regulators and government departments on their efforts to govern crypto in the US. Germany and Switzerland have tailored their regulatory regimes while Dubai won plaudits in the sector after creating its bespoke Virtual Assets Regulatory Authority.

Lisa Cameron, an MP with the Scottish National party and head of the UK parliamentary group on cryptocurrency, recently toured “crypto valley” — where banks and brokerages have set up shop — in the Swiss canton of Zug. The visit, she says, left her more convinced that the UK is “a little bit behind”.

Britain’s departure from the EU has added another dimension to its appeal to the crypto sector. “If other [countries] go first, they set the [regulatory] standard. Do you want other jurisdictions to set your standards?” asks Jana Mackintosh, managing director for payments at UK Finance, a lobby group.

New benchmarks could be imminent. Under the six-month presidency of France the EU is close to finalising a comprehensive set of digital asset rules that would force cryptocurrency issuers and service providers to meet tougher standards on transparency, money laundering and capital requirements. By contrast UK efforts have yet to be published.

Industry lobbyists have also tapped into a deep-seated need within the government to show the benefits of Brexit, says Philip Hammond, former UK chancellor, who last year became a paid adviser to Copper, a UK company that acts much like a share registrar to guard crypto assets on behalf of investors.

“Do not underestimate with this government the politics of a French-driven EU agenda that is essentially waving a banner and saying ‘crypto companies come to Paris’,” Hammond says. “The fact that it’s the EU that is making real progress here [will be] particularly shocking to a government that has sold the British public an agenda about taking back control so that the UK can be more competitive.

“The government,” he adds, “[will] need to get the regulator to buy in to its agenda.”

Beauty parade

To win this business, the UK will need to offer a more crypto-friendly, lighter-touch regulatory environment than the EU or US. “If the UK offers the same rules, they’re not going to win that battle,” says Charley Cooper, managing director of R3, a blockchain software company in New York.

Yet the decision to place crypto assets high on the agenda still took some industry lobbyists by surprise due to the UK’s traditionally cautious approach to an industry that has made a virtue of its ability to move and operate across borders and organise itself with minimal central authority.

Such decentralised finance projects are developed by consensus among members and automate the network’s rules in computer code. Blockchains, the digital ledger on which transactions are recorded, are maintained by a global network of computers. Exchanges are hosted on cloud computing, which can make it difficult for regulators to determine where deals are done. Even those with physical assets, like crypto miners, were quickly able to relocate to the US and Kazakhstan after being banned in China.

Cooper argues that people trading tokens like dogecoin could be based anywhere in the world but those that want to intersect with traditional finance may have little choice but to build a bridge in a financial centre like London or New York and expose themselves to regulation.

“We want to open up offices in places where, first of all, investors feel comfortable with their asset class, where investors feel protected by regulation that is issued by certain central authorities,” says Omar Itum, head of international business development at Arca, a US digital asset fund manager.

For many politicians in the UK the government’s embrace of crypto is a natural extension of its recent collaborations with financial technology companies. The FCA’s sandbox — an online test environment for proposals to see how they might work in the market — has been copied by authorities around the world. The Bank of England is working on a similar project for digital ledger technology in financial market infrastructure.

“For years, the UK regulators really worked on establishing the fintech industry and have been relatively successful,” says Swen Werner, head of digital custody at $4tn US asset manager State Street. “A lot of those fintech players then got engaged in crypto.”

Politicians vs regulators

It threatens to be a less cozy relationship. On the same day that Glen threw London’s doors open to the industry, Bank of England governor Andrew Bailey also gave a speech. In it he called cryptocurrencies “the new front line” for criminal scams. The FCA has banned crypto derivatives trading for retail investors, blocked the launch of exchange-traded crypto products — which are popular in Europe, the US and Canada — and plans to impose strict controls on the advertising around the industry.

“We are seeing a slight divergence of views between politicians keen to promote their jurisdiction as being open to crypto and regulators who are very nervous and see potential systemic risk in this area and are keen to avoid consumer harm,” says Joby Carpenter, global head of crypto assets at the Association of Certified Anti-Money Laundering Specialists, who worked at the FCA until 2019.

The FCA is a particular bugbear for many crypto firms. The bad feeling peaked in March over the register the FCA set up for UK-based firms undertaking crypto asset activity — the one Bitstamp was unable to join.

Designed to ensure crypto companies were compliant with UK rules on money laundering and terrorist financing, it has ended up turning away most who applied. CryptoUK, the lobby group, estimates that 80 per cent of British companies that applied later withdrew those applications, and many have moved offshore.

Companies that quit the UK are usually free to keep servicing their British clients, which leaves the regulators with little control over firms that still have thousands of UK customers. For instance, they may no longer be required to conduct detailed checks on the source of their customers’ money.

The FCA argues it is not “anti-crypto”, noting that blockchain-based services have used its sandbox technology. “Crypto is a priority for us,” it said in a statement. But it added that it had a responsibility to ensure an appropriate degree of protection for consumers.

“We set an achievable standard required to be registered with us for [anti-money laundering] purposes. Our focus was on ensuring firms are not a conduit for money laundering and they have the systems to properly manage financial crime risks. We will continue to work closely with HM Treasury, who set the scope of crypto regulation in the UK,” the statement read.

The Bank of England declined to comment on the UK government plans or Bailey’s comments. But Glen has committed the UK government to a review of the scope of the rules. Big banks and small cryptocurrency companies alike are now waiting to see if the UK will make good on that pledge.

Among the issues likely to be under discussion are a full-scale regulatory regime for crypto exchanges and infrastructure providers, and revisiting the rules for including crypto assets in fund structures. This could potentially set lawmakers on a collision course with regulators but there will be just one winner say industry figures.

“It doesn’t matter how many people you get from the Treasury on your side or how many people you have in Parliament on your side, what happens in practice is that they then put you in front of the FCA,” says Daniel Masters, chair of CoinShares, the crypto fund management and trading group regulated in Jersey. “They will not cross the rubicon of the FCA’s independence.”

Masters says that in 2019 Glen brokered a meeting with then FCA boss Bailey (now at the Bank of England). While he found Bailey “extremely affable and quite open minded,” the attitude of other FCA officials left him convinced of their hostility to digital assets. “What that taught me is that somewhere else at the FCA, this anti-crypto sentiment exists,” says Masters.

The government insists its aim is to maintain the highest standards. Cameron agrees: “We’re not saying the UK will be the most permissive in the world. I don’t think anyone is looking for that. It’s a place for reputable companies to set up.”

For Hammond the Glen speech was intended to reassure the crypto-minded sectors of the UK financial industry and buy time to deliver the promised changes to how digital assets will be governed. The message was: “OK guys, we recognise that there’s a problem here . . . Stick with us.”

Additional reporting by George Parker in London