Initiatives to make the UK a hub for cryptoasset firms

Firstly, Glen detailed how the UK government will legislate and establish a Financial Market Infrastructure Sandbox (FMIS), with the intention of testing and developing blockchain technologies, to enable firms to experiment and innovate. Such a regulatory Sandbox provides a testing ground for new types of businesses and products that are outside of existing regulations. This offers a framework for fintech companies and start-ups to conduct live experiments in a controlled environment, under the supervision of the regulator. The FCA states the Sandbox “allows firms to test innovative propositions in the market with real consumers”.

An example of this is the blockchain-based Sandbox created by the Bank of Lithuania in March 2020. The aim was to accelerate blockchain-based technologies in the financial sector. Some examples of products that have gone to market through the Sandbox include:

• Know Your Client (KYC) solution for Anti-Money Laundering (AML) compliance
• Cross border payments
• Smart contract for factoring
• Mobile POS and payment card solution
• Unlisted share trading platform
• A crowdfunding platform.

The UK FMIS is expected to be similar in design but will likely operate at a much wider scale.

Secondly, Glen confirmed the government will begin research to explore the use and benefits of blockchain technology in sovereign debt instruments. Issuing debt on-chain can provide greater transparency and security in the process, allowing debt to be tracked from its origination to competition or default, while also tracking repayments with timestamps. This reduces risk and improves recovery rates. Other benefits include cost saving, convergence with monetary policy, the introduction of new methods of settlement and introduction of payment channels which could be used to restructure debt burdens. The first-ever digital bond was issued by the European Investment Bank in collaboration with Goldman Sachs in 2021, when a 200 million Euro-denominated bond was issued on the Ethereum blockchain. Issuing sovereign debt on-chain could pave the way for other financial products being issued using blockchain technology including other debt products, securitised products, syndicated loans and developed use of smart contracts.

Additionally, Glen stated that the UK government will explore ways to adapt the tax system to encourage further developments in cryptoassets, including the treatment of DeFi loans for tax purposes and the extension of the Investment Manager Exemption to include cryptoassets. DeFi lending is anonymous and decentralised as the use of blockchain technology removes the need for a central counterparty between the borrower and lender. Such loans are often made through lending pools, increasing market access. Much like the debt products discussed earlier, DeFi loans can benefit from higher collection rates, lower costs and increased security, as well as greater market access with the use of loan pools. The greatest risk in DeFi is presented by the price volatility of the underlying collateral, though this is usually mitigated by over-collateralisation.

Loan pools are also set such that if the price of the underlying starts to fall, the pool starts to liquidate the collateral to cover the loan when the price hits a predetermined level, leaving the losses to be absorbed by the borrower. There is also a chance the price will increase, which could allow the borrower to repay the loan and make more profit. Bringing DeFi loans under tax regulation will bring greater certainty and consumer confidence and allow the area to continue growing.

Glen also confirmed that the Chancellor has commissioned the Royal Mint to create an NFT. NFTs are digital assets stored on a blockchain which are unique in their metadata and are therefore individual from one another.

These differ from cryptocurrencies, which are all identical fungible tokens. NFTs have gained significant traction with digital artwork in recent time with the likes of the Bored Ape Yacht Club, selling several tokens for well in excess of $2 million apiece. The most expensive NFT to date was Pak’s ‘The Merge’, in which 28,893 collectors purchased 312,686 single NFTs for a combined total price of $91.8 million.

The Royal Mint have created collectable coins for centuries and said that as ‘one of the world’s leading providers of premium collectables, making this a natural progression for us’. Minting NFTs will produce tax revenue for the exchequer and could be the future of collectables, Glen said the NFT is “an emblem of the forward-looking approach we are determined to take”.

Finally, the FCA is to hold a two-day CryptoSprint in May, and the Economic Secretary will create and chair a Cryptoasset Engagement Group with key figures from both the industry and the regulatory authorities. The CryptoSprint will focus on developing solutions to the regulatory problems and align policy with the fast-changing technologies in this space. The three topics to be covered are as follows:

• How information relating to the issuance of cryptoassets should be disclosed to investors
• How the FCA should identify where regulatory obligations on cryptoasset firms should be placed, for both centralised and decentralised models, including testing of proposed regulations
• What gaps need to be addressed in the UK's existing custody regulatory framework for custody of cryptoassets, to help protect UK consumers and markets

These measures demonstrate the strong intention of the UK government to develop the economy as a hub for cryptoasset firms, and to take advantage of new and innovative technologies. However, it also shows the commitment of regulators to work alongside firms to ensure customer protection and consumer outcomes.

Definitions

• Stablecoins are a form of cryptoasset that are typically pegged to a fiat currency such as the dollar and are intended to maintain a stable value.
• A DeFi loan is a loan made using cryptoassets where the borrower also posts cryptoassets as collateral

References

• https://www.fca.org.uk/firms/innovation/regulatory-sandbox
• Global Experiences from Regulatory Sandboxes, World Bank, 2020
• https://www.lb.lt/en/lbchain
• https://www.goldmansachs.com/insights/pages/blockchain-and-the-capital-markets.html