Blockchain 2022 Comparisons

2022 has been an exciting year for the blockchain market, with a significant growth in investments and public awareness of the wider blockchain ecosystem, beyond the traditional focus on cryptocurrency and digital value transfer.

Non-fungible tokens (NFTs), the metaverse and supply chain solutions have been some of the buzzwords underlining the multidisciplinary growth in the blockchain market in the last 12 months.

Technological developments have pushed business interests in the wider blockchain ecosystem to the frontlines of business models and investments, accelerated by the COVID-19 pandemic.

Integration with other technologies such as artificial intelligence and the internet of things (IoT), cross-blockchain interoperability solutions and a wide range of other novel products have dramatically increased the scale and variety of blockchain use cases across industries. These include, for example, cloud storage decentralisation, decentralised finance (DeFi), counterfeit prevention, royalties distribution, secure sharing of medical data, supply chain monitoring and play-to-earn gaming.

Businesses are using blockchain technology across a wide range of sectors to solve challenges faced by businesses and customers alike. Blockchain provides particular value to businesses built around the following framework:

• a predictable, repeatable process that lends itself well to automation;
• an ongoing or long-running transaction or process;
• multiple stakeholders in the process or value chain;
• reconciliation of disparate data traditionally under the control of one party or a limited number of parties;
• an element of value transfer; and
• value in an immutable record.

While there are many successful and promising use cases, the following three areas are of particular interest.

• Supply chain solutions that combine private blockchain, smart contracts and distributed ledger technology (DLT) with artificial intelligence, the IoT and other services to provide businesses with end-to-end solutions to increase transparency, predictability, resiliency and agility in their supply chains. Companies like Everledger in the UK and IBM in the USA have been developing blockchain solutions to address supply chain disruption (one of the most critical issues faced by businesses worldwide), reducing critical costs, time and quality risks faced by businesses across the construction, pharmaceutical, manufacturing, energy, retail and other sectors relying on global supply chains.
• Blockchain analysis and compliance services for businesses in the crypto-assets industry – for example, London-based Elliptic provides blockchain analytics, training and certification for crypto businesses, financial institutions and regulators, managing financial crime risk and regulatory compliance.
• Dispute resolution costs and efficiency: while still a relatively niche market in the UK, businesses and institutions alike have started exploring and using blockchain technology to increase efficiency and decrease costs in dispute resolution. International arbitration and mediation institutions such as the London Chamber of Arbitration and Mediation and ENERAP in London are currently working on several initiatives in the field.

One of 2022’s most significant developments in the UK DeFi environment is of a regulatory nature. On 24 March 2022, the Bank of England’s Financial Policy Committee published a paper on "Financial Stability in focus: Cryptoassets and decentralised finance".

The paper sets out detailed views, expectations, regulatory considerations and recommendations for the actors in the UK DeFi and crypto-assets industry. It also highlights that, while the UK DeFi ecosystem is currently relatively small, it grew by a factor of five since February 2021 to almost GBP180 billion in March 2022, and is likely to develop further as technology facilitates transactions in a much broader range of assets on DeFi applications in the future.

NFTs have generated global interest of late with the general public and across the arts, media, gaming and virtual reality industries. An NFT is a unique and non-interchangeable unit of data stored in a ledger and used to authenticate, own and trade digital files such as photos, videos and audio.

NFTs have generated an unusually high level of activity in the UK art scene, across collectors, galleries and auction houses alike – including Christie's auction house, the Saatchi Gallery and the British Museum, to name a few. Corporate investment entities such as NFT Investments are also slowly emerging.

NFTs are increasingly used and integrated in shared online virtual environments (metaverse) and in the gaming industry, as part of a growing economic ecosystem alongside e-gaming, sponsoring and play-to-earn platforms, where players earn tokens as they play. A wide range of UK residents, businesses and individuals alike participate in this global environment.

The UK regulatory framework remains in a state of evolution. At the most fundamental level, crypto-asset exchange providers and custodian wallet providers must be registered with the Financial Conduct Authority (FCA) under the Money Laundering, Terrorist Financing and Transfer of Funds (Information on the Payer) Regulations 2017 (the Money Laundering Regulations).

There is also the potential for cryptocurrencies and related services to be captured by the UK regulatory perimeter, including the UK payments regime – see the Financial Services and Markets Act (Regulated Activities) Order 2000 (the RAO), the Electronic Money Regulations 2011 and the Payment Services Regulations 2017 and associated FCA guidance on the perimeter. In reality, a careful analysis still needs to be conducted in each case to determine whether products and services are UK regulated.

There are also important closed or closing consultations that will bring more bespoke regulation to this area, most likely in the course of 2022/23. HM Treasury has recently closed an important consultation on the UK regulatory approach to crypto-assets and stablecoins, and confirmed its intention to bring stablecoins as a payment mechanism within the scope of the UK regulatory perimeter. The FCA also recently closed a consultation about the introduction of regulation applicable to financial promotions related to crypto-assets (CP22/2).

A wider and potentially more comprehensive regulatory framework, including in respect of DeFi and the use of DLT, is set to be consulted on later in 2022. Overall, the UK regulatory approach at this stage can be described as cautious and incremental but with a significant degree of enthusiasm for new technologies.

In parallel, the Law Commission plans to publish a paper in 2022 covering questions such as how UK law concepts such as possession might relate to crypto-assets.

There has also been some limited judicial consideration given to crypto-assets (see 2.5 Judicial Decisions and Litigation).

Finally, the Bank of England has said that it is looking at the possibility of introducing its own digital currency, but no final decision has yet been taken.

Standards created by international bodies have not been specifically implemented into UK law, but are certainly relevant to the direction of travel of the UK government and judicial decision making.

The UK government has said that, in developing its rules, it will enable sufficient flexibility to allow UK regulators to adapt rules to accord with international standards.

The UK’s key regulatory bodies for businesses and individuals in the blockchain sphere are the FCA, the Prudential Regulatory Authority and the Payment Systems Regulator.

In 2018, the seven largest crypto companies formed CryptoUK, the UK’s "self-regulatory trade association representing the cryptoasset sector". All of its members are signed up to a robust Code of Conduct, which "includes provisions on know your customer (KYC) and anti-money laundering (AML) checks". The aspirations of the association can be summarised as follows:

• to provide industry expertise to politicians and regulators, in order to assist them in developing an "appropriate operating framework for the UK";
• to represent the industry in relation to the "broader financial system and other stakeholders"; and
• to self-regulate its members, as an "important stepping stone to full regulation".

CryptoUK now represents myriad actors within the UK’s crypto space, such as:

• crypto marketplaces;
• trading platforms and brokers;
• comparison platforms;
• third-party transaction facilitators; and
• asset managers.

There is also the British Blockchain Association and Global Digital Finance.

Membership of all of these bodies is voluntary, and all seek to promote collaboration and good practice.

The leading case on the legal principles applicable to blockchain technology that buttress cryptocurrency protocols such as bitcoin is AA v Persons Unknown [2019] EWHC 3556 (Comm). Bryan J sought to provide clarity on a key foundational question concerning blockchain: can crypto-assets such as bitcoin be treated as property under English law? By answering in the affirmative, he brought blockchain-backed crypto-assets within the scope of the claims and relief available to other types of property under English law.

Bryan J began by explaining, through a Legal Statement on crypto-assets and smart contracts" issued by the UK Jurisdictional Taskforce (UKJT) in November 2019, that, even though crypto-assets do not fit neatly into either of the two principal categories of property recognised under English law, as outlined by Fry LJ in Colonial Bank v Whinney [1885] 30 Ch. D 261, this should not preclude their recognition as property.

Two recent cases had, in fact, without considering the issue in much depth, treated crypto-assets as property: Vorotyntseva v Money 4-Limited t/a Nebeus.com [2018] EWHC 2596 (Ch) and Liam David Robertson v Persons Unknown (unreported, 15.07.2019). The Patents Act 1977 had also recognised patents as a class of intangible property, despite the fact that they cannot strictly be a "chose in action" either.

Bryan J cited, with approval, the UKJT’s Legal Statement that, whilst crypto-assets could not be said to be either "choses in possession", as they are not tangible, or "choses in action", as they do not embody an enforceable right, Colonial Bank should not be treated as "limiting the scope of what kinds of things can be property at law".

The Legal Statement further states that the English courts have recently come to recognise other classes of intangibles as property: see, for example, Dairy Swift v Dairywise Farms Ltd [2000] 1 WLR 1177, concerning milk quotas, and Armstrong v Winnington [2012] EWHC Civ 37, concerning EU allowances.

In short, whilst crypto-assets are not, in the words of Bryan J, "thing[s] in action on a narrow definition of that term, that does not mean that [they] cannot be treated as property": Fry LJ’s statement in Colonial Bank is not to be treated as a legal straitjacket.

He supported his analysis by stating that crypto-assets meet the four abstract criteria of property set out by Lord Wilberforce in National Provincial Bank v Ainsworth [1965] AC 1175:

• they are "definable";
• they are "identifiable by third parties";
• they are "capable in their nature of assumption by third parties"; and
• they "have some degree of permanence".

This was, furthermore, the approach taken by the Singapore International Commercial Court in B2C2 Ltd v Quoine PTC Ltd [2019] SGHC (I) 03.

This understanding of crypto-assets by Bryan J has been endorsed in the following cases:

• Ion Science Ltd v Persons Unknown (unreported, 21.12.2020);
• Wang v Darby [2021] EWHC 3054 (Comm);
• Director of Public Prosecutions v Breidis and another [2021] EWHC 3155 (Admin);
• Danisz v Persons Unknown and another [2022] EWHC 280 (QB); and
• Tulip Trading Limited v Van Der Laan and others [2022] EWHC 667 (Ch).

Whilst the FCA has certainly made threats to take action (for example, in respect of unregistered crypto ATMs), there is as yet no published enforcement action of note.

However, the case of Gidiplus v FCA is due to be heard by the Upper Tribunal, potentially in the course of 2022. Gidiplus’ application to be registered under the Money Laundering Regulations was rejected and it is challenging the FCA’s decision.

The Upper Tribunal has already published an interim decision on whether the FCA’s decision to terminate Gidiplus’ interim permissions should be suspended pending the appeal. The Upper Tribunal may make some comments of wider significance, although probably more in the context of the standards required before registered status is obtained rather than in respect of the scope of the regulatory perimeter.

Whilst there is no blockchain-specific sandbox, the FCA does operate a regulatory sandbox with eligibility criteria, including the need to apply for FCA authorisation where necessary. The FCA also provides bespoke support at an earlier stage to businesses that want to understand more about the UK regime and how it may impact on their proposition.

HMRC published a manual for tax on crypto-assets on 19 December 2018 that has since been updated (see www.gov.uk). HMRC treats crypto-assets as traditional assets for tax purposes, and crypto-assets do not have their own tax treatment in the UK. Instead, they are taxed subject to the existing UK tax regime. Depending on how a crypto-asset is held, traded and disposed, one may be liable to pay one or more of the following taxes:

• corporation tax;
• income tax;
• national insurance contributions;
• stamp taxes; and/or
• value-added tax.

For example, if an individual buys and "disposes" of crypto-assets as a personal investment, they will pay capital gains tax on the profits made. If they trade crypto-assets, then income tax will be applied to the trading profits. The HMRC manual provides further examples of the circumstances in which each tax regime applies to the use of crypto-assets.

More recently, HMRC updated the manual to include guidance that seeks to bring DeFi within the existing income and capital gains tax parameters. Whether a DeFi transaction falls within this regime will depend on whether the return on the transaction is more akin to capital (ie, the disposal of an asset) or revenue (ie, income from providing a service). The former will fall within the capital gains tax regime and the later income tax regime. HMRC provided some worked examples that set out the five most common financing structures used on DeFi platforms and their tax implications.        

The Cryptoasset Taskforce comprised of the FCA, the Bank of England and the Treasury reported on the benefits and challenges posed by DLT in 2018. It concluded that, whilst DLT is at an early stage, it has the potential to offer considerable benefits to the UK markets.

However, as noted, there is considerable regulatory activity in this area and an awareness between the different authorities as to what the others are doing, such that the resulting framework should be coherent.

It is now clear that digital assets constitute property in English law (see 2.5 Judicial Decisions and Litigation). There is still uncertainty as to whether a third category of property beyond "choses in possession" and "choses in action" exists for digital assets and, if it does, how that category should be defined.

The Law Commission recognises the legal uncertainty that remains and has since undertaken to review the law to consider legal reform to accommodate digital assets. Part of the Law Commission’s project includes recommendations to solve the problems caused by the law’s approach to “possession” in relation to digital assets. This project is at the pre-consultation stage, with the consultation paper set to be published in mid-2022.

In the meantime, as indicated by the UKJT, all circumstances should be looked at when determining the ownership and transfer of a digital asset. Digital assets are wide-ranging and have different characteristics from one another; therefore, the way they can be owned depends on their characteristics.

Broadly, ownership of a digital asset that is held on-chain, such as NFTs, can be evidenced through the blockchain, which is a distributed ledger that traces, verifies and authenticates transactions to provide undeniable proof of ownership of the tokens. Transfer of ownership on-chain will take place when the transferor authenticates the record of the transfer by digitally signing it with the private key. The transfer will then be broadcasted to the network, which verifies the transfer before it is recorded on the ledger. Once a token has been transferred on-chain, ownership is shown by a new crypto-asset being created under the transferee’s name.

Digital assets can also be held and transferred off-chain through private keys. Parties can enter into an agreement to transfer the digital asset via exchange of the private key without having the transfer recorded on a blockchain. In this situation, the expectation is that the person with knowledge and control of a private key would generally be considered the owner of the corresponding digital asset.

The way in which a digital asset is held (whether on-chain or off-chain) is only one factor to consider when looking at the ownership of digital assets. As identified by the UKJT, ownership also depends on the circumstances – parties may have reached an arrangement to share ownership of the crypto-asset through multiple keys, or a person may hold the private key on behalf of another through a trust or custodian/intermediary relationship.

The categorisation of digital assets in the UK can be determined using the FCA’s classification as set out in its Guidance on Cryptoassets 2019. Accordingly, digital assets can be categorised as one of three types of tokens:

• security;
• e-money; or
• unregulated.

Digital assets that have the characteristics of security or e-money tokens fall within the UK regulatory parameters. Those digital assets that do not have the characteristics of security tokens or e-money remain unregulated in the UK (other than in relation to anti-money laundering-related requirements).

• Security tokens have characteristics that are similar to traditional securities, such as shares, debentures or units in a collective investment scheme. They confer rights and obligations on the owner, and they fall within the UK regulatory framework as "specified investments" under the Financial Services and Markets Act 2000 (FSMA).
• E-money tokens cover digital assets that function like electronic money for the purposes of the Electronic Money Regulations 2011. E-money is regulated in the UK as specified investments under the FSMA.
• Unregulated tokens cover a wide range of digital assets. They include cryptocurrencies that are not issued or backed by any central authority and are intended and designed to be used as a means of trade or exchange, such as Bitcoin and Litecoin. They also include utility tokens, which grant holders access to a network or prospective service or product with characteristics similar to securities. An example is reward-based crowdfunding. If a token combines the characteristics of an “exchange token” and a “utility token”, it will also be unregulated. Unregulated tokens are not specified investments under FSMA.

The term "stablecoin" covers a broad category that encompasses any digital asset that is either:

• asset-backed (whether backed by fiat currency or another type of asset);
• algorithmically stabilised based on supply and demand; or
• a hybrid that consists of an asset-backed stablecoin that also incorporates an algorithmic stabilisation.

As it currently stands, stablecoins are not separately or specifically regulated under the UK currency regime. Instead, they are subject to regulation only where the stablecoin itself constitutes a regulated instrument or the services in question constitute regulated services, within the existing regulatory framework.

In April 2022, in its response to the HM Treasury Consultation and Call for Evidence on the UK regulatory approach to crypto-assets, stablecoins and DLT in financial markets (the HMT Consultation Response), the UK government confirmed that it intends to focus the first phase of legislative changes on certain stablecoins that are used as a means of payment and backed by fiat currency, and in particular their use by retail customers (for additional detail on payments, refer to 3.4 Use of Digital Assets).

The UK government plans to bring currency-backed stablecoins used as a means of payment into the existing category of "e-money". This is intended to extend the existing regime to both the issuers of such stablecoins as well as entities providing certain related services, with the aim of avoiding any "regulatory arbitrage" between traditional e-money and currency-backed stablecoins.

The HMT Consultation Response anticipates amendments to the following:

• the Electronic Money Regulations 2011;
• the Payment Services Regulations 2017;
• Parts 5 of the Banking Act 2009; and
• the Financial Services (Banking Reform) Act 2013.

It notes the need for a regulatory mandate, in relation to such stablecoins, to be developed for each of the FCA, the Bank of England and the Payment Systems Regulator.

The HMT Consultation Response also notes that other forms of stablecoin less analogous to "e-money" or fiat currency will be excluded from the initial legislative phase – eg, stablecoins predominantly used to facilitate trading and investment activities in unbacked crypto-assets.

However, the UK government has flagged that additional regulation on a broader set of digital asset activities, particularly by way of investment, should form a second legislative phase, and a further consultation will follow later in 2022.

The use of cryptocurrencies, and indeed digital assets more generally, as a means of payment is not currently prohibited or regulated, save where the transaction falls within the existing regulatory remit.

However, as touched on in 3.3 Stablecoins, the UK government's primary initial focus is to regulate the use of digital assets (and stablecoins in particular) as a means of payment. This is a significant move away from the existing position as this suggests that the UK government now expects – and is willing to legislate in order to facilitate and regulate – the use of certain digital assets as a means of payment.

The HMT Consultation Response prioritises extending the safeguarding requirements that exist under the Electronic Money Regulations 2011 to customer funds received in exchange for issuing a currency-backed stablecoin. In order to do so, the UK government is considering the need for funds issued in the form of currency-backed stablecoins to be covered by an equivalent amount of liquid assets providing 1:1 safeguarding or equivalent insurance arrangements.

The UK government also intends to extend the scope of the Financial Services (Banking Reform) Act 2013 to bring currency-backed stablecoins within the remit of the Payment Systems Regulator, and to widen the application of the Banking Act 2009 to capture a defined set of service providers.

The service providers in question are likely to include wallet providers, exchanges and custodians of stablecoin reserves, which the UK government considers necessary to manage risks related to a systemic stablecoin failure (as highlighted by the Bank of English in its discussion paper on New Forms of Digital Money).

Generally, NFTs will fall into the unregulated token category as being neither a security token nor an e-money token. This means there is no regulation on the way they can be created, traded or invested. The need for more clarification regarding NFTs has been recognised by the intergovernmental Financial Action Task Force (FATF).

As identified by FATF, if a so-called NFT has a payment or investment purpose in practice, it may be considered a virtual asset capable of having characteristics similar to those of traditional securities, in which case it would be regulated as a security in the UK. NFTs that are sold on secondary markets are more likely to be virtual assets and operators of NFT marketplaces may fall under the scope of AML regulations in the UK.

The UK government has announced plans for new legislation to address misleading crypto-asset promotions, including NFTs. In March 2022, the Committee of Advertising Practice published advice on advertising crypto-assets, including guidance that advertisers must clearly state that crypto-assets are not regulated by the FCA. Ads must also make clear that crypto-assets are not protected by financial compensation schemes, so that potential investors are aware that they would not be subject to any protections afforded by either the Financial Ombudsman Service or the Financial Services Compensation Scheme.

The primary crypto-asset markets used in the UK for fiat-to-crypto (or vice versa) and crypto-to-crypto transactions are centralised exchanges (CEXs) and decentralised exchanges (DEXs), including automated market makers, order book DEXs and DEX aggregators.

Commonly, users of CEXs will store their crypto-assets in custodial wallets controlled by the CEX, while users of DEXs will use non-custodial wallets controlled by the user. However, there are exceptions to this general rule – for example, OpenSea (the leading NFT marketplace) is a non-custodial CEX allowing for peer-to-peer NFT exchanges.

At present, there are a limited number of crypto-asset exchanges based in the UK, but many of the largest global exchanges operate (or can be accessed) in the UK.

One of the most common methods for exchanging fiat currency into crypto-assets (an “on-ramp”) is through a custodial CEX. This process involves a person opening an account with the CEX, paying for the desired crypto-assets with fiat currency via a debit card or bank transfer and receiving the crypto-assets into the custodial wallet linked to that person’s account.

However, the crypto ecosystem has been constantly expanding and now people can on-ramp through application programming interfaces (APIs), which integrate directly into DEXs and hot and cold wallets (hot wallets are connected to the internet and cold wallets are not). As with on-ramping, CEXs are often used as a method of converting crypto-assets into fiat currency ("off-ramping"), although other off-ramping methods are also used, such as using a crypto debit card to pay for goods or services.

In the UK, firms operating crypto ATMs, which offer services exchanging crypto-assets through certain ATMs, must be registered with the FCA and comply with the UK Money Laundering Regulations. However, currently no crypto-asset firms registered with the FCA have been approved to offer crypto ATM services.

Under English law, money transmission businesses are generally regulated through the electronic money and the payment services regulatory frameworks, primarily through the Electronic Money Regulations 2011 and the Payment Services Regulations 2017, respectively.

The issuance of e-money is regulated under the Electronic Money Regulations, and the regulation of payment services under the Payment Services Regulations only covers activities involving funds, which can include bank notes, cash and e-money. Therefore, unless the crypto-asset in question is considered to be e-money, crypto-assets and their use should not fall within the scope of the Electronic Money Regulations and the Payment Services Regulations – whether a particular crypto-asset can be considered e-money can only be determined on a case-by-case basis. If crypto-assets are used to facilitate a payment service that relates to funds, such service will be within the scope of the PSRs.

Finally, even when the Electronic Money Regulations and the Payment Services Regulations do not apply, crypto-asset exchange and trading platforms and wallet providers and custodians must be registered with the FCA and comply with the Money Laundering Regulations.

Those who provide digital asset exchange services or custodian services are subject to the Money Laundering Regulations, which require compliance with prescriptive customer due diligence measures in certain circumstances – namely, where they:

• establish a business relationship;
• carry out an occasional transaction involving a transfer of funds within the meaning of Article 3.9 of the Funds Transfer Regulation;
• suspect that money laundering or terrorist financing may be taking place; or
• doubt the validity of documents or information obtained as part of the know your customer/customer due diligence (CDD) process.

In line with the general anti-money laundering (AML) regime, such digital asset service providers will also be required to apply enhanced CDD in certain high-risk circumstances (pursuant to Regulation 33 of the Money Laundering Regulations).

However, the UK government has indicated in the HMT Consultation Response that the regulatory framework will be closely monitored going forward to ensure that digital assets continue to be regulated in a clear and proportionate manner. It notes that amendments have been proposed to FATF’s "travel rule" in relation to the transfer of digital assets, which are currently the subject of a consultation process undertaken by HM Treasury. All relevant service providers operating within the UK are also required to register with the FCA if they fall within the scope of the Money Laundering Regulations.

Regulation of digital assets is so far primarily addressed through the existing regime for financial services regulation, although there is increasingly targeted regulation (see 2.1 Regulatory Overview and 2.3 Regulatory Bodies). There are multiple UK regulators involved, of which the FCA is probably the most significant.

In respect of fraudulent and manipulative practices, there are no regulations that focus on crypto-assets in particular. As noted in 2.6 Enforcement Actions, there has not yet been any regulatory enforcement to speak of.

There are currently no specific regulatory limits on the ability of a crypto-asset exchange to re-hypothecate (on-transfer) the crypto-assets it holds for customers in the UK.

Businesses that provide hot (online) or cold (offline) wallet solutions for private cryptographic keys that control the ability to give instructions with respect to crypto-assets are likely to fall within the definition of a "custodian wallet provider". Custodian wallet providers that perform their services by way of business in the UK must be registered with the FCA and comply with the Money Laundering Regulations.

Also, if a firm provides custody services in respect of any security tokens, the provision of such services may be a regulated activity, so firms must ensure that they have the relevant permissions as required under FSMA.

In the UK, FSMA principally regulates fundraising through the creation and sale of crypto-assets intended to be used as part of a decentralised network (an ICO). Whether the crypto-assets being issued as part of an ICO fall within the scope of FSMA needs to be considered on a case-by-case basis. However, it is worth noting that if the relevant crypto-assets are classified as security tokens, the issuer of such security tokens would not be regulated in the same way as other market participants (eg, issuers of security tokens that are equivalent to shares or debentures may not carry on a regulated activity under FSMA).

Furthermore, if such crypto-assets are considered "transferable securities" within the meaning of MiFID II and the ICO involves offering such crypto-assets to the public in the UK or admitting them to trading on a regulated market, they may be subject to the rules and regulations of the Prospectus Regulation.

Additionally, the issuer of the crypto-assets pursuant to an ICO will also likely fall within the definition of a "crypto-asset exchange provider", which is broadly defined. Crypto-asset exchange providers that perform their services by way of business in the UK must be registered with the FCA and comply with the Money Laundering Regulations.

A firm operating a crypto-asset exchange or trading platform must ensure it has the appropriate authorisation to perform all of its proposed activities, which would need to be considered on a case-by-case basis.

For example, if a crypto-asset exchange is being used as an intermediary for fundraising through the sale of crypto-assets intended to be used as part of a decentralised network (an IEO), if such crypto-assets are considered to be security tokens, the exchange will likely need permissions for arranging deals in investments (Article 25(1) of the RAO) and making arrangements with a view to investments (Article 25 (2) of the RAO).

Additionally, if the crypto-assets are considered to be "Financial Instruments" under MiFID, the crypto-asset exchange may need to be authorised to operate a multilateral trading facility or an organised trading facility (Articles 25D and 25DA of the RAO).

There are no specific regulations in the UK applicable to distributions of crypto-assets to community members likely to utilise a particular protocol via an airdrop or similar mechanism that does not necessarily involve a purchase of the crypto-asset. However, whether a crypto-asset is classified as a security token is not contingent on it being purchased for value, so the regulations that apply to the issuance of security tokens would apply to such airdrop or other distribution mechanism, as set out in further detail in 5.1 Initial Coin Offerings and 5.2 Initial Exchange Offerings.

There are no specific regulations in the UK applicable to investment funds or collective investment schemes that invest in crypto-assets.

There are no specific regulations in the UK applicable to broker-dealers or other financial intermediaries dealing in crypto-assets. However, any such broker-dealer or other financial intermediary must ensure it has the appropriate authorisation to perform all of its proposed activities, which would need to be considered on a case-by-case basis. Please see 4.6 Wallet Providers and 5.2 Initial Exchange Offerings for further details.

There are no specific laws dealing with the enforceability of self-executing contracts, or “smart contracts”.

From a practical perspective, as smart contracts are immutable, once a trigger event takes place their performance cannot be avoided or altered by a party unilaterally. Therefore, they are often seen as not requiring enforcement outside of the blockchain.

From a legal perspective, in its November 2019 Legal Statement, the UKJT indicated that, in principle, smart contracts are capable of giving rise to binding legal obligations, enforceable in accordance with their terms, provided they satisfy the traditional English law requirements for the conclusion of a contract.

This was confirmed by the Law Commission in its comprehensive advice to the UK government dated 25 November 2021, in which it stated that smart contracts must satisfy the requirements for the formation of a legally binding contract – namely:

• agreement (offer and acceptance);
• consideration;
• certainty and completeness;
• intention to create legal relations; and
• formality requirements.

The Law Commission identified some risk areas, particularly in relation to contractual interpretation, completeness and immutability. Its recommendations and practical solutions to those issues include:

• having a separate natural language agreement that explains the workings of the code and address issues not embedded within the code such as governing law and jurisdiction; and
• designing the code so that it can be terminated or suspended pending the outcome of a dispute.

While there are no specific laws that establish code developers as fiduciaries responsible for losses that arise through the use of the blockchain networks they develop, the issue was recently discussed in the English High Court case of Tulip Trading Limited v Bitcoin Association for BSV [2022] EWHC 667 (Ch).

In this particular case, the High Court looked at traditional English law authorities on fiduciary duty and found that the developer owed no fiduciary duty to the claimant.

DeFi platforms are not prohibited in the UK and, as with traditional commercial lending, the provision of loans via such platforms is generally not a regulated activity.

However, this may be subject to change as certain stablecoins are soon to be brought within the "e-money" regulatory regime, with the potential for a split between regulated and unregulated DeFi platforms.

The Bank of England's Financial Policy Committee has confirmed that it will be undertaking regular assessments of the market to mitigate potential risks as it becomes appropriate to do so.

Digital assets are considered property under English Law. Whether they fall within the category of a "chose in action" or a "chose in possession" will depend on the nature of the digital asset; indeed, some digital assets do not fit neatly within either category or have characteristics of both (see 2.5 Judicial Decisions and Litigation). In its Call for Evidence on Digital Assets and their Interim Update (together, the Law Commission's Consultation), the Law Commission is consideringwhether it would be most appropriate for English law to recognise a new third category of personal property that is intangible in nature but has elements indicative of a "chose in possession".

Currently, traditional security principles apply to digital assets. English law recognises four distinct forms of security:

• mortgages;
• charges;
• pledges; and
• liens.

In addition, statute can create a security interest, such as a security financial collateral arrangement under the Financial Collateral Arrangement (No 2) Regulations 2003. The precise nature of the security interest shall be determined by reference to the extent to which the secured party has ownership, possession or control of the asset in question. For example, the nature of digital assets means that, at present, possessory security is not available and therefore a lien is not capable of being granted over digital assets. The practical issues in perfecting security interests specific to digital assets was noted by the Financial Markets Law Committee in its response to the Law Commission's Consultation (the FMLC Response), particularly the difficulty in protecting the priority of security taken over a digital asset. The FMLC Response also notes that a digital asset may exist in a number of different jurisdictions simultaneously, which again causes issues regarding the applicable law(s) and navigating any conflicts of laws that may arise.

The FMLC Response proposes the creation of a specific class of digital asset security together with an appropriate registration regime, either internationally or nationally, as a more robust way forward, though the outcome of the Law Commission's Consultation must be awaited to see whether this opinion is shared across the industry.

There is not currently any requirement for digital assets to be held by a custodian, though many owners of digital assets choose to hold their digital assets in this way. The current position is that custodians of digital assets are subject to the existing regulatory regime, to the extent that it is applicable. Such custodians would not be subject to regulation, such as MiFID II, unless the digital assets in question fell within the classification of certain other types of assets (such as transferable securities).

However, the HMT Consultation Response indicates that the UK government intends to legislate in order to ensure that such custodians are brought firmly within the regulatory regime. This legislation is intended to capture those who arrange for the custody of stablecoins used as a means of payment (eg, wallet providers). Such custody arrangements would then require authorisation by the FCA, subject to certain exclusions, which are yet to be determined.

The HMT Consultation Response states that the FCA will publish a detailed set of rules applicable to such stablecoin custodians, and notes that such custodians that meet the requirements of the Banking Act 2009 will be dual regulated by the FCA and the Bank of England.

Blockchain-based products and services can potentially conflict with several principles of the GDPR and the Data Protection Act 2018, including data subjects’ rights to request erasure or alteration of personal data, the right to be forgotten, and controllers' obligations to ensure the accuracy of personal data and retain personal information only for as long as needed.

Issues of data security, minimisation, international data transfers and conflicts with other data protection principles are also likely risks, particularly in public blockchain environments, given their global decentralised nature.

Following the publication of its new National Cyber Strategy on 15 December 2021, which placed blockchain as one of the seven key strategic technologies, the UK government has recently announced “ambitious, pro-growth and innovation-friendly” reforms in data privacy.

The authors speculate that the new regime may provide guidance and regulatory solutions to limit the potential for conflict between data privacy and blockchain, and build on the potential of blockchain solutions to enhance data privacy.

See 8.1 Data Privacy.

The "mining" of cryptocurrencies, whereby nodes within a given network compete to validate transactions and are rewarded for it through the application a "proof of work" consensus protocol, is permitted in the UK. It is not subject to any specific set of regulations but it is a crypto-asset-based activity that may attract a tax liability in the UK.

According to the HMRC Guidance on this topic, mining can either be taxable as income tax (miscellaneous income), or it will amount to taxable trade. Whether such activity amounts to taxable trade depends on a range of factors, such as the degree of activity, organisation, risk and commerciality.

As with mining, "staking" – whereby the node’s stake in the crypto-asset, as an alternative to proof of work, is determinative towards validating new transactions – is also unregulated in the UK at present. This extends to businesses that operate in this sector.

From a tax perspective, HMRC has largely brought staking within the same broad definitional parameters as mining (see 9.1 Mining).

DAOs have now been around for several years, and are a logical extension of the potentials of blockchain technology. However, whilst there have been notable and well-publicised examples of this blockchain application in the USA, the extent to which it has been taken up in the UK is unclear. The main reason for this is because DAOs remain outsiders from a legal perspective. As a result, the Law Commission launched a project on this subject in response to the UK government’s push in early 2022 to bring in a friendly crypto regime.

At present, DAOs are entirely unregulated as they fall outside the FCA’s authority and do not have legal personhood. An interesting question this raises, however, is whether some form of recognition of the latter will impact the status of the former.

Only time will tell what settlement is reached regarding the DAO concept, but it is clear that its fate is intimately intertwined with that of the underlying technology and its existing applications.

See 10.1 General and 10.2 DAO Governance.