By Trevor Clawson.

The cryptocurrency investment market has attracted its fair share of dubious or fraudulent operators. For instance, earlier this month, the Financial Conduct Authority issued a warning to investors about the activities of a so-called ‘clone’ company calling itself Cryptobourse. Although not authorised to sell financial services in the UK, the company had taken – or cloned –  the registration details of a fully-regulated provider in order to present itself as a legitimate undertaking. Warning investors to be wary of cold calls from fraudsters, the FCA went on to list other clone companies claiming to work in the cryptocurrency investment space.

The presence of this kind of fraudulent activity is probably an indicator of just how much interest there is in cryptocurrencies as an investment opportunity – certainly enough to attract the scammers.  And perhaps comfortingly, the FCA’s warning is a reminder that regulators are taking a close interest in the risks to consumers.

It’s an interest that’s set to become more intense in the coming months if a report from the Cryptoassets Taskforce is put into action. Against a background of volatile virtual currency prices – the fluctuating Bitcoin being the most obvious example – and growing interest in investment via tradeable tokens, the Taskforce has been deliberating on what regulation of so-called crypto assets could and should look like in the near future. And by the end of 1919, everyday investors and consumers may be locked out of some of the more complex investment opportunities.

A Circle to Square

To many of us, cryptocurrencies exist only on the periphery of our financial radar screens. But to others, the proliferation of virtual currencies and tokens is offering a new way to transact and an expanding universe of investment products. The tough challenge facing regulators has been to work out ways to protect consumers without suffocating innovation in the financial services market.

Enter the  Cryptoassets Taskforce – a body set up in March 2018 and comprised of officials from the  Bank of England, the Treasury and the Financial Conduct Authority. The role of the Taskforce was to assess the impact of the  ‘distributed ledger technology’ – blockchain to its friends – that has underpinned the growth of virtual currencies.

The Taskforce had a tricky circle to square. On the one hand, the UK government and its agencies are keen to encourage the kind of innovation that will maintain Britain’s position is a global financial hub. But on the other hand,  regulators are in the business of protecting investors while maintaining the stability and integrity of the financial system.

Protecting The Investor

 Tighter Bitcoin Era Regulation On The Horizon But Is It Needed?

So how can that be done? Well, in terms of investor protection, the problem highlighted by the task force is not necessarily that increasing numbers of people have stashed away bitcoins in the hope that their value will grow and, thus,  provide a financial umbrella for a rainy day. In addition to this fairly straightforward, if uncertain, kind of investment, financial services firms are developing so-called derivative products. In theory, these are meant to reduce the risks of investment by packaging assets – for instance, cryptocurrencies – within contractual agreements. In practice, derivatives can complex and difficult to understand. More importantly, the TaskForce view is that cryptocurrency based assets could be highly risky.

So the Taskforce has given a strong indication that ‘retail investors – or to put another way,  those of who are not particularly wealthy or financially literate  – should be prohibited from buying complex products based on cryptocurrencies. This aspect of the regulatory framework could be put together as early as 2019.

Is Regulation Necessary?

But is regulation necessarily the way to deal with the ‘risk’ problem. Edan Yago is founder and CEO of CementDAO, a platform that is being developed to offer cryptocurrencies that are roughly pegged to conventional currencies such as the dollar. Yago acknowledges that the virtual currency explosion has posed risks to investors but he doesn’t necessarily believe that an extension of regulation is the way forward.

“What we saw was a kind of mass hysteria around investing in crypto last year,” he says. “That’s something that happens every few years. It makes sense to protect investors. But I don’t think we need new regulations. What regulators should be doing is enforcing the regulations that they already have.” 

Or to put it another way, while blockchain technology is understood by relatively few people – a computer science degree and a solid understanding of the financial markets will always help – the crucial protection for investors is that they are given honest information when they are being sold an investment product. Yago says those protections are already in place.

“If you are misleading an investor or withholding information from an investor, then it is clear that you are doing something wrong and at that point, the authorities can take action,” he says.

Commenting on the report, Matt Hopkins of accountancy firm BDO Financial Services took a similar view.

“Although cryptocurrencies remain unregulated  – in reality, a significant number of directly attributable and complementary activities already are,” he said.

There is, however, likely to be a further tightening of the rules.  While the blockchain ledgers than underpin cryptocurrencies operate globally – and are therefore to some extent out of the reach of national jurisdictions, anyone buying into bitcoins or signing up to an investment product linked to a cryptocurrency will often be transacting with parties who are local or at least identifiable. These include wallet providers,  exchanges where coins can be traded, financial intermediaries and brokers and payments provider.  Again, looking ahead to 2019, the Taskforce is promising proposals as to how these market players can be regulated more effectively.

Business Models

Regulating the new and potentially groundbreaking innovations that may emerge from the blockchain sector is another matter. Yago’s main concern is that governments – not just in the UK – will also try to regulate the rapidly evolving business models that we are seeing in the crypto-currency space. He cites the example of the evolution of e-commerce. As new commercial models were developed, it was notoriously hard for analysts to evaluate the potential of young companies by using conventional measures, he says. As a result, some businesses were overvalued others were underestimated. Yago says similar mistakes could be made by regulators trying to assess the risks associated with, say, a crypto-based investment product.

“The assessment tools aren’t really there,” he adds.

Money Laundering

In addition, the Taskforce Report has promised measures to crack down on illicit activities, such as money laundering or criminal transactions. Arguably this is likely to be most difficult area to deal with at a national level as movements of virtual cash via blockchain based systems take place across of a globally distributed ledger and out of sight of national police authorities. This points to a need for international measures.

“The ever-increasing role of global regulation in financial crime but also wider Fintech regulation cannot be underestimated,” noted Hopkins.

The blockchain world – occasionally described as the wild west –  may be a little bit tamer in 2019 and beyond. Some investments may not be available to the majority of us and in terms of openness and transparency, there are likely to be more protections in place. The question remains, can that be done without stifling innovation.