Regulatory Discussion on Cryptoassets by FCA (Discussion Paper 25/1)

UK Financial Conduct Authority Takes Comprehensive Approach to Regulating Cryptoassets

The Financial Conduct Authority (FCA) in the UK is taking a comprehensive regulatory approach towards cryptoasset trading platforms, intermediaries, staking, and decentralized finance (DeFi), with a focus on investor protection, prudential standards, and compliance with financial crime rules.

Cryptoasset Trading Platforms (CATPs)

The FCA requires trading venues (exchanges) to be authorized as regulated firms, adhering to standards similar to traditional financial markets. This includes transparency requirements, conflict-of-interest rules, and protections for retail investors. Operating crypto exchanges and custody services falls under FCA oversight once platforms register as Virtual Asset Service Providers (VASPs). Platforms must comply with anti-money laundering (AML), counter-terrorist financing (CTF) rules, and sanctions compliance, including the use of blockchain analytics to detect illicit activity.

Cryptoasset Intermediaries

Intermediaries, such as brokers or dealers, are expected to follow best-execution rules to act in the client’s best interest. Payment for order flow is banned to avoid conflicts of interest. Lending and borrowing crypto to consumers could be heavily restricted, and there is a proposed ban on buying cryptoassets with credit cards to manage consumer risk.

Staking Activities

Staking activities are brought under FCA regulation as qualifying cryptoasset activities, requiring authorization and adherence to associated prudential capital and liquidity rules. Proposed capital requirements for authorized crypto firms include holding sufficient “own funds” distributed across common equity tier 1, additional tier 1, and tier 2 capital instruments, ensuring financial resilience.

Decentralized Finance (DeFi)

Decentralized systems with no controlling party are broadly exempt from FCA regulation because they lack an identifiable operator. However, if an entity controls or operates aspects of a DeFi platform, those activities may be regulated. The focus is on ensuring that regulated activities within DeFi ecosystems comply with financial promotion, AML, and market integrity rules.

Key Regulatory Requirements

Firms must obtain FCA authorization or registration as VASPs.
Adherence to AML/CTF compliance and safeguarding against sanctions violations is mandatory.
Prudential regulations require crypto firms to hold regulatory capital adequate to cover operational and market risks.
Financial promotions for cryptoassets must be clear, fair, and not misleading.
Reporting taxable crypto transactions to HMRC is required for platforms and consumers.

The FCA’s approach aims to build a "safe, competitive and sustainable" crypto sector by extending existing financial regulations to cryptoasset activities while considering unique crypto risks and innovations. Conflicts of interest must be mitigated or removed, and Payment for Order Flow (PFOF) is prohibited. CATPs should eliminate or manage conflicts of interest, and intermediaries will need to ensure orders are ultimately executed only on UK authorized execution venues.

The FCA requires CATPs to operate non-discretionary trading systems and proposes both pre-trade and post-trade transparency requirements. The FCA is considering a requirement that any cryptoasset needs to be admitted to trading on at least one UK authorized CATP before any intermediary can deal in it or arrange deals for UK retail customers. The FCA is considering whether crypto-specific rules or guidance on retail customer opting up practices are needed.

The FCA intends to provide more guidance on the obligations on Decentralised Finance (DeFi) and intends to hold a roundtable for industry participants and experts. The FCA is considering the best way to balance retail customers' participation with protecting their privacy and sensitive data in the crypto market. CATPs will require FCA authorization and will be subject to higher standards when there is retail access, algorithmic or automated trading, and market making activity. Intermediaries will need to comply with prompt, fair, and expeditious order execution, including the FCA’s best execution rules. The FCA is considering the necessity and exact nature of pre-post trade transparency for an intermediary.

The FCA has published a discussion paper to gather views on their approach to the cryptoasset regulatory framework. The discussion paper covers chapters on Cryptoasset Trading Platforms (CATPs), Cryptoasset Intermediaries, Cryptoasset Lending and Borrowing, restricting credit for crypto purchases, Staking, and Decentralised Finance (DeFi). The FCA is seeking views on the risks associated with CATPs admitting cryptoassets issued by affiliated entities or where the firm has a financial interest. The FCA is considering the location, incorporation, and authorization of CATPs, particularly for global crypto businesses with liquidity outside the UK.

[1] FCA Consultation Paper 23/2 (CP23/2) - Cryptoasset-related activities: regulatory framework [2] FCA Policy Statement 23/2 (PS23/2) - Cryptoasset-related activities: regulatory framework [3] FCA Consultation Paper 21/2 (CP21/2) - Cryptoassets: guidance for firms [4] FCA Policy Statement 21/2 (PS21/2) - Cryptoassets: guidance for firms [5] FCA Speech - Building a safe, competitive and sustainable cryptoasset sector

The Financial Conduct Authority (FCA) plans to regulate staking activities in the crypto industry as qualifying cryptoasset activities, requiring authorization and adherence to associated prudential capital and liquidity rules, much like finance and business sectors.
In the education-and-self-development sector, the FCA has published a discussion paper to gather views on their approach to the cryptoasset regulatory framework, covering various aspects such as cryptoasset trading platforms, intermediaries, staking, and decentralized finance.
For the casino-and-gambling and sports sectors, the FCA is considering the necessity and exact nature of pre-post trade transparency for an intermediary to ensure prompt, fair, and expeditious order execution, including adherence to the FCA’s best execution rules.