13 Nov 2020

The Legal 500: Blockchain Country Comparative Guide 2020 - UK chapter

The Blockchain Country Comparative Guide aims to provide an overview of the law and practice of blockchain law across a variety of jurisdictions. This chapter relates to UK law.

  1. Please provide a high-level overview of the blockchain market in your jurisdiction. In what business or public sectors are you seeing blockchain or other distributed ledger technologies being adopted? What are the key applications of these technologies in your jurisdiction?

Distributed ledger technologies (“DLT”) are emerging in diverse sectors across the United Kingdom (“UK”), from financial technology to security, energy, entertainment, healthcare, cryptocurrency trading, transport and logistics, real estate and the “Internet of Things”. Financial services is a key area of strength and focus, as both financial institutions and government bodies explore the potential efficiencies that blockchain could bring to the clearing process, identity checks, settlement systems and payment systems. The COVID-19 pandemic has also incentivised governments to explore new uses of blockchain, as we consider further at question 3 below.

There are currently, however, few applications which are developed beyond a proof of concept stage. While there has been a degree of engagement with cryptocurrencies on the retail side—with cryptocurrency trading companies reportedly dominating the UK retail blockchain industry—this uptake is yet to translate into more than a handful of retailers accepting cryptocurrency as a means of payment. On the wholesale side, financial institutions have exhibited a degree of latency, owing perhaps in part to the legacy reputational issues surrounding the Bitcoin blockchain and uncertainty about how legal and regulatory frameworks will apply. Despite this, some financial institutions have begun to take more decisive steps to use the technology—particularly now that the views of the UK’s financial regulators are beginning to crystallise—and we have observed an increasing number of use cases being trialled in the market. Perhaps the most concrete gains to date are to be found outside of financial services in the area of supply chain management, as businesses look to increase transparency, coordination and efficiency across their supply chains, and both businesses and individuals increasingly place a premium on the responsible and ethical resourcing of products and assets.

The blockchain market may evolve now that the UK has left the European Union (the “EU”). The UK Government has emphasised that Britain will be the natural global home of new and innovative financial services after Brexit, and there are many who believe that the UK will be in a unique position to boost its financial services industry by positioning itself as a blockchain jurisdiction. How this might take shape is, however, unclear at this early stage.

  1. To what extent are tokens and virtual assets in use in your jurisdiction? Please mention any notable success stories or failures of applications of these technologies.

The majority of projects utilising blockchain in the UK remain in their infancy, although many appear promising. In the financial services sphere, a good number of firms have passed through the Financial Conduct Authority’s (“FCA”) Regulatory Sandbox (discussed in further detail at question 6 below), to test how DLTs might improve existing processes such as the issuance of short-term debt instruments.

A number of large-scale international blockchain projects involving global financial institutions also have a UK nexus. A notable example is the Libra payment system, which seeks to offer stablecoins in a number of jurisdictions including the United Kingdom in a manner that complements existing fiat currencies. Stablecoins are discussed further at question 4. Another key example is Fnality International (previously known as Utility Settlement Coin), a UK-based project which is backed by a consortium of financial institutions led by UBS. Fnality is developing tokenised versions of five major fiat currencies, and reportedly raised £50 million in June 2019 from 14 shareholder banks. Owing to outstanding regulatory approval, the project is likely to be commercialised by the first quarter of 2021. UK-based banks have also invested in blockchain technologies. For instance, Lloyds Bank has announced that it is developing the use of blockchain in trade finance operations with the aim of digitising their entire commodity trade finance process, while also making it possible for businesses to exchange data and other documents (including letters of credit) faster.

Encouraging progress has also been made in other sectors. Established industry players have been exploring how they might use blockchain to their advantage, such as UK energy supplier Centrica which has been investigating how peer-to-peer energy trading on a blockchain platform could reduce customer bills. The UK has also proven fertile ground for a number of successful start-ups, including: Provenance, a digital platform which seeks to provide businesses with greater transparency by tracking products along their supply chains; Zamna, a blockchain-powered service which streamlines airport check-in by enabling airlines or government agencies to verify identity quickly; and Medicalchain, a decentralised platform that enables the secure, fast and transparent exchange and use of medical data. Automakers, particularly of electric vehicles, are also harnessing blockchain technology in order to ensure that the materials and individual components they use are ethically sourced. For example, Volvo is using blockchain technology to track the supply of cobalt from the mine into the car itself.

The UK Government and various regulators have themselves also trialed the integration of blockchain technologies into their own processes, which we discuss further at question 5 below.

As yet, there have been no heavily publicised failures of blockchain technologies in this jurisdiction. This is likely a by-product of the nascent nature of blockchain-related applications here in the UK.

  1. Has COVID-19 provoked any novel applications of blockchain technologies in your jurisdiction?

The UK government and many UK-based businesses are exploring the potential uses of DLT in the current COVID-19 crisis.

In June 2020 Innovate UK—a government-led agency that supports businesses in developing and realising the potential of new ideas—awarded the Polish-British Billion Group a £50,000 grant to build a distributed ledger platform to store COVID-19 related certificates to support workers’ safe return to the workplace. Using this platform, which Billion will design to comply with data privacy legislation, employers could certify essential standards for returning to work. For example, they could verify that a worker has completed specialised training, or has received a vaccine.

On the financial services side, on 5 May 2020 the FCA announced its intention to pilot a “Digital Sandbox” which will provide enhanced support to innovative firms tackling challenges caused by the pandemic. The sandbox is intended to allow firms to test and develop proofs of concept in a digital testing environment, and enable greater collaboration to solve complex industry-wide problems.

Finally, on 6 June 2020, techUK—a UK technology membership organisation—launched an online discussion on the value of blockchain during and post COVID-19. It identified areas in which blockchain technology could potentially be harnessed by governments to cope with the pandemic, including healthcare (i.e. medical credentialing) and supply chain implementation (i.e. procurement for PPE and tests.)

Legal and regulatory framework

  1. Please outline the principal legislation and the regulators most relevant to the use of blockchain technologies in your jurisdiction. In particular, is there any blockchain-specific legislation or are there any blockchain-specific regulatory frameworks in your jurisdiction, either now or envisaged in the short or mid-term?

There is no blockchain-specific legislation or regulatory rules addressing blockchain technologies in the UK. The FCA has, however, prohibited the marketing, distribution or sale—in or from the UK—to all retail clients of derivatives and exchange traded notes (“ETNs”) that reference certain types of unregulated, transferable cryptoassets. These rules, contained in PS20/10 and published in October 2020, come into force on 6 January 2021 and we discuss them further at question 10.

It is incorrect to assume that applications of blockchain that sit outside of this ban are outside the scope of existing legal and regulatory regimes. There are several touch points where—depending on the precise nature of the application—existing frameworks will be engaged.

An immediate example of such a touch point is the fifth Money Laundering Directive as implemented in the UK (“MLD5”). This explicitly references the blockchain architecture surrounding cryptocurrencies, bringing virtual currency exchange platforms and custodian wallet providers within the scope of anti-money laundering regulation such that they will be required to implement anti-money laundering (“AML”) and counter terrorist financing (“CTF”) policies, controls and procedures, and will be subject to reporting requirements.

Other areas of UK law which are technology neutral but which may be engaged by a blockchain application include data protection, property law, tax, insolvency law, privacy law, payment services and e-money regulations, intellectual property law, and rules regarding financial promotions (which may be engaged on an Initial Coin Offering or “ICO”). Applications of blockchain technologies may also fall within the perimeter of investments and activities regulated by the FCA and the Prudential Regulation Authority (“PRA”). For example, in April 2018 the FCA confirmed that cryptocurrency derivatives are capable of being financial instruments under the Markets in Financial Instruments Directive II (“MiFID II”) and so dealing in, arranging transactions in, advising or providing other similar services in relation to derivatives that reference either cryptocurrencies or tokens issued through an ICO could require authorisation from the FCA. The FCA has, moreover, recently confirmed that certain types of cryptoassets will fall within its regulatory regime (discussed in further detail at question 9 below). Notably, cryptocurrencies such as Bitcoin currently remain outside of the regulatory perimeter.

Casting forwards, there are signs that the UK’s legal and regulatory regimes may be expanded to embrace a broader range of blockchain applications in the near future.

The UK is in a somewhat transitional phase as the legislature seeks to establish legal principles from which to approach blockchain technologies. Most significantly in this area, the UK Jurisdiction Taskforce (“UKJT”)—a body which brings together the Judiciary, the Law Commission of England and Wales and technology and legal professionals—published a legal statement which seeks to provide answers to critical legal questions as regards the status of cryptoassets and smart contracts under English and Welsh private law on 18 November 2019. This includes consideration of: (i) the ability of cryptoassets to be characterised as personal property; and (ii) the circumstances in which a smart contract is capable of giving rise to binding legal obligations. This legal statement was referenced and found to be compelling in a recent case heard in December 2019 in the High Court of England and Wales (“EWHC”), AA v Persons Unknown, and is likely to provide the foundation for further evolution of the UK’s legislative approach to blockchain technologies.

In addition, Her Majesty’s Treasury (“HMT”) is currently considering: (i) bringing further cryptoasset service providers within the scope of the UK AML and CTF regime; (ii) bringing the promotion of certain “qualifying cryptoassets” within the scope of the financial promotions regime (discussed further at question 7 below); and (iii) examining whether the regulatory perimeter needs to be expanded to include more categories of (currently unregulated) cryptoassets. Historically, both the FCA and PRA have taken a “technology neutral” approach to regulation, meaning the use of new technology alone has not affected how they make judgements, but this may be subject to change following HMT’s review.

This interest in expanding the regulatory perimeter coincides with increased attention on the role of so-called ‘stablecoins’ within the economy, and how their attendant AML and CFT risks should be managed. While there is no settled definition of a stablecoin, they have been defined by the Financial Stability Board (“FSB”) as a type of cryptoasset that aims to maintain a stable value relative to a specified asset, or a pool or basket of assets. Taking its cue from global reports such as that of the Financial Action Task Force (“FATF”) to the G20 on stablecoins in June 2020, the Financial Policy Committee of the Bank of England (“BoE”) has observed in its most recent report, in August 2020, that the current regulatory framework requires adjustment in order to accommodate the innovations posed by stablecoins. This sentiment was echoed by Andrew Bailey, Governor of the BoE, in his speech on stablecoins in September 2020, and by HMT in its July 2020 consultation paper on cryptoasset promotions (although HMT expects such adjustment to be minimal). Any legislative or regulatory change is likely to take into account the findings of an FSB report, published in October 2020, which contains recommendations to address the regulatory, supervisory and oversight challenges raised by global stablecoin arrangements. Notably, this report calls for national authorities to implement these recommendations—which include regulating, supervising, overseeing and, if necessary, prohibiting stablecoin activities—by July 2022.

Taking this together, a broadening of the UK’s legislative framework to encompass a wider range of cryptoassets seems likely. This is further suggested by recent legislative proposals put forward by the European Commission in September 2020, which seek to take a comprehensive approach to the regulation of cryptoassets (including stablecoins) which are currently not covered by existing EU financial services legislation. The proposed framework establishes uniform rules in relation to the authorisation and supervision of cryptoasset issuers and service providers, and will bring significant stablecoins under government control. While the UK will not be required to implement any resultant EU legislation, it will undoubtedly influence the UK’s approach.

  1. What is the current attitude of the government and of regulators to the use of blockchain technology in your jurisdiction?

To date, the UK Government and regulators have taken a balanced and flexible approach to the use of blockchain technology. Both have recognised that this technology has the potential to deliver significant benefits and have voiced support for its development, with the UK Government notably establishing an All-Party Parliamentary Group on Blockchain in January 2018 to ensure that industry and society benefit from the full potential of blockchain. Both have also stressed the need for caution, emphasising the need to manage the range of risks observed in the cryptoasset market, and to ensure that UK financial markets remain safe and transparent.

It is this measured approach which saw the FCA prohibiting the sale of certain investment products referencing cryptoassets (discussed in further detail at question 10 below), while also supporting tests of blockchain technology within its Regulatory Sandbox; or indeed, BoE and HMT undertaking analytical work to evaluate the risks and opportunities involved in the creation of a UK central bank digital currency (discussed at question 7 below) while issuing a strong statement in October 2019 that Libra will need to meet the highest standards of resilience, and be subject to appropriate supervisory oversight.

Both the UK Government and regulators have, moreover, explored how blockchain technology might be used to improve their own internal processes. For example, in addition to the examples relating to the COVID-19 pandemic highighted at question 3, in 2016 the UK Government tested the use of a blockchain-based system to distribute welfare payments. Her Majesty’s Land Registry (“HMLR”) has also been looking at the possibility of tokenising UK real estate on a blockchain to reduce friction in real estate transactions, and in April 2019 demonstrated an end-to-end proof of concept real estate transaction using blockchain technology that took less than 10 minutes to complete.

  1. Are there any governmental or regulatory initiatives designed to facilitate or encourage the development and use of blockchain technology (for example, a regulatory sandbox)?

There are several initiatives in the UK designed to encourage the development of blockchain technology, concentrated in the financial services sector.

Innovate UK has invested over £10 million in blockchain projects focused on energy distribution, clean water provision, electoral systems and maximising value from items donated to charity. The UK Government has also created a £20 million GovTech Catalyst Fund to explore technology based solutions for public sector challenges, potentially including the use of DLT.

The FCA began its own innovation project in 2014, which consists of a Regulatory Sandbox, an Innovation Hub and a Global Financial Innovation Network (“GFIN”). This is in addition to FCA’s Digital Sandbox launched in May 2020 in response to the pandemic, further described at question 3 above. The Regulatory Sandbox allows businesses to test innovative products, services, business models and delivery mechanisms with real consumers in a controlled environment. The FCA’s Innovation Hub provides a means by which new and established businesses—both regulated and non-regulated—can introduce innovative financial products and services to the market, with support from the FCA on the application of the regulatory framework. The GFIN was launched in January 2019 in collaboration with 38 other financial regulators. It creates a new framework for cooperation, promoting information and knowledge sharing amongst regulators on emerging innovation trends, tests, initiatives and policies. It also provides firms with an environment in which to trial cross-border solutions. Finally, in 2019 the FCA consulted on whether a cross-sectoral sandbox or similar mechanism is needed to ensure a consistent and efficient approach to emerging technologies.

The BoE has a Fintech Hub through which it seeks to understand what fintech means for the stability of the financial system, the safety and soundness of financial firms and its ability to perform its operational and regulatory roles. Between 2016 and 2018, the BoE has supported four DLT focused proofs of concept with firms to understand how new technologies are being adopted and how they might relate to its objectives.

In 2019 the Information Commissioner’s Office, the main data privacy regulator in the UK, launched a sandbox to support organisations who are developing products and services that use personal data in innovative and safe ways, including organisations that utilise blockchain.

  1. Have there been any recent governmental or regulatory reviews or consultations concerning blockchain technology in your jurisdiction and, if so, what are the key takeaways from these?

Following consultation in January 2019, the FCA published guidance in a Policy Statement (FCA Policy Statement 19/22, (“PS19/22”)) in July 2019 seeking to clarify the regulatory perimeter for market participants carrying on activities in the cryptoasset market. The aim of the guidance is to enable participants to be clear on where they are conducting activities that require authorisation. The guidance examines three different categories of cryptoassets—exchange, utility and security tokens—and considers whether they can fall within the established regulatory perimeter. As explored in further detail below at question 9, it concludes that security tokens are within the regulatory perimeter, and that utility tokens may meet the definition of e-money in some circumstances and so fall to be regulated. It also observes that the UK Payment Services Regulations (which implement the EU’s Second Payment Services Directive) may apply to international money remittance where exchange tokens are used.

More recently, in July 2020 HMT launched a consultation on proposals to bring the promotion of certain “qualifying cryptoassets” within the scope of the financial promotions regime. A “qualifying cryptoasset” is defined as “any cryptographically secured digital representation of value or contractual rights” that uses a form of DLT and which is fungible, transferable and does not fall within other regulated buckets, such as e-money, and is not a central bank currency.

At a high-level, such a change would mean that in the UK most unrestricted marketing or promotion of exchange tokens (such as a cryptocurrencies) and utility tokens would be a criminal offence unless approved by an authorised person under the Financial Services and Markets Act 2000 (“FSMA”). When carried out by an authorised person, the marketing or promotion would need to be clear, fair and not misleading and comply with other rules governing promotions of financial products. The aim is to protect consumers from misleading advertising and trading in these assets without adequate information as to the relevant risks. The proposed change is currently only focussed on promotions, but the FCA notes that further analysis is required to determine whether it is appropriate for the FCA to regulate cryptoasset trading activities themselves. The outcome of the consultation is expected to be published in 2021.

In March 2020 the BoE launched a discussion paper on the potential introduction of a central bank digital currency (“CBDC”). The paper considers both the challenges and opportunities presented by CBDCs, and emphasises that the BoE has not yet made a decision on whether to introduce a CBDC. This hesitancy was echoed in a recent speech given by Andrew Bailey, governor of the BoE, in September 2020. There he observed that a CBDC, while offering much potential, also raises profound questions about the shape of the financial system, the implications for monetary and financial stability and the role of the central bank. Any steps to issue a CBDC is likely to take into account a report published by a group of central banks (including the BoE, Bank of Canada Federal Reserve and the European Central Bank), and the Bank for International Settlements in October 2020 concerning the foundational principles of CBDCs, which underscores attendant financial stability implications.

At the consumer level, in March 2019 the FCA published research exploring consumer attitudes to, and awareness of, cryptocurrencies. The FCA identified four main findings: (i) many consumers see cryptoassets as a fast-track to easy wealth; (ii) many consumers may not fully understand what they are purchasing; (iii) there are signs that cryptoassets are accompanied by risky behaviours; and (iv) anecdotal evidence about cryptoassets may overstate their potential harm. This was followed up by the publication of a quantitative research publication in June 2020, in which it was estimated that 3.86% of the general population currently own cryptocurrencies, and that the most popular reason for consumers buying cryptocurrencies was as a speculative investment.

These are in addition to the consultations and reviews identified in question 4 above, that is: (i) the UKJT’s legal statement which will consider the ability of cryptoassets to be characterised as personal property, and the circumstances in which a smart contract is capable of giving rise to binding legal obligations; and (ii) HMT’s review of the regulatory perimeter. Much of this work has been informed by previous FCA discussion papers, as well as a paper published in October 2018 by the Cryptoassets Taskforce (which brought together HMT, the FCA and the BoE in order to develop an approach to cryptoassets and DLT) and an inquiry into digital currencies and DLT launched by the House of Commons Treasury Committee in February 2018, culminating in a report published in September 2018.

  1. Has any official guidance concerning the use of blockchain technology been published in your jurisdiction?

In June 2018 the PRA wrote to CEOs of UK-authorised banks, insurance companies and large complex investment firms to emphasise the risks associated with cryptoassets—namely high price volatility, relative illiquidity, and concerns related to misconduct and market integrity—and set out those risk strategies and management systems that the PRA considers most appropriate to cryptoassets business activities. These include firms considering the risks relating to crypto-exposures in their capital and solvency assessments, and ensuring they have an appropriate risk management approach.

The UK’s tax authority, Her Majesty’s Revenue and Customs (“HMRC”), has published guidance, last updated in December 2019, on the tax treatment of cryptoasset exchange tokens for individuals and businesses (including sole traders and partnerships). HMRC does not consider cryptoassets to be money or currency, but rather assets that can be invested or traded. As a result, transactions in cryptoassets by an individual will normally be an investment activity and subject to capital gains tax (“CGT”) (and, in certain circumstances, Income Tax and National Insurance contributions). Transactions in cryptoassets by businesses may be subject to a number of different taxes depending on the activity involved, including Capital Gains Tax, Corporation Tax, Income Tax, National Insurance contributions and Stamp Taxes. VAT will be due in the normal way on any goods or services sold in exchange for Bitcoin or other similar cryptocurrency. Further detail on the tax treatment of cryptoassets is set out at question 9 below.

More recently, in July 2020 the Joint Money Laundering Steering Group (which encompasses the leading UK financial services trade associations) updated its guidance on the prevention of money laundering and terrorist financing in the UK financial services sector to include new guidance for cryptoasset exchanges and custodian wallet providers. This guidance was approved by HMT in August 2020.

This guidance is in addition to PS20/10 (referenced in question 4 above), PS19/22 (referenced in question 7 above), and to EU guidance which—although the UK has left the EU—will apply until the expiry of the implementation period on 31 December 2020 and may continue to be helpful even after that date. The European Banking Authority (“EBA”) has published a number of useful reports, including an assessment of the applicability and suitability of EU law to cryptoassets (January 2019) and an opinion on virtual currencies (July 2014). The European Securities and Markets Authority (“ESMA”) has also published helpful advice on ICOs and cryptoassets (January 2019). In June 2019 the FATF—the global standard setting body responsible for measures to combat money laundering and terrorist financing—adopted binding global standards for the regulation of virtual asset financial activities and virtual asset service providers, which cover transfers of virtual assets, safekeeping and administration of virtual assets and ICO issuances. Finally, the International Organization of Securities Commissions (“IOSCO”) has, in February 2020, published a report describing the issues and risks associated with cryptoasset trading platforms, and sets out key considerations to assist regulatory authorities in addressing these issues.

Cryptocurrency

  1. What is the current approach in your jurisdiction to the treatment of cryptocurrencies for the purposes of financial regulation, anti-money laundering and taxation? In particular, are cryptocurrencies characterised as a currency? 

For the purposes of financial regulation, the FCA has adopted three categories for the classification of cryptoassets: (i) exchange tokens, which are not issued or backed by a central authority and are intended to be used as a means of exchange; (ii) security tokens, which are tokens amounting to a debt and/or equity interest; and (iii) utility tokens, which can be exchanged by the holder for the use of a digital resource (such as use of a network, digital storage, computing power or an application). The classification of a particular cryptoasset will depend on the features of the particular asset and may change over time. Cryptocurrencies (such as Bitcoin or Litecoin) are generally classified as exchange tokens.

The FCA’s current position, articulated in PS19/22, is that exchange tokens (including most cryptocurrencies) and most utility tokens are usually outside the FCA’s regulatory remit. However as referenced at question 10 below, in October 2020 the FCA published new rules—to take effect on 6 January 2021—banning the marketing, distribution or sale to retail consumers of derivatives and ETNs that reference certain types of cryptoassets. Additionally, utility tokens which amount to “e-money” may be regulated under the UK’s E-Money Regulations, and the UK’s Payment Services Regulations may apply to international money remittance where exchange tokens are used. HMT is currently considering whether the regulatory perimeter should be expanded to bring exchange tokens and utility tokens within the remit of the FCA. At the moment, most cryptocurrencies would fall outside the scope of financial regulation in the UK.

MLD5, the majority of which came into force in the UK on 10 January 2020 via amendments to the Money Laundering, Terrorist Financing and Transfer of Funds (Information on the Payer) Regulations 2017 (“MLRs”), requires all cryptoasset exchanges and custodian crypto-wallet providers to comply with AML regulations, including registering with the FCA, implementing identity and other AML checks. They must also clearly disclose to customers where a cryptoasset activity is not covered by the Financial Ombudsman Service or the Financial Services Compensation Scheme (as most cryptocurrency transactions will not be so covered).

For tax purposes, cryptoassets (including cryptocurrencies) are generally regarded by HMRC as capital assets that are subject to CGT. Therefore, subject to various exemptions and deductions, when a cryptoasset is disposed of (including where it is used to purchase something, where it is sold for a fiat currency or where it is exchanged for another cryptoasset), any increase in value (by reference to Pounds Sterling) over the period that the asset was held, will be a capital gain on which the person or entity disposing of the asset will have to pay CGT. Any loss of value over that period will be a capital loss which can off-set any other capital gains the person or entity may have.

For VAT, in line with the Court of Justice of the European Union’s decision in the 2014 Skatteverket v David Hedqvist case, the position adopted by HMRC is that the exchange of a cryptocurrency for a fiat currency is a transaction that is exempt from VAT (as are financial services provided by a cryptocurrency exchange in facilitating the exchange of a cryptocurrency for a fiat currency or other exchange tokens). Where a cryptocurrency is used to pay for goods and services, VAT will still be chargeable in the normal way on the supply of those goods or services, but will not be due on the supply of the cryptocurrency itself. Cryptocurrency received from mining activities or other rewards for participating in a cryptocurrency network is not generally subject to VAT, but will usually be treated as miscellaneous income for the purposes of income tax.

If the cryptoasset activities of a person or business amount to taxable trading, Income Tax will be applied to their trading profits. Transactions involving cryptoasset exchange tokens that are undertaken by businesses may, depending on the activity being undertaken, attract further taxes such as Corporation Tax, National Insurance contributions and Stamp Taxes. 

On the question of characterisation, the dominant (although by no means the only) view in the UK appears to be that cryptocurrencies are not considered to be “currency” or “money”. This is, at least, the position adopted by the Cryptoassets Taskforce. This point has not yet received judicial attention and may be subject to change, although the view of the Cryptoassets Taskforce is persuasive.

However, in UK law the consequences of cryptocurrencies not being characterised as currency are less significant than one may assume. For example, while cryptocurrencies are treated as capital assets for tax purposes, this is similar to the approach taken in the UK to all foreign currency. Subject to various exemptions (such as certain personal expenses) and deductions, when foreign currency is disposed of (spent), changes in the value of that currency by reference to Pounds Sterling will be treated as capital gains or losses for the purposes of CGT. Additionally, in terms of asserting or exercising legal rights over cryptocurrencies, much more turns on whether or not a cryptocurrency can be characterised as property (considered further below) than whether it is characterised as currency.

  1. Are there any prohibitions on the use or trading of cryptocurrencies in your jurisdiction?

There are currently no specific prohibitions on the use or trading of cryptocurrencies in the UK.

However, the FCA has instituted a ban—effective from 6 January 2021—on the marketing, distribution or sale to retail clients of certain investment products (such as derivatives and ETNs) which reference cryptoassets. The FCA is of the view that retail consumers cannot reliably assess the value of these products because: (i) the underlying cryptoassets have no reliable basis for valuation; (ii) there is a prevalence of abuse and financial crime in the secondary market for cryptoassets; (iii) there is extreme volatility in cryptoasset prices; and (iv) retail consumers have an inadequate understanding of cryptoassets and there is a lack of a clear investment need for investment products referencing cryptoassets. The FCA has estimated that the harm to retail consumers that could be reduced by implementing this ban in the UK is in the range of £75 million to £234.3 million per year.

Additionally, as discussed in more detail in questions 4 and 9: (i) the MLRs require cryptoasset exchange providers and crypto-wallet providers to register with the FCA, comply with AML checks and make certain disclosures to customers; and (ii) HMT is also currently consulting on a proposal to regulate promotions of certain cryptoasset investments.

  1. To what extent have initial coin offerings taken place in your jurisdiction and what has been the attitude of relevant authorities to ICOs?

There are no outright prohibitions on launching an ICO in the UK, although, depending on the particular ICO, various regulations may apply (as further described in question 12 below).

In terms of the UK market: in the peak period of ICOs in early 2018, according to a report by PWC in collaboration with Crypto Valley, the UK was in the top 5 countries globally (based on funding volume) for launching ICOs. In line with the global trend, the market for ICOs declined significantly during 2018—the so-called “crypto winter”. However, more recently the market appears cautiously to be growing again, with the focus shifting away from ICOs involving the launch of unbacked cryptocurrencies towards more stablecoins, security tokens and utility tokens.

The advent of ICOs has seen the UK authorities adopt a relatively sceptical approach, urging caution on the part of investors. In September 2017, the FCA issued a consumer warning about the risks of ICOs advising consumers that ICOs are “high-risk, speculative investments” and that “[y]ou should only invest in an ICO project if you are an experienced investor, confident in the quality of the ICO project itself (e.g. business plan, technology, people involved) and prepared to lose your entire stake.” The warning goes on to highlight that this is an unregulated space, there is no investor protection, the value of tokens tends to be extremely volatile, there is a high potential for fraud, there is usually inadequate documentation for many of these projects and many of the projects are very early stage, meaning “[t]here is a good chance of losing your whole stake.” 

The House of Commons Treasury Committee echoed such sentiments in its September 2018 report on cryptoassets, emphasising that “[c]rypto assets and ICOs are extremely risky” and the PRA and the Cryptoassets Taskforce share largely the same concerns. Indeed, as highlighted at question 8, the PRA has written to the CEOs of banks, insurance companies and designated investment firms to emphasise the risks associated with cryptoassets, enjoining firms to consider the risks relating to crypto-exposures in their capital and solvency assessments, and ensure they have an appropriate risk management approach.

  1. If they are permissible in your jurisdiction, what are the key requirements that an entity would need to comply with when launching an ICO?

ICOs as such are not regulated in the UK, in that there are no overarching laws imposing legal and/or regulatory requirements on the activity of launching or running an ICO. As a result, whether an ICO will be subject to regulatory requirements is determined on a case-by-case basis. It is worth highlighting that all ICOs will be subject to generally applicable laws such as those concerning taxation, the sale of goods, trading standards, and laws preventing the deception of consumers/investors.

Where an ICO is of a cryptocurrency which functions like Bitcoin or Litecoin—that is, an exchange token—the UK’s regulatory perimeter is not engaged (as further detailed at question 9 above), and no regulatory requirements apply. Subject to the application of the UK’s E-Money Regulations, the position is the same for utility tokens. Where a utility token does constitute e-money, however, the issuance may itself be a regulated activity for which authorisation or registration is required. A known problem that has been reported, moreover, is that security tokens are occasionally dressed up as utility tokens.

Organisations looking to raise money by means of an ICO would usually be looking to do so by way of selling debt and/or equity (i.e. shares in, or a right to profits of, the organisation). In these cases, the token will almost certainly be regarded as a security token and thus subject to financial regulation as a security. This means that the issuer will have to comply with, for instance, AML requirements, restrictions on financial promotions, and may be required to comply with prospectus and disclosure and transparency obligations. A company will not usually need regulatory permissions to act as an issuer of its own security tokens, but other market participants involved in an ICO, such as consumer advisers and brokers, may require authorisation or registration.

It is possible that further regulatory requirements will be imposed on ICOs in future. The House of Commons Treasury Committee, in its report published in September 2018, recommended that the FCA should be given more power to control how crypto-exchanges and ICO issuers market their services by bringing the activities they perform into the regulatory perimeter. Finally, as discussed in question 7, in July 2020 HMT published a consultation paper proposing that the FCA’s regulatory perimeter be expanded to include the promotion of certain cryptoassets, which would increase the regulation around ICOs in the UK.

  1. Is cryptocurrency trading common in your jurisdiction? And what is the attitude of mainstream financial institutions to cryptocurrency trading in your jurisdiction?

According to the BoE in a submission from May 2018, cryptocurrencies are not widely accepted as a means of payment in the UK, with no major UK high street or online retailer accepting the most common cryptocurrency Bitcoin. While the BoE estimates that around 500 independent stores do accept Bitcoin, this amounts to an average of less than one per town in the UK.

Investment and trading in cryptocurrencies is likely somewhat more common, though, with a number of large cryptocurrency exchanges offering direct exchange of Pounds Sterling for Bitcoin and other cryptocurrencies. According to Coin ATM Radar, there are also 275 Bitcoin ATMs in the UK. It is therefore relatively simple for individuals and organisations to buy and trade cryptocurrencies. While the pseudonymity afforded by most cryptocurrency networks means it is difficult to compile geographical statistics on cryptocurrency investment, the Cryptoassets Taskforce in its October 2018 report noted that online consumer surveys had found that 5-10% of respondents reported owning cryptoassets, with the figures for the general population likely to be lower.

As highlighted at question 7 above, FCA consumer research published in June 2020 indicates that 3.86% of the general population own cryptocurrencies, which amounts to approximately 1.9 million adults in the UK. The report also highlights a statistically significant increase in those who hold or held cryptocurrencies from 3% in the 2019 FCA Consumer Research to 5.35% in 2020. This represents an increase from approximately 1.5 million people to 2.6 million people.

The Cryptoassets Taskforce also observed in its report that while a number of online cryptoasset exchanges operate in the UK, only around 15 of a global market of 206 were headquartered in the UK. Of these 15, the 12 with visible trading activity accounted for around 2.66% of daily global trading volumes.

By contrast, mainstream financial institutions have remained fairly sceptical of cryptocurrency investments. This may also be influenced by the PRA’s warning to the CEOs of UK-authorised banks, insurance companies and large complex investment firms discussed at question 8 above. The BoE in March 2018 observed that systematically important UK financial institutions had negligible exposure to cryptoassets and to the ecosystem around them.

It has also been suggested that COVID-19 has increased the appetite for cryptocurrency, in particular Bitcoin, with high profile investors turning to it as a hedge against potential inflation. Alongside this increase in cryptocurrency interest, there has been an uptick in levels of cyber scams and criminals requesting cryptocurrency as methods of payment for ransomware attacks or payment for fake goods on fraudulent websites. There are also reports of an influx of cryptocurrency investment scams, where scammers are impersonating crypto traders or crypto exchanges promising investors high returns in exchange for buying cryptocurrency such as Bitcoin.

Other tokens, virtual assets (including crypto-securities)

  1. Are there any relevant regulatory restrictions or initiatives concerning tokens and virtual assets other than cryptocurrencies (e.g. trading of tangible property represented by cryptographic tokens)?

Aside from the ban on investment products referencing cryptoassets and the proposed regulation of cryptoasset promotions (highlighted at questions 4 and 9 above), there are no prohibitions in the UK on issuing or trading virtual assets. In many cases virtual assets other than cryptocurrencies will amount to securities which will be subject to financial regulation by the FCA.

As discussed in more detail at questions 7 and 8 above, UK regulators are taking a keen interest in cryptographic tokens and virtual assets, undertaking consultations and publishing numerous reports. The FCA’s Regulatory Sandbox, the BoE’s Fintech Hub and the ICO’s data protection sandbox (discussed in question 6 above) also represent some practical initiatives taken by regulators/public sector bodies that are designed to facilitate innovation in this area in the UK.

  1. Are there any legal or regulatory issues concerning the transfer of title to or the granting of security over tokens and virtual assets?

Whether UK law recognises title to tokens and virtual assets (and thus permits legal transfer of that title), and whether security (such as a charge or lien) can be granted over tokens and virtual assets, largely turns on whether tokens and virtual assets are considered property under UK law.

The current trend points towards tokens and virtual assets being recognised as property in UK law.

The main challenge from an English legal perspective stems from the fact that the common law traditionally only recognises property as either real property (land) or personal property, with all personal property being either a chose in possession (tangible property) or a chose in action (an intangible legal right to possess something that can be enforced by an action in a court). Because of this, English courts have historically refused to recognise information or data (other than intellectual property rights subsisting in that information or data) as property, as they are neither tangible nor are they a legal right capable of being enforced. Cryptographic tokens and virtual assets simply exist as information or data on a distributed ledger or blockchain, with anyone who knows the relevant private key (itself simply information/data) having the ability to deal with those tokens or virtual assets. It is therefore possible to reason by analogy that they are not property for the purposes of English law.

However, it is recognised that tokens and virtual assets have many of the characteristics of property. A classic statement at common law of key characteristics of property comes from Lord Wilberforce in the 1965 case of National Provincial Bank v Ainsworth: property “must be definable, identifiable by third parties, capable in its nature of assumption by third parties and have some degree of permanence or stability”. A virtual asset such as Bitcoin, for example, is readily seen as having all of these characteristics.

Several more recent court decisions support the view that English law may recognise tokens and virtual assets as property. In the 2012 case Armstrong DLW GmbH v Winnington Network Ltd, the EWHC recognised EU carbon trading allowances as property. This was despite the fact that they were are not a chose in possession and do not neatly fit into the category of a chose in action. Instead, it is possible they are “some form of ‘other intangible property’”. In the 2019 Singaporean case of B2C2 Ltd v Quoine Pte Ltd, common law principles similar to those in England were applied to find that virtual currencies could be regarded as property under Singaporean law. In 2019, in an unreported interlocutory decision in Robertson v Persons Unknown, Justice Moulder of the EWHC granted an asset preservation order over 80 Bitcoin, showing that the English courts are open to recognising virtual assets as property for certain purposes. Most recently in December 2019, in AA v Persons Unknown, Justice Bryan of the EWHC found that cryptocurrencies are a form of property capable of being the subject of a proprietary injunction. This decision, which does not constitute definitive legal authority as it relates to an interim application, was reached on the basis that the UKJT’s legal statement on cryptoassets and smart contracts was found to be an accurate statement as to the position of cryptoassets under English law.

In this legal statement—published in November 2019—the UKJT concluded that cryptoassets like Bitcoin are to be treated in principle as property under English law, as they “possess all the characteristics of property set out in the authorities” and are not otherwise disqualified. The UKJT suggested that cryptoassets can be regarded as intangible personal property (whether or not they meet the definition of a chose in action), and should be treated as such, in principle. This means that, under English law, security can likely be granted over virtual assets in generally the same way as it is granted over other intangible property.

Smart Contracts

  1. How are smart contracts characterised within your legal framework? Are there any enforceability issues specific to the operation of smart contracts which do not arise in the case of traditional legal contracts?

There is at present no definitive authority demonstrating that smart contracts are legally binding and enforceable under English law, neither in the form of a test case nor legislation. However, a degree of certainty has been introduced by the publication of the UKJT Legal Statement referred to in question 4 and elsewhere in this publication. The Law Commission is expected to publish a call for evidence relating to smart contracts later in 2020 which is to analyse the law relating to smart contracts, highlight any uncertainties or gaps, and identify any reforms to the law that may be required.

The prevailing view is that it should be possible to enter into a binding smart contract as long as the usual requirements for a valid contract under English law are met, namely, an offer and acceptance; an intention to create a legal relationship; certainty of terms; and each party giving something of benefit, referred to as “consideration”.

The UKJT concluded that the ordinary rules and interpretative principles of English contract law can, and should, apply to smart contracts, including those written entirely in computer code. It notes in its Legal Statement that: “a Smart Contract is capable of satisfying those requirements just as well as a more traditional or natural language contract, and a Smart Contract is therefore capable of having contractual force”.

One important interpretative difficulty with this approach is whether, and how, smart contracts might be avoided in cases of frustration, mistake or fraud. The automatic, self-executing and immutable nature of smart contracts gives rise to doubts as to whether they could be void, voidable and rescinded under English law, either by the parties or the courts.

Another challenge is the application to smart contracts of English legal rules which require certain documents to be “signed” or “in writing”. On this point, the general consensus, supported by the Legal Statement of the UKJT, is that a statutory “signature” requirement can be met by a private key, or where the code element of a smart contract is recorded in source code. There is, as yet, no definitive solution to this issue in the case of a smart contract which is represented only in object code, as it is not considered to be in a form that can be “read”. There is no requirement under English law for parties to a contract to know each other’s real identity and, as such, a smart legal contract between anonymous or pseudonymous parties ought to be capable of giving rise to binding legal relations. There are, however, likely to be practical problems in an enforcement scenario where one party is unable to identify a named defendant for the purpose of proceedings where the smart contract is not performed, or is performed incorrectly.

There are outstanding questions around the development of on-chain dispute resolution mechanisms, raised in a recent report published by the Law Society and the Tech London Advocates' (TLA) Blockchain Legal and Regulatory Group. The data governance challenges associated with the creation of correctly performing smart contracts are also discussed in that report and more generally by commentators.

  1. To what extent are smart contracts in use in your jurisdiction? Please mention any key initiatives concerning the use of smart contracts in your jurisdiction.

A number of important UK initiatives are in progress, indicating that smart contract technology is maturing.

Many UK financial services market participants, including trade associations, are proponents of the mainstream adoption of smart contract technology. The International Swaps and Derivatives Association (“ISDA”), for example, has argued that smart contracts can play a role in the derivatives market and has published guidelines that aim to support technology developers by promoting compliance with existing legal, regulatory and commercial standards, many of which are reflected within the existing ISDA documentation architecture. Most recently, ISDA launched a pilot implementation of an industry-standard, digitised representation of derivatives transactions and events, the ISDA Common Domain Model, for the clearing of interest rate derivatives using an open-source smart contract language.

Governmental agencies and IP registers, for example the European Union Intellectual Property Office, are also looking into the capabilities of smart contract technologies.

As noted in question 5, HMLR (and its Digital Street unit) continues to explore the use of blockchain, distributed ledgers and smart contracts in the land registration and property buy-sell process. Its first proof of concept involved a case study on the use of blockchain to optimise the conveyance process; though this represents just one possible application of DLT within the UK real estate sector.

Firms that have participated and that continue to participate in the FCA Regulatory Sandbox are using smart contracts for a variety of purposes, including to automate payments, transfer assets, provide fully automated, decentralised flight delay insurance, or facilitate charitable donations. Please refer to question 6 above for further details.

The Accord Project is a UK-based non-profit and collaborative initiative that seeks to develop an ecosystem and open source tools for smart legal contracts. Among other things, its goal is to introduce a common format for smart agreements, reducing the need to adopt and learn different technologies and futureproofing templates.

In March 2020, the British Standards Institute published a draft publicly available specification (PAS) on smart legal contracts which was intended to provide some universal technical parameters to assist organisations wishing to develop or adopt smart contracts, or to digitise their conventional contracts. 

It is worth noting a few other important smart contract projects, albeit not UK-specific. One of the most popular smart contract implementations is Ethereum which allows contracts to be written in a bespoke programming language, Solidity. There is also the R3 consortium's Corda, which aims to enable the codification of smart contracts and to provide a decentralised ledger that is authoritative and immutable.

Please also refer to question 1 above for prominent examples of applications of blockchain technologies in the UK.

Enforcement and judicial consideration

  1. Have there been any governmental or regulatory enforcement actions concerning blockchain in your jurisdiction?

The UK authorities have acknowledged the need, and have shown willingness, to take measures to protect consumers from harm arising from the deployment of blockchain technologies. As considered more fully in question 10, the FCA will ban the sale, marketing and distribution to all retail consumers of all derivatives and ETNs that reference unregulated transferable cryptoassets, with effect from 6 January 2021.

In June 2019 Europol announced the arrest of six people who were suspected of a Bitcoin scam worth $27 million, a theft that affected over 4,000 victims over 12 different countries. The investigation was carried out as a joint operation by the UK South West Regional Cyber Crime Unit, the UK's National Crime Agency, and the Dutch police.

In June 2020 the Secretary of State for Business, Energy and Industrial Strategy in the UK successfully petitioned the High Court to wind up a company that facilitated an online cryptocurrency trading platform. This followed enquiries by the Insolvency Service which found that at least 108 clients claimed they had lost in total just under £1.5 million using the trading platform.

The Cryptoassets Taskforce’s final report published in October 2018 noted that UK law enforcement authorities have increasingly identified cases of cryptoassets being used to launder proceeds of offline crime.

The UK’s Economic Crime Plan 2019-2022, published in July 2019, contemplates taking action to ensure cryptocurrencies are not used for money laundering and other illicit activity and will involve going “beyond the requirements set out in 5MLD, bringing all relevant cryptoasset businesses into AML/CTF regulation in January 2020. This will aim to not only meet the latest international standards but provide one of the most comprehensive responses globally to the use of cryptoassets for illicit activity.” As discussed in questions 4 and 9, since January 2020 the FCA has had new regulatory powers (including investigation and sanctioning powers) to supervise cryptoasset businesses for money laundering and counter-terrorist financing purposes.

HMRC has reportedly requested that digital currency exchanges provide it with information about customers’ names and transactions aiming to identify cases of tax evasion.

We are not aware of any other significant examples of formal UK Government or regulatory enforcement actions concerning blockchain. An expansion of the UK’s legal and regulatory regimes to cover a broader range of blockchain applications (further described at question 4 above) may, however, result in an increase in enforcement activity.

Please also refer to question 5 above for details of the current attitude of the UK Government and regulators to the use of blockchain technology.

  1. Has there been any judicial consideration of blockchain concepts or smart contracting in your jurisdiction?

There is some limited case law authority concerning blockchain technology in the UK. As discussed in more detail at questions 15 and 16, the UKJT has considered legal questions relating to cryptoassets, including whether they constitute property under English law and the validity of smart contracts.

In the 2019 case of Ang v Reliantco Investments Ltd the EWHC held that it had jurisdiction to hear a case between a Cyprus-based trading platform that included Bitcoin futures, and one of its retail customers, Ms Ang, because she was classified as a consumer under the Brussels I Regulation (recast) (EU) 1215/2012 (which enables a consumer to bring proceedings in the courts of the member state in which they are domiciled). This case concerned the procedural question of claiming jurisdiction, rather than a substantive question.

As noted in question 9 above, the Court of Justice of the European Union accepted in the 2014 case Skatteverket v David Hedqvist that no VAT is payable on an exchange of cryptocurrency for a national currency. Various UK tax cases have acknowledged the findings in the Hedqvist case.

The Singapore Court of Appeal did not come to a final position on the treatment of cryptoassets as property for the purposes of being held in trust in B2C2 v Quoine, referenced at question 15 above. However, Menon CJ referred to the UKJT Legal Statement and commented that: "there may be much to commend the view that cryptocurrencies should be capable of assimilation into the general concepts of property”. We refer in question 15 to the decision in Robertson v Persons Unknown, in which the EWHC granted an asset protection order over Bitcoin, and to the decision in AA v Persons Unknown in which the EWHC found that cryptocurrencies are a form of property capable of being the subject of a proprietary injunction.

On 8 April 2020, the High Court of New Zealand issued a judgment concluding that cryptocurrencies are a species of intangible personal property capable of being the subject matter of a trust. This judgment also referred to, and generally followed the reasoning set out in, the UKJT Legal Statement.

The Financial Markets Law Committee has considered questions of governing law and the application of conflict of laws rules, proposing several potential solutions (‘Distributed Ledger Technology and Governing Law: Issues of Legal Uncertainty’ (March 2018)). 

 Other generally-applicable laws or regulations

  1. Are there any other generally-applicable laws or regulations that may present issues for the use of blockchain technology (such as privacy and data protection law or insolvency law)?

As noted above in question 4 the UK has not legislated specifically in relation to blockchain, DLT or cryptoassets, with the exception of the recent FCA ban on the marketing, distribution or sale to retail clients of certain derivatives and ETNs referencing certain types of cryptoassets. A number of areas of law may yet, however, be engaged by a blockchain application.

A notable issue for all UK or EU blockchain applications is compliance with the EU General Data Protection Regulation, (“GDPR”). The GDPR, which will be retained in the UK statute book after the end of the Brexit transition period, imposes strict obligations on the gathering and processing of personal data, as well as conferring a right on data subjects (i.e. natural persons) to have their data corrected or deleted. Currently, the only certain means of ensuring compliance is to keep personal data off the blockchain, although with permissioned or private blockchains which confer a right on a node to alter the content of the blockchain retrospectively there may be alternative means of compliance. Please see our 2019 paper March of the Blocks for further detail, available on our website. More recently, we have also considered whether the rise of quantum computing threatens the ability of blockchain solutions to respect the fundamental principles of data protection and privacy in our article The Collapse of Cryptography? Considering the quantum threat to blockchain.

Please see question 4 above for details of how the UK AML framework applies to blockchain.

Another source of uncertainty is how to treat cryptoassets for the purposes of insolvency proceedings. Difficult questions in this context may also include how to trace cryptoassets in cases where the debtor does not disclose their existence and how to dispose of them.

  1. Are there any other key issues concerning blockchain technology in your jurisdiction that legal practitioners should be aware of?

As suggested at question 1 above, the end of the Brexit transition period may galvanise the UK into positioning itself as a more blockchain friendly jurisdiction. At this early stage, however, this remains purely speculative. It can be said, however, that any divergences between the UK and EU legal and regulatory regimes that develop over time could well impact the domestic legal and regulatory framework for blockchain applications.

International (including UK) antitrust authorities are increasingly showing interest in the potential risks of anticompetitive conduct associated with the use of blockchain technology.

Contact Information
Ben Kingsley
Partner at Slaughter and May
Duncan Blaikie
Partner at Slaughter and May
Ian Ranson
Associate at Slaughter and May
Emily Rose Bradley
Professional Support Lawyer at Slaughter and May
Selmin Hakki
Senior PSL at Slaughter and May