Regulators in the United Kingdom and elsewhere responded slowly to the rise of cryptocurrencies. That changed as crypto emerged from its niche into the mainstream. Now, regulators in Britain are clamping down on the crypto industry’s excesses. CoinIQ’s survey of crypto laws in the UK will help you understand British crypto rules and regulations.
British Crypto Laws Today
For the most part, crypto laws in the UK simply extend existing laws to include cryptocurrency. However, some of the unique aspects of cryptocurrencies leave them outside the “regulatory perimeter.”
Meet the regulators
Cryptocurrency crosses many aspects of British society, but there are three regulators that impact the crypto industry the most.
Bank of England
The Bank of England (BoE) is Britain’s central bank. Responsible for the stability of the country’s financial system, the BoE regulates banks, issues money and sets British monetary policy. The BoE also regulates banks, building societies and major investment firms.
Financial Conduct Authority
The Financial Conduct Authority (FCA) is an independent regulator charged with overseeing Britain’s financial services industry. The more than 58,000 businesses whose conduct the FCA oversees include consumer credit firms, fintech companies and payment institutions.
HM Revenue & Customs
HM Revenue & Customs (HRMC) is Britain’s tax department. Working with the Treasury ministry, HRMC maintains and implements tax policy.
The rise of cryptocurrency didn’t change one simple fact: you must pay your taxes.
As long ago as 2014 with Revenue and Customs Brief 9, the HMRC has explained how British crypto users must pay taxes. The rapid escalation of crypto’s popularity among the British public in 2017 led HMRC to issue the policy paper Cryptoassets for Individuals in late 2018. HMRC will release another policy paper for businesses in 2019.
The following overview will introduce you to several ways cryptocurrency activities, in general, could be taxed. Your specific situation, however, is unique. Consult with a tax expert to understand your tax obligations.
Buying with crypto
The British government’s Cryptoasset Taskforce found that “no major high street or online retailer accepts [crypto] as a form of payment, and only around 500 independent [retailers] around the UK accept Bitcoin.”
For those few merchants who do accept crypto, Value Added Tax (VAT) applies whenever crypto is used to buy goods or services. Responsibility for collecting VAT falls on the seller of the goods or services.
Mining crypto and network fees
Individual crypto miners, whether operating on their own or as part of a pool, must pay income tax on their activities. This applies both to the coins earned for adding blocks to the blockchain as well as to network fees earned for bundling each transaction into the blocks.
Miners who hold onto their coins may have to pay capital gains tax when they sell the coins off.
Airdrops and hard forks
Whether tokens received in an airdrop are subject to income tax depends on whether there’s a quid-pro-quo. For example, tokens earned in exchange for services like promoting an ICO would be considered income. Capital gains taxes could apply when the tokens are sold.
Tokens received in a hard fork may not be considered income. As we will see, hard fork tokens could impact the capital gains you pay.
Crypto capital gains
When people “dispose” of cryptocurrency, they may be subject to capital gains taxes. Among the ways that HMRC says disposal could result in a capital gain include:
- Selling crypto for fiat.
- Exchanging one crypto for another crypto.
- Using crypto to buy goods or services.
- Giving crypto to somebody else.
Calculating crypto taxes
For the purposes of income tax and VAT, the taxable amount is based on the cryptocurrency’s value in pound sterling at the time it’s received. Determining that value can get complicated as it may require applying a number of crypto-to-crypto, crypto-to-fiat and fiat-to-fiate exchange rates.
For the purposes of capital gains, HMRC doesn’t require each crypto sale to be matched to a specific crypto purchase. Instead, crypto holdings have a “pooled allowable cost” that fluctuates as assets are bought and sold.
For example, if someone bought 50 bitcoin in 2014 for £270 each and 50 bitcoin in 2017 for £1600 each, then the pooled allowable cost would be £935. Capital gains calculations would be based on this £935 pooled allowable cost. Holdings of litecoin, ether and other coins would have their own pooled allowable costs.
A hard fork dilutes the “pooled allowable cost” of the original holdings. A distribution of 100 tokens in the Bitcoin Cash hard fork of 2017 would dilute our hypothetical pooled allowable cost to £467.50 for each cryptocurrency. This dilution could increase capital gains exposure when the coins are later sold.
Regulating crypto dealing
The FCA does not regulate crypto directly. In evidence presented to the House of Commons Treasury Committee, the FCA said that crypto “will not meet the criteria to be considered a specified investment under the Regulated Activities Order, nor would they typically qualify as ‘funds’ or ‘e-money’.”
Firms that handle both fiat and cryptocurrency, however, would be subject to FCA regulation for the fiat side of their operations.
Protecting British investors
Whether the FCA can regulate an initial coin offering (ICO) depends on the nature of the token. The FCA can regulate security tokens as well as crypto-based financial instruments.
In mid-2018, the FCA restricted the sale of advanced crypto products to retail investors. The regulator limited the sale of contracts for difference (CfD) and capped retail investors’ margin exposure on CfDs. The FCA also imposed an outright ban on the sale of crypto-based binary options to retail investors.
Exchange and utility tokens, however, fall outside the FCA’s regulatory perimeter. FCA Director of Policy David Geale explained the situation to Parliament:
“The bulk of this [ICO] activity seems to be in the unregulated space around things like the utility tokens, where you are buying, for example, future rights to access a theme park or something that does not exist at the moment. Is that the sort of thing we would regulate? It is certainly not the sort of thing we regulate at the moment.”
In the place of regulations, the FCA can only highlight the risks retail investors face. A late 2017 statement, for example, explained why “ICOs are very high-risk, speculative investments.”
Combating crime and terrorism
Although not a perfect vehicle for crime, Britain’s Cryptoasset Taskforce views crypto’s combination of “accessibility online, their global reach and their pseudo-anonymous nature” as a growing risk. Regulators and police already have the power to prosecute criminals who use crypto to finance their operations.
In mid-2018, for example, the Crown Prosecution Service (CPS) announced the first-of-its-kind prosecution of bitcoin-supported crime. Surrey Police arrested a suspected owner of a marijuana factory in 2017 and seized the man’s crypto holdings. The CPS successfully “restrained” those holdings in 2018. The Surrey Police sold the 295 bitcoins for more than £1.2 million.
Plans for Crypto Laws in the UK
There is a growing sense among British politicians and regulators alike that cryptocurrencies need to be fully regulated. Bank of England Governor Mark Carney said in a recent speech that “the time has come to hold the crypto-asset ecosystem to the same standards as the rest of the financial system. Being part of the financial system brings enormous privileges, but with them great responsibilities.”
The British crypto industry established its own trade association in early 2018. Crypto UK set out standards of conduct for crypto-based companies to follow. At the same time, the industry acknowledged to Parliament that the lack of clear regulations “create[s] an environment where there is a risk to consumer manipulation.”
After a seemingly endless series of exchange hacks and the excesses of 2017’s ICO market, British politicians lost their patience. Nicky Morgan MP, the chair of the House of Commons Treasury Committee, declared that “Bitcoin and other crypto-assets exist in the Wild West industry of crypto-assets.” Morgan went on to say that “this unregulated industry leaves investors facing numerous risks. It’s unsustainable for the Government and regulators to bumble along issuing feeble warnings to potential investors, yet refrain from acting.”
House of Commons regulatory direction
In its Crypto-assets report, the Treasury Committee endorsed the simplest approach to empowering the FCA. Rather than creating custom legislation, the report said, “extending the Regulated Activities Order would be the quickest method of providing the FCA with the necessary legal powers to execute its duties of protecting consumers and maintaining market integrity.”
Extensions to the Regulated Activities Order would give the FCA authority over any ICO available in the UK.
“While there may be no explicit promise of financial returns, investors in ICOs clearly expect them…. The development of ICOs has exposed a regulatory loophole that is being exploited to the detriment of ordinary investors.”
That authority would also include oversight of the projects’ advertising to ensure retail investors are not misled.
The committee called on the British government to fold crypto exchanges into British anti-money-laundering (AML) and counter-terrorism financing (CTF) regulations by adopting the European Union’s Fifth AML Directive (5MLD) as quickly as possible.
Over the course of 2018, Britain’s regulators worked together to map the direction for crypto laws in the UK. The Cryptoassets Taskforce released its findings in October 2018.
Although criminals’ use of cryptocurrency “remains low”, the Taskforce said increasing risks require stronger crypto-focused AML/CTF regulations. The regulators’ first step will be transposing the EU’s 5MLD rules into British policy. This simple action will “bring fiat-to-cryptoasset exchange firms and custodian wallet providers within the scope of AML/CTF regulation.”
The British government will go beyond the EU’s regulations, to create “one of the most comprehensive responses globally to the use of cryptoassets for illicit activity.” Further consultations will lead to legislation in 2019 that could regulate:
- Crypto-to-crypto trading.
- Peer-to-peer crypto platforms.
- Crypto ATMs
- Non-custodian wallet providers.
- Crypto firms outside the UK.
Regulating financial instruments
Besides its existing limits on crypto-based CfDs and binary options, the FCA will consider a broader ban of crypto-based derivatives. More specifically, the FCA would ban derivatives based on exchange tokens like bitcoin.
The ban would not apply to derivatives based on security tokens, but those will get greater scrutiny as well. The FCA pledged to withhold approval of “a transferable security or a fund that references exchange tokens [including exchange-traded funds or ETFs]… unless it has confidence in the integrity of the underlying market and that other regulatory criteria for funds authorisation are met.”
Security tokens fall within the FCA’s existing remit, but the regulator believes the regulations are “not being correctly understood” by the crypto industry. By the end of 2018, the FCA will have released detailed guidance “to provide further clarity.”
Some tokens, however, use structures that avoid regulation while still acting like securities. In early 2019, the British government will consider new rules to “ensure that FCA regulation can be applied to all cryptoassets that have comparable features to specified investments, regardless of the way they are structured.”
Despite Brexit, the British government will fully adopt Europe’s 5MLD regulations. The UK plays a leading role in global financial policies and plans to shape discussions of crypto regulations through international bodies such as:
- G20 and G7 Finance Ministers and Central Bank Governors
- Financial Action Task Force
- International Organization of Securities Commissions
- Basel Committee on Banking Supervision
- Global Financial Innovation Network
“The government, the FCA and the Bank of England will continue to be actively involved in international efforts,” the Cryptoasset Taskforce declared, “and the UK will be a thought leader in shaping future regulatory approaches.”
Fostering Blockchain Technology
At the same time regulators clamp down on irresponsible crypto companies and criminal activity, they understand that innovative blockchain technology could benefit the British economy.
Supporting Blockchain Startups
The FCA lets blockchain-based startups participate in its Regulatory Sandbox. This program makes it easier for fintech companies to experiment with new business models while still protecting the public. More than 40% of the latest cohort joining the program use distributed ledger technologies (DLT). In addition, FCA accepted “a small number of firms that will be testing propositions relating to cryptoassets.”
The British government’s research councils and Innovate UK have provided £10 million in direct support for DLT-based companies. In addition, the GovTech Catalyst Fund has set aside £20 million that DLT companies can access to help make government more efficient. Several government departments already have DLT-based pilot projects underway.
BoE Real-Time Gross Settlements
In the speech referenced earlier, Bank of England Governor Mark Carney explained that blockchains and digital ledger technologies are part of the world financial system’s future.
“Crypto-assets are part of a broader reorganisation of the economy and society into a series of distributed peer-to-peer connections across powerful networks,” Carney observed before pointing out that today’s financial system “continues to be arranged around a series of hubs and spokes like banks and payments, clearing and settlement systems…. distributed ledger technology could transform everything.”
The BoE itself is exploring ways to adopt DLT to improve its own operations. DLT could be part of its next-generation system for Real-Time Gross Settlements (RTGS). The RTGS would let banks and other financial institutions transfer money to each other faster and with less paperwork.
Many early adopters thought crypto would overturn the established financial system. Today those hopes look naive. British regulators were content to take a hands-off approach so long as crypto confined itself to a small niche.
Now that crypto has entered the consciousness of the British public, the country’s politicians and regulators are getting more hands-on. Widespread adoption comes with an expectation that the government will establish level playing fields, investor protection, and criminal enforcement. Crypto is here to stay and so are crypto laws in the UK.