Cryptoassets: Dealing with the risks of digital assets

Posted on 24 December 2018

The Cryptoassets Taskforce was put together in March 2018 as part of the UK government’s Fintech Sector Strategy to make it easier for fintech firms to follow complex regulations and manage risks. The taskforce is made up of HM Treasury (“HMT”), the Financial Conduct Authority (“FCA”) and the Bank of England (“BoE”).

Whilst the UK maintains that it is committed to being “at the cutting edge of the digital revolution”, the UK market growth in cryptoassets is not as advanced as other jurisdictions. The UK (as do many jurisdictions) faces the challenge of balancing international reputation as a safe place to do business with high regulatory standards and embracing innovation and change.

Taskforce Report

The Taskforce published its final report on 28 October 2018 and provided an overview of Distributed Ledger Technology (“DLT”) and cryptoassets (which are one application of DLT). The Taskforce identified a number of risks associated with cryptoassets. In some respects, cryptocurrencies are similar to other currencies as they have fluctuating exchange rates (driven by market factors) and you can trade cryptocurrency. Some but not all cryptocurrencies use blockchain technology. However, key differences to currencies are that cryptocurrencies are not legal money or currency, they are not managed by banks and the currency is held in a digital wallet. These features and the fact that you can buy cryptocurrencies on the dark web make regulation and compliance challenging and increase the risk of money laundering and fraudulent activities.

The key risks highlighted included:

• Financial crime and cyber threat risks as a result of cryptoassets being used for illegal activities;
• Consumer risks due to lack of regulation;
• Market integrity risks; and
• Financial stability risks.

The report proposes a potential ban on all cryptoasset derivatives including Contracts for Difference (“CFDs”) and future contracts. “The FCA will consult on a prohibition of the sale to retail consumers of all derivatives referencing exchange tokens such as Bitcoin, including CFDs, futures, options and transferable securities.”

Tax

Tax is outside the scope of the Taskforce Report yet the report noted that HM Treasury is working closely with HM Revenue & Customs (“HMRC”) to consider the tax issues. HMRC’s main concerns regarding cryptoassets are tax avoidance and tax evasion.

Currently cryptoassets are classified by HMRC as intangible assets and so unless there is evidence of trading, some gains are subject to capital gains tax. Some may argue that buying and selling cryptoassets is akin to gambling and therefore there are no tax implications – however, it is unlikely that HMRC will accept this. A key issue taxpayers will face is the lack of recordkeeping in this area and in fact some trading platforms only retain information for a 6 month period. HMRC’s most recent guidance was published in 2014 which leads to further uncertainty on the tax treatment.

Conclusions

The report concluded that the technology can be helpful in boosting different sectors, most importantly the financial industry and that the authorities “do not believe there are regulatory barriers to further adoption of DLT”. Nevertheless, the report highlighted that the technology requires further development “before it could be used at scale and before these opportunities could be realised”. As always, striking the balance between managing risks responsibly and harnessing technology is a challenge.

HMRC is updating its guidance by early 2019 based on the reports’ conclusions and we expect that cryptoassets will see increased scrutiny from HMRC