A Word About Tokens – An FCA Perspective
The key thing to note is that any token that is not a security token, or an e-money token is an unregulated token.
What are unregulated tokens?
Unregulated tokens are those tokens that do not provide rights or obligations akin to specified investments (like shares, debt securities and e-money).
These tokens can be centrally issued, decentralised, primarily used as a means of exchange, or grant access to a current or prospective product or service. They might be used in one or many networks or ecosystems.
They can be ‘privacy tokens’, ‘fungible utility tokens’, ‘non-fungible tokens’, ‘access tokens’ etc. They can be fully transferable or have restricted transferability.
Below we provide further details based on the two broad categories of unregulated tokens identified in the UK Cryptoasset Taskforce report, and a further category specific to the FCA’s Guidance; exchange tokens, utility tokens, and tokens referred to as ‘stablecoins’.
Each of these categories can be further subdivided based on characteristics, such as transferability, fungibility, function, degree of centralisation etc.
So what are Exchange tokens?
Exchange tokens are used in a way similar to traditional fiat currency.
However, while exchange tokens can be used as a means of exchange, they are not currently recognised as legal tender in the UK, and they are not considered to be a currency or money.
They are generally more volatile than any currencies and commodities in general use, and as such they are not widely accepted as a means of exchange in the UK outside crypto and digital communities, and they are not typically used as a unit of account or a store of value.
These factors mean that very few merchants accept exchange tokens as a payment tool; numbers are limited to fewer than 600 in the UK.
Exchange tokens typically do not grant the holder any of the rights associated with specified investments. This is because they tend to be decentralised, with no central issuer obliged to honour those contractual rights — if any existed.
The FCA are aware that exchange tokens can be acquired and held for the purpose of speculation rather than exchange, as token-holders may anticipate that the value of these tokens will increase in the future on cryptoasset markets.
However, we do not view this as being sufficient for exchange tokens to constitute specified investments. The analogy would be an individual holding different fiat currency or a commodity, both of which are unregulated, in the hope of a gain.
Does the FCA regulate exchange tokens?
Exchange tokens currently fall outside the regulatory perimeter.
This means that the transferring, buying and selling of these tokens, including the commercial operation of cryptoasset exchanges for exchange tokens, are activities not currently regulated by the FCA.
For example, if you are an exchange, and all you do is facilitate transactions of Bitcoins, Ether, Litecoin or other exchange tokens between participants, you are not carrying on a regulated activity.
This is in line with our approach to other assets that remain outside our regulatory perimeter, but could nonetheless be purchased speculatively by some consumers with a view to realising profits if their value increases (eg fine wine or art).
However, firms should note that 5AMLD has been transposed into UK law on 10 January 2020 to introduce AML requirements to certain cryptoasset activities.
The Government has announced that in the UK they will go beyond the scope of 5AMLD which proposes to extend AML/CTF regulation to entities carrying out the following activities:
- exchange services between one cryptoasset and another, or services
- allowing value transactions within one cryptoasset exchange or
- peer-to-peer exchange service provider
- cryptoasset Automated Teller Machines
- transfer of cryptoassets (In this context of cryptoassets,
- transfer means to conduct a transaction on behalf of another natural or
- legal person that moves a cryptoasset from one cryptoasset address or account to another)
- issuance of new cryptoassets, for example through ICOs
- the publication of open-source software (which includes, but is not limited to,
- non-custodian wallet software and other types of cryptoasset related software)
It should be noted that this refers to an AML regime, and does not have the effect of bringing any participant into the full FSMA regulatory perimeter.
The Financial Action Task Force (FATF) has published guidance for cryptoasset firms that may assist firms, and the FCA has a Financial Crime Guide in their Handbook.
Utility tokens provide consumers with access to a current or prospective service or product and often grant rights similar to pre-payment vouchers.
In some instances, they might have similarities with, or be the same as, rewards-based crowdfunding. Here, participants contribute funds to a project in exchange, usually, for some reward, for example access to products or services at a discount.
Much like exchange tokens, utility tokens can usually be traded on the secondary markets and be used for speculative investment purposes.
This does not in itself mean these tokens constitute specified investments if they do not have the characteristics of relevant specified investments.
Does the FCA regulate utility tokens?
As utility tokens do not exhibit features that would make them the same as security tokens, they won’t be captured in the regulatory regime.
Attempts to stabilise token volatility
Attempts might be made to stabilise the volatility of cryptoassets, where the resulting token is commonly referred to as a ‘stablecoin’.
These ‘stablecoins’ are a type of token, and depending on what they are backed with, how they are arranged and how they are structured, will fall in different categories of our taxonomy. For instance, a ‘stablecoin’ could be considered a unit in a collective investment scheme, a debt security, e-money or another type of specified investment.
It might also fall outside of the FCA’s remit. Ultimately, this can only be determined on a case-by-case basis.
The most popular observed methods of stabilisation are Fiat-backed: these tokens are backed with fiat currencies, most commonly the United States Dollar (USD), but we have seen tokens backed with other fiat currencies, including the British Pound (GBP) or a basket of currencies.
In some cases, this involves the issuer “pegging” the value to that currency— i.e guaranteeing the value of the token, while holding a reserve offiat currency(ies) to ensure it can meet any claims. In other cases, the token gives the token holder an interest or right to the custodied fiat currency(ies), with the value of the tokens being directly linked to the value of the fiat currency held.
These distinctions are also relevant for the models described below.
- Crypto-collateralised: these tokens are backed with a basket of cryptoassets with the aim of spreading risk and reducing price volatility.
- Asset-backed: these tokens are backed with a tangible or intangible asset that usually has some economic value.
- Algorithmically stabilised: these tokens attempt stabilisation through algorithms that may, for example, control the supply of the tokens to influence price.
Where attempts have been made to stabilise the volatility of cryptoassets these tokens will be regulated where they provide rights or obligations akin to specified investments as security tokens and e-money tokens do.
If they do not, they will be unregulated tokens, but some of the activities performed may still be subject to regulation, for instance AML requirements.
Tokens might be backed by financial assets, physical assets, or other cryptoassets. These tokens may in certain circumstances be security tokens or e-money tokens, depending on among other things, the rights granted by such tokens, the nature of the underlying assets and other relevant arrangements. For example, while gold itself is not a specified investment, a token that gives token holders a right or interest to gold held by a token issuer, or rights to payments from profit or income generated from the holding, buying or selling of gold may in certain circumstances be a specified.