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As money-laundering risks rise with the increased adoption of cryptocurrencies, the UK needs to accelerate its response to maintain its future as a centre for financial innovation.
It’s been two years since the UK rolled out its anti-money laundering and countering the financing of terrorism (AML/CFT) regime for cryptoassets. And there’s been one clear lesson in that time: getting it right isn’t easy. As the Treasury Select Committee report on Economic Crime (TSC Report) launched on 2 February noted, ‘registration of crypto-asset firms for money laundering has been slow’, leading the Committee to urge quicker progress.
However, UK progress should be seen in its wider context. UK policymakers and regulators face a dilemma shared with their counterparts around the world. Developments in the cryptoasset space move at the speed of light, while policy and regulatory progress is glacial.
Over the past two years, the cryptoasset space has exploded with new innovations and developments. Decentralised finance (DeFi) – which involves the provision of financial services normally undertaken by banks using self-executing software applications – has grown exponentially, bringing new opportunities but also new financial crime risks; non-fungible tokens (NFTs) are revolutionising the consumption of art, but also raising concerns about money laundering; and decentralised autonomous organisations (DAOs) are overturning models of corporate ownership and social organisation.
Concurrently, the UK’s Financial Conduct Authority (FCA) has approved only 31 out of more than 150 registration applications from cryptoasset businesses. And policymakers in the UK have yet to grapple with the implications that DeFi, NFTs, DAOs and other emerging innovations could have for this nascent domestic supervisory regime.
This gap between the speed of cryptoasset innovation and regulatory response has led some observers, including MPs, a former Cabinet official and industry participants, to allege that the UK risks losing its competitive edge as a FinTech leader. ‘Find a way to speed up the policy and regulatory process, or risk losing the race to harness the opportunities of cryptoassets’, they warn. The TSC Report likewise calls on the government and FCA to speed up progress.
However, this is easier said than done; and while there is certainly room for substantial improvement, the UK is not alone.
In the past two years, Singapore has approved a mere four cryptoasset service providers under its financial crime licensing framework. In the EU, France has approved 28 cryptoasset firms and the Netherlands a similar number, while Germany has approved just three. Japan, which has had its cryptoasset supervisory regime in place since 2017, has approved only 28 businesses in five years.
If the UK wishes to be at the forefront of financial services innovation it must strike a better balance between the dynamism required to keep pace with new technologies and addressing the financial crime risks involved
By this measure, the UK might not be a trailblazer, but it is certainly not lagging behind comparable economies and financial centres. Moreover, the slow pace is not the responsibility of regulators alone. The FCA has observed that many applications were not fit for approval, with compliance operations falling short of expectations.
And while illicit activity remains a relatively small proportion of overall cryptoasset trading, regulators' concerns about financial crime are not unwarranted. In late January, Europol indicated that organised crime networks of all stripes are increasingly integrating cryptoassets into their money-laundering operations. There are certainly good reasons for UK regulators to apply close scrutiny, and ensure the sector matures with integrity and soundness.
Yet, something must change. A country that wishes to be at the forefront of financial services innovation must strike a better balance between the dynamism required to keep pace with new technologies and addressing the financial crime risks involved.
To do this, the government should adopt four key principles to enable a more constructive approach to cryptoasset supervision.
First, education across government is critical. Supervisors not only need to understand how the sector operates, but must be equipped with the skills, tools and analytical capabilities needed to conduct regulatory oversight of the cryptoasset space effectively. Policymakers must also have an adequate understanding of related emerging technological developments to craft appropriate guidance and policy responses.
Second, promising public-private sector dialogue and partnership must be boosted to facilitate policy and operational responses to fast-moving and complex cryptoasset developments. The public sector benefits from the private sector’s technological expertise, while the private sector benefits when it can better understand the public sector’s concerns and objectives.
Third, regulatory enforcement must be a central feature of the UK supervisory approach. Any country that wants to reduce financial crime risks in cryptoassets must ensure that businesses failing to comply with AML/CFT provisions are held accountable. Allowing compliance violations to pass unpunished undermines efforts to foster innovation by eroding trust in the sector and in regulators’ authority.
It is vital that firms flouting the AML/CFT regime are subject to penalties, and that the consequences of failing to comply are made clear
The FCA has acknowledged that there are more than 200 cryptoasset firms operating in the UK that it has not yet approved. While many of these are currently waiting for the FCA to approve their applications, some have not attempted to apply for registration at all and are therefore operating unlawfully. As the TSC Report notes, ‘It is unacceptable that, having introduced AML regulations for cryptoasset firms in 2020, there are so many firms which have not yet been registered. Large numbers have not even applied for registration, and it is not clear what sanction they face’.
It is vital that firms flouting the AML/CFT regime are subject to penalties, and that the consequences of failing to comply are made clear. But effective enforcement will require investment in capabilities that enable supervisors to meet the complexity of this sector.
Finally, a comprehensive, ‘all-of-government’ approach to cryptoasset policymaking is needed. Specifically, one that focuses not only on AML/CFT supervisory concerns, but also on law enforcement, taxation and other matters, to ensure that a holistic approach is taken to policy development, coordination and implementation that remains aligned to movements in the sector.
The UK got off to a good start in 2018 when it launched its Cryptoasset Taskforce, which provided a consolidated government view on necessary policy steps and measures at that time. Since then, efforts have become less cohesive, a challenge the Biden administration is also seeking to address in a new coordinated approach to crypto policy.
There are some bright spots. The FCA’s recent launch of proposed measures on cryptoasset promotions to protect consumers is a welcome indication that the government is thinking beyond AML/CFT supervision and seeking to take a broader, more holistic approach. Certainly, though, a more concerted interagency effort will be required to address the broad array of challenges cryptoassets present.
Policy and regulation will never move as fast as the technology that drives FinTech and cryptoasset developments. To wish this is fantasy. But by taking some pragmatic steps, the UK can certainly make up some ground and ensure that it remains an attractive and dynamic market for financial technology developments.
The views expressed in this Commentary are the author’s, and do not represent those of RUSI or any other institution.
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Associate Fellow; Independent Consultant