Regulatory guidance on cryptoassets and digital currency companies may lead to a legitimisation of crypto-businesses as an investable asset class.
By Stuart Davis, Sam Maxson, David Walker, Tom Evans, and Catherine Campbell
Recent and upcoming regulatory guidance on cryptoassets and the regulation of companies engaged in digital currency, such as issuers, crypto-exchanges, crypto-custodians, crypto-brokers, and other service providers, could help facilitate private equity investment in this space. While there has been some institutional investment in crypto-businesses — such as Goldman Sachs’ investment in Circle (owners of the Poloniex crypto-currency exchange) and Tiger Global’s investment in Coinbase — this has been a relatively nascent market with most money coming in the form of early-stage and venture investing.
Drivers of Volatility in Cryptoassets Values
Regulatory uncertainty has been a key driver in dampening the market value of cryptoassets. Regulators around the globe have issued warnings that cryptoassets may be regulated financial instruments, and issuers and intermediaries may require licences. Further, the application of AML/KYC rules to cryptoassets has been unclear.
This regulatory uncertainty has made it difficult for institutional investors to consider businesses operating in this space as legitimate investments, due to concerns that those businesses are not operating in compliance with regulation, potentially in breach of civil or criminal law.
Are Cryptoassets the New Payment Services?
Regulation designed to stimulate competition and encourage new entrants in the payment processing sector has seen buyout firms scouring the market for payments deals. In our view, the UK is now leading the way in regulating cryptoassets, making institutional investment more likely. There are parallels between the digital currency and payments sectors, with crypto-technology being used in back-office processing. A range of crypto-companies seeking to disrupt the payments market are emerging, including digital banks (e.g., Revolut), cross-border payments networks (e.g., Ripple) and exchanges (e.g., Coinbase).
Will Regulatory Certainty Revive the Cryptoassets Market?
UK regulators have begun to articulate how cryptoassets are regulated, and to identify gaps in regulation that may require enhanced legislation. This pragmatic approach to regulation should provide comfort to prospective cryptoasset investors.
The Cryptoasset Task Force (a consortium of the FCA, HM Treasury, and the Bank of England) published its final report in late 2018, setting out the steps UK regulators will take to clarify the regulatory position in 2019. The first step in this process is the FCA’s consultation, which has: (i) provided clear guidance on applying the existing regulatory perimeter, (ii) stated that cryptoassets can be used for legitimate purposes; and (iii) clarified that many cryptoassets facilitating payments and access to digital platforms fall outside the scope of licensing and compliance requirements.
Later in 2019, HM Treasury will publish a consultation on changes to the regulatory perimeter for cryptoassets, as well as guidance on the AML/KYC position, and HM Revenue and Customs will issue revised guidance on tax treatment. For PE firms considering investments in UK crypto-companies, 2019 could be a breakthrough year.
Contrasting Regulatory Approaches — An Ongoing Challenge
Deal teams should take care when approaching multinational crypto-businesses as global regulatory challenges remain. Recent reports from the European Securities and Markets Authority (ESMA) and European Banking Authority suggest that EU regulators take a similarly technology-neutral approach to that of the UK. However, ESMA also notes concern that individual Member States are taking divergent approaches, leading to uncertainty and the potential for regulatory arbitrage. The regulatory position in the US is more expansive. US regulators continue to adopt a broad-brush approach to cryptoassets, treating the majority as securities, which requires service providers and intermediaries to hold licenses — the majority of service providers and intermediaries do not.
A Tipping Point for UK Cryptoassets
While the global regulatory environment requires careful navigation, the UK framework should largely be settled by 2020. This may lead to a legitimisation of crypto-businesses — and new focus on such businesses as an investable asset class for buyout firms.
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