In the second installment of fscom’s “Decoding Digital Assets” series, led by Heather O’Gorman, Head of Digital Assets, we delve into the question: What exactly is a cryptoasset? This series is designed to equip businesses with the insights needed to navigate the rapidly evolving crypto landscape, breaking down complex concepts into practical knowledge.
As digital transformation accelerates, cryptoassets have gained significant attention from investors, businesses, and regulators. The variety of tokens and their underlying purpose creates challenges for regulators seeking to establish clear regulatory frameworks. Jurisdictions need to define what constitutes a regulated activity and identify the assets relevant to these activities. As part of the UK’s regulatory roadmap this year, consideration will need to be given to how cryptoassets are defined in a manner that is specific but also takes into account the innovative nature of these assets.
Defining cryptoassets: a global challenge
There is no universal definition of “cryptoasset”, “digital asset”, or “virtual asset”, however, there is growing agreement on their basic elements in UK and international laws, as well as global standards. The definition provided in the UK’s Financial Services and Markets (FS&M) Bill closely aligns with the term “cryptoasset” as defined in the EU’s Markets in Crypto-Assets (MiCA) legislation, and it also exhibits similarities with the definition of “virtual asset” outlined in the FATF’s recommendations.
The UK government plans to refine the definition through secondary legislation to suit specific regulatory frameworks. According to HM Treasury (HMT) consultations, the term “cryptoasset” refers to spot cryptoassets, stablecoins, and unbacked cryptoassets (such as Bitcoin and Ether). This does not include those already covered under the existing list of ‘specified investments’ in Part III of the Financial Services and Markets Act 2000 (Regulated Activities) Order 2001 (RAO), like tokenised financial instruments or the rights to them, which encompass security tokens. The government’s intention is that trading and payments activities will be regulated, rather than the asset itself.
Current regulatory landscape
Currently, businesses offering crypto exchange services or custodian wallet services must register with the FCA under the Money Laundering, Terrorist Financing, and Transfer of Funds (Information on the Payer) Regulations 2017 (MLRs). The MLRs offer a regulatory definition of “cryptoasset”. It is the responsibility of each exchange business to determine whether the assets they trade fall within this definition.
Cryptoasset exchange platforms facilitate the trading of a wide variety of cryptoassets, each with distinct characteristics and uses. Here is a breakdown of the most common types:
Exchange tokens
Exchange tokens, also known as cryptocurrencies, are a type of digital or virtual currency that uses cryptographic technology to secure transactions and control the creation of new units. Unlike traditional currencies, cryptocurrencies operate on decentralised networks based on blockchain technology, which ensures transparency, security, and immutability. Cryptocurrencies are not issued or regulated by central authorities like banks or governments. An example of an exchange token includes Bitcoin (BTC), the first cryptocurrency and the creation of blockchain.
In the UK, cryptocurrencies are used for investment and trading, with platforms like Kraken and Gemini enabling transactions, as well as the tokens being used for payments to businesses that accept digital currencies by way of payment. They are also utilised for cross-border remittances due to lower fees and faster processing times compared to some traditional methods.
A couple of alternative cryptocurrencies include meme coins and privacy tokens.
- A meme coin is a type of cryptocurrency that is created largely for fun or as a joke, often inspired by internet memes or trends, with no intended intrinsic value or utility.
- A privacy coin is a type of cryptocurrency designed to provide enhanced anonymity and confidentiality for users by obscuring transaction details, such as the sender, receiver, and transaction amount. They are generally out of appetite for exchanges in the UK complying with the anti-money laundering requirements.
Stablecoins
A stablecoin is a type of cryptoasset designed to maintain a stable value by pegging its worth to a reference asset, such as a fiat currency (e.g., USD, GBP), a commodity (e.g., gold), or through algorithmic mechanisms. This stability makes stablecoins less volatile compared to traditional cryptocurrencies like Bitcoin or Ether, making them more suitable for day-to-day transactions, remittances, and as a store of value.
In the UK, stablecoins are utilised for purposes such as facilitating payments, including cross-border transactions, and for trading and managing exposure to cryptocurrency market fluctuations. They are also used on decentralised finance (DeFi) platforms for activities like lending, borrowing, and staking. Examples include Tether (USDT) and USD Coin (USDC), which are pegged to the US Dollar and frequently used in trading and payments.
Central Bank Digital Currencies (CBDCs)
Central Bank Digital Currencies (CBDCs) are digital versions of a country’s official currency, issued and regulated by central banks. In the UK, the Bank of England is researching the potential for a digital pound to improve payment systems, enhance financial inclusion, and give the central bank more control over monetary policy. CBDCs also have the potential to make cross-border payments more efficient. Examples of CBDCs include the European Union’s ongoing exploration of a Digital Euro, whilst the UK are still in early consultation on the approach to implementing a Digital Pound. The U.S. recently stated it has no appetite for a USD Digital Dollar, rather, focusing on stock piling Bitcoin.
Non-Fungible Tokens (NFTs)
Non-Fungible Tokens (NFTs) are primarily used to represent ownership and authenticity of unique digital assets, such as art, collectibles, music, in-game items, and virtual real estate. NFTs are widely used in digital art markets, where creators sell unique works on platforms like OpenSea and Rarible. They also feature in blockchain-based gaming, where in-game assets are tokenized for trading.
The government excluded NTFs from the scope of the cryptoassets financial promotions regime, since NFTs can represent a wide array of different assets which might constitute non-financial services products.
Utility Tokens
A utility token is a type of digital asset that provides holders with access to specific products, services, or features within a blockchain ecosystem. Unlike cryptocurrencies, utility tokens are not primarily designed as an investment or as a representation of ownership but rather serve as a functional tool within a particular platform.
Utility tokens can be used to access specific services or features within blockchain ecosystems, facilitate participation in decentralised governance, support customer reward programs, and enable transactions in gaming and entertainment platforms. Examples of utility tokens include Basic Attention Token (BAT) for digital advertising and Chiliz (CHZ) for fan engagement in sports.
A governance token is a type of utility token that grants holders the right to participate in the decision-making processes of a blockchain-based project or decentralised platform. Holders can vote on proposals, protocol upgrades, and other decisions that shape the development and future of the ecosystem. Governance tokens empower communities to manage decentralised applications (dApps), Decentralised Autonomous Organisations (DAOs), and other blockchain-based initiatives in a democratic manner.
Security Tokens
A security token is a type of cryptoasset that represents ownership or a stake in a real-world asset, such as equity in a company, real estate, or a share in a fund. Security tokens are subject to regulations similar to traditional securities and are often used to raise capital through a process known as Security Token Offerings (STOs). Unlike utility or governance tokens, security tokens are typically designed for investment purposes and may provide rights to dividends, profit-sharing, or voting power.
In the UK, security tokens are used to raise capital, represent ownership in real-world assets like real estate or equities, and enable fractionalised ownership, providing easier access to traditionally illiquid investments.
Asset-referenced tokens are a subset of exchange tokens which include commodity-linked tokens and crypto-backed tokens.
DeFi Tokens and staking
A DeFi token is a type of cryptoasset used within decentralised finance (DeFi) ecosystems to facilitate various financial activities, such as lending and borrowing, without the need for traditional financial intermediaries like banks. These tokens operate on blockchain platforms, primarily Ethereum, and enable users to interact with decentralised applications. DeFi tokens can represent assets, governance rights, or rewards within DeFi protocols.
Staking in crypto involves locking up cryptocurrency in a blockchain to secure and validate transactions, earning rewards in return. This is common in proof-of-stake (PoS) blockchains, where validators stake tokens to support network operations. The more crypto staked, the higher the chances of validating transactions and earning rewards.
Conclusion
Whether it’s cryptocurrencies for trading, stablecoins for transactions, or security tokens representing real-world assets, each type of cryptoasset offers distinct use cases. As technology continues to advance, new innovations such as CBDCs and Meme coins are emerging, presenting both opportunities and challenges for businesses, investors, and regulators alike.
Understanding these various cryptoassets is essential as regulators globally strive to establish regulatory definitions and frameworks in response to their development and the emergence of new initiatives.
The FCA’s future definition of a relevant cryptoasset is currently unknown, making it important to understand the different types of assets presently in circulation to determine which exchanges may be subject to future regulation. As the UK begins to regulate cryptoasset trading platforms (CATPs), exchanges and issuers should prepare for possible admissions procedures, which will formalise the process of CATPs permitting different assets to be traded on their platforms. By keeping up with regulatory developments, businesses can navigate the changing environment while maintaining compliance and adaptability in a dynamic market.
This post contains a general summary of advice and is not a complete or definitive statement of the law. Specific advice should be obtained where appropriate.
