Crypto View - May 2023

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This month we saw a major event in cryptoasset regulation as the Council of the European Union adopted the regulation on markets in crypto-assets (MiCA)! If you’re anything like me, you would have struggled to contain your excitement – we look a little at the next steps for MiCA at the end of this issue. Besides MiCA, we also take a look at the less than helpful intervention from the UK’s Treasury Select Committee, a new consultation on DAOs in the ADGM, the IOSCO consultation on crypto regulation, an interesting case with the first discharge of a freezing injunction against a cryptocurrency exchange, and everyone’s favourite topic: tax.

I should also say that I’ll be attending Money20/20 Europe in Amsterdam next week with several colleagues to discuss all things crypto and payments. We’re going to be demoing Crypto Reviewer, our digitised solution for reviewing cross-border regulation around cryptocurrencies and tokens as well as the latest product in our stable, Payments Reviewer, which looks at cross-border regulation in relation to payment services. It should be a great conference, and if you are attending, please do come and visit us at stand C11. We may also have a few spaces left for a drinks reception on Tuesday 06 June if you are in Amsterdam and want to discuss payments or crypto… Please get in touch with me, Lee Curtis, George Morris, Oli Irons or Yingyu Wang. Please also feel free to get in touch about booking an online demo for either of these products if you won’t be in Amsterdam.

Treasury Select Committee Gambles with UK’s Crypto Future

On 10 May 2023, the Treasury Select Committee (TSC) published its report on Regulating Crypto. The headline grabbing takeaway from it was that the committee “strongly recommend[s] that the Government regulates retail trading and investment activity in unbacked cryptoassets as gambling rather than as a financial service, consistent with its stated principle of ‘same risk, same regulatory outcome’.”

Coming as it does, after numerous reports, FCA and HMT consultations, policy statements and (lest we forget) actual changes to law, it feels as though the timing of the TSC’s report is a little off. The implementation of financial services regulation for cryptoassets is already well underway in the UK, and it does seem to us to be the best approach. To suggest that consumers would be better protected under gambling legislation than financial services regulation shows a misunderstanding of both. The financial promotions changes which are expected to come into force in September, for example, would not be possible under gambling laws.

The report quotes a former FCA Chair as saying that:

“The social purpose of regulated financial markets is to facilitate economic growth by enabling people’s savings to be channelled to productive business ventures…. It is, therefore, disappointing that the government’s Consultation and Call for Evidence about the Future Financial Services Regulatory Regime for Cryptoassets proceeds on the false premise that speculative crypto is a “financial service”. From this premise, it proposes that the issue and trading of speculative cryptoassets should be endorsed by regulating it as a financial service, even though it provides no useful service to consumers.”

Even if one were to take the view that speculating on cryptoasset markets is akin to gambling, this seems to ignore the fact that day trading (both on FX, as well as on equities) has an outcomes distribution that looks a lot like gambling (according to an FCA insights article…). Not to mention that the Gambling Act has to explicitly exclude from the definition of “bet” those bets, the making or accepting of which, are regulated activities under the Financial Services and Markets Act, because things like CFDs would be classed as gambling, if they weren’t regulated as a specified investment under the FSMA. Should CFDs be carved out of financial regulation as they don’t enable people’s savings to be channelled to productive business ventures? Should FX trading be regulated as gambling? We would suggest not, and we doubt whether the TSC would either. The TSC also didn’t delve into the fact that proceeds from gambling are generally not taxable. We are curious to know what HMRC made of the TSC’s report.

Whatever we think of the TSC’s report, TSC does not have the power to change the course of legislation. Rather, it is appointed by the House of Commons to examine the expenditure, administration and policy of HM Treasury- though it may influence some MPs when it comes to vote time. An HM Treasury spokesperson did say: “Risks posed by crypto are typical of those that exist in traditional financial services and it’s financial services regulation - rather than gambling regulation - that has the track record in mitigating them.” So it seems that government policy remains unchanged.

Freezing injunctions

Binance has secured the first discharge of a freezing injunction against a cryptocurrency exchange in the English courts: Piroozzadeh v Persons Unknown & Ors [2023] EWHC 1024 (Ch) (2 March 2023). The injunction had been obtained, without notice to Binance, by an individual claiming to be the victim of a fraud perpetrated on the exchange by ‘persons unknown’. It required Binance to preserve cryptocurrency alleged to be the proceeds of the fraud, on grounds that Binance was a ‘constructive trustee’ of the misappropriated assets, holding them on behalf of the claimant. Similar injunctions have been obtained against crypto exchanges on similar grounds in other recent English cases, but none had previously been contested.

In discharging the injunction, the court made clear that claimants need to meet a number of conditions when applying for such measures, including: distinguishing between the position of different defendants (e.g. the alleged fraudsters vs the exchange) when making the application ‘without notice’; being clear about any potential defences to the claim; and explaining how the exchange is actually able to identify and freeze the proceeds of the fraud. The decision provides helpful guidance to both applicants and respondents of such injunctions going forwards and we expect the courts to scrutinise future applications to ensure they meet the sorts of conditions confirmed in this case.

Tax liability for crypto gains

The German Federal Fiscal Court (BFH) clarified this month that capital gains made on cryptocurrencies are taxable. The court also confirmed the speculation period of one year, meaning that if this yearlong holding period is exceeded, the disposal proceeds do not come within the scope of income tax. Likewise, gains up to an amount of €600/year remain tax-free.

The issue was triggered by a taxpayer who traded in various crypto currencies, some of which he bought and sold within a short period of time. For the tax office these trades constituted taxable capital gains. The BFH shared this view, and made clear that gains from the purchase and sale of crypto currencies are subject to income tax. According to the BFH virtual currencies qualify as “economic goods” with a market value, and are bought and sold as a means of payment on trading platforms. The judges did not agree with the argument of the taxpayer that virtual currencies such as Bitcoin, Ethereum and others are ultimately only algorithms and not real “economic goods”. An economic good means, in addition to things and rights, actual conditions, possibilities and advantage. The taxpayer incurs a cost when obtaining these, which are capable of a separate, independent valuation. Contrary to the view of the plaintiffs, the technical details of virtual currencies - for example, how they are described in a white paper - are not relevant for determining whether they are an economic good. More details can be found in a circular, here, and you can also reach out to Jochen Kindermann.

If you’re interested in how crypto is taxed more generally, we have built a helpful tool covering a number of jurisdictions.

IOSCO Consults on Crypto Regulation

The International Organization of Securities Commissions (IOSCO) published a consultation this month calling on global regulators to step up the regulation of cryptoassets. The consultation detailed 18 policy recommendations covering six key areas:

• Conflicts of interest arising from vertical integration of activities and functions
• Market manipulation, insider trading and fraud
• Cross-border risks and regulatory cooperation
• Custody and client asset protection
• Operational and technological risk
• Retail access, suitability, and distribution.

The aim is to achieve greater consistency with respect to regulatory frameworks and oversight across its member jurisdictions. The Consultation specifies one overarching recommendation, which informs all other policy recommendations, and that is that regulators should use either existing or new frameworks to regulate and oversee crypto-asset trading, other crypto-asset services, and the issuing, marketing and selling of crypto-assets (including as investments), in a manner consistent with IOSCO Objectives and Principles. The regulatory approach should seek to achieve regulatory outcomes for investor protection and market integrity that are the same as, or consistent with, those that are required in traditional financial markets.

IOSCO welcomes input from the public, including crypto-asset market participants, academics, technology experts, data providers and from any other interested party, on the presentation of information and recommendations in this document, as well as on any other crypto-asset related issues. Comments on the consultation paper should be sent to cryptoassetsconsultation@iosco.org on or before 31 July 2023, and it is expected that a final report will be published by the end of the year at the latest.

DAOs in the ADGM

The ADGM recently released a proposed legislative framework to govern distributed ledger technology foundations (DLT Foundations) in the Abu Dhabi Global Market (ADGM). The proposed framework would allow for the creation of DLT Foundations, which are legal entities that can be used to operate DLT projects. The framework would provide a number of benefits for DLT projects, including:

• A clear legal framework for operating DLT projects
• A low initial capital requirement
• The ability to use decentralised governance models

In essence, a DLT Foundation would be a standalone entity, similar to the way in which current foundations operates. An important differentiating factor to the plethora of DAOs in the current web3 space is that under the ADGM’s proposals, DAOs would be given legal personality, and in theory, allow any type of activity, provided that it is not unlawful. Giving a DAO a legal personality would certainly help give much-needed protections to members of DAOs from potentially unlimited liability. With a clear capital requirement, this is intended to ensure that DAOs that apply for regulation under the ADGM’s rules have a minimally viable level of funding to carry out their operations as well as consensus from their members to do so. Given the ADGM’s consultation paper requires a significant level of transparency, including annual accounts and KYC information, it remains to be seen whether many DAOs, where the founders and members prize anonymity and avoid being ‘doxxed’, will be able to apply under the ADGM’s regime. If you want to know more, contact Robbie Nakarmi or Adam Wolstenholme.

This month in MiCA

The 16th of May saw the formal adoption of MiCA, which was the final step in the (seemingly never ending) legislative process. So, what now? Well, it’s still not quite in force. It is anticipated to enter into force on the 20th day following its publication in the Official Journal of the European Union, so probably next month – we’ll keep you updated. We’re also expecting some consultations on level 2 legislation to come out over the summer, and we look forward to engaging with those

Due to popular demand, we are launching the Simmons’ MiCAdemy, a series of webinars, podcasts and articles that will give you everything you need to know about MiCA, whether you are a custodian, exchange, a bank or an asset manager. This should be up and running in the next couple of weeks.