DP25/1: Regulating Cryptoasset Firms

Following HM Treasury's recent release of the Draft SI and Policy Note, which enables the FCA to develop Handbook rules for regulating cryptoassets, the FCA published Discussion Paper 25/1: Regulating Cryptoasset Activities (DP) on 02 May. This paper invites feedback on the proposed regulatory framework, focussing on qualifying cryptoasset trading platforms (CATPs) obligations, cryptoasset intermediaries obligations, lending and borrowing practices, credit use for purchasing cryptoassets, staking, and decentralised finance (DeFi).

One important initial observation on the DP is that, in contrast to MiCA, which does not differentiate between retail and institutional investors, the FCA has identified several areas where retail investors might require greater protection compared to institutional ones.

Cryptoasset Trading Platforms

The DP introduces proposals for CATPs aimed at improving market integrity and consumer protection, drawing from the existing regulatory obligations applied to trading venues in traditional financial markets. The FCA addresses crypto market innovation, such as high levels of automation, disintermediation and 24/7 trading head on.

• Territoriality: The FCA is not planning to extend the current Overseas Person Exclusion to cover crypto asset activities. As an alternative, the FCA has proposed potentially allowing overseas trading platforms to operate in the UK via a branch, providing there is also a UK subsidiary in the group handling other related activities, such as onboarding or e-money issuance. This proposal presents promising opportunities for exchanges without a UK liquidity venue and potentially increases UK customer's access to international liquidity. However, the DP does not elaborate how roles and responsibilities should be allocated between a branch and a subsidiary.

• Systems and controls: The DP outlines additional requirements for CATPs when admitting market participants, including direct retail participants, algorithmic traders, and market makers.

  • Direct retail access:The FCA highlights the need to identify individuals responsible for transactions on a CATP to maintain market integrity and compliance. This is challenging with direct retail access, as retail customers may not be subject to regulatory requirements. To mitigate risks against market integrity associated with direct retail access, the FCA suggests that CATPs should take responsibility for addressing risks associated with direct retail access, for example, by monitoring trading for rule violations, setting controls for customer profiles, and having the ability to revoke or suspend access.

  • Algorithmic traders: The DP explores concerns over the lack of proper controls and oversight on the use of algorithmic and automated trading strategies, especially by retail participants who are not authorised and thus not subject to typical regulatory requirements. Although the FCA acknowledges the need for CATPs to ensure fair and non-discriminatory access to trading and maintain orderly markets, it has not yet decided whether to impose additional requirements or what those requirements would entail.

  • Market makers: While market makers are crucial in traditional markets, their role in cryptoasset markets is less defined. Concerns exist regarding market making practices that could compromise market integrity, such as potential anti-competitive or collusive behaviour between trading platforms and market makers. The FCA proposes that CATPs should disclose legal, contractual, or commercial relationships with market makers and establish appropriate agreements to align with current financial market standards. Alternatively, given the complexities and direct retail access, these requirements can apply only to significant market makers, which would require the FCA to define a minimum threshold.

• Trading and execution

  • Discretionary trading practices: The FCA plans to require all CATPs to implement non-discretionary trading systems to ensure fairness and consumer protection. Under this set up, CATPs are not expected to provide best execution or additional protections to these investors. Instead, the responsibility for additional investor protection measures should lie with intermediaries rather than the CATPs themselves.

  • Dealing as principal: The DP proposes banning CATPs from principal trading both on and off their platforms. On-platform trading raises concerns for the FCA about conflicts of interest between CATP operators and their clients, which could undermine market integrity and deter investors from trading on the platform. Off-platform trading concerns include CATP operators potentially taking market positions against clients, posing risks of conflicts of interest and market manipulation. As an alternative, the FCA suggests allowing separate but affiliated principal trading firms to operate on a CATP, noting that this could create competitive advantages (we note that these structures do exist in traditional financial markets). For this, the FCA stipulates that principal trading entities should be operationally or legally separate from the CATP operator, or that a UK subsidiary in a branch-subsidiary model be authorised to trade in a principal capacity.

  • Matched principal making: Additionally, the FCA suggests restricting CATPs from matched principal trading, citing two main concerns. Firstly, matched principal trading could lead to conflicts of interest, as CATP operators might trade against their clients in a principal capacity, potentially exploiting their position to take active market positions against clients. Secondly, it also exposes CATPs to credit and market risks, especially if a counterparty defaults, potentially undermining their role as risk-neutral marketplaces and increasing the risk of market disorder.

However, acknowledging the prevalence of matched principal trading in cryptoasset markets, the FCA is exploring alternative regulatory options.

• Pre-trade and post-trade considerations

  • Issuance of cryptoassets: The DP proposes requiring legal or functional separation between platforms and issuers of cryptoassets, alongside necessary disclosure requirements to avoid conflicts of interest.

  • Counterparty credit risk: While the FCA CATPs should implement effective measures to ensure the successful completion of trades, it believes that CATPs should operate as risk-neutral entities and avoid counterparty or credit risk to maintain transparency and market stability.

  • Settlement rules: Given that the settlement process is quite different in cryptoasset markets and CATPs do not have control of blockchains, the FCA also queries whether there is a need to change the interpretation or definition of settlement for the purpose of CATP settlement rules.

• Transparency and reporting requirements: The FCA proposes applying pre-trade and post-trade transparency requirements to CATPs, so CATPs may be required to ensure public and non-discriminatory access to their order book data. Waivers from traditional finance for pre-trade transparency requirements will not be applicable, as it is likely premature to establish specific liquidity thresholds for various assets.

Cryptoasset Intermediaries

The FCA is considering rules to regulate the conduct of intermediaries in line with the principle of "same risk, same regulatory outcome" wherever possible, taking into account the specific feature of the crypto market.

• Order handling and execution: The FCA plans to apply the Consumer Duty to cryptoasset intermediaries so they act to deliver good outcomes for retail customers, in particularly through a set of best execution rules achieving similar regulatory outcomes to those under COBS 11.2A.

  • Any cryptoasset needs to be admitted to trading on at least one UK authorised CATP before any intermediary can deal in it or arrange deals for UK retail customers.

  • In line with COBS 11.3, the FCA proposes that firms executing client orders should establish procedures ensuring prompt, fair, and swift execution. Additionally, cryptoasset intermediaries should adhere to best execution rules akin to COBS 11.2A, with policies to secure the best terms for client orders and the ability to demonstrate compliance upon request.

  • Orders for UK consumers may only be ultimately executed on UK authorised execution venues.

  • Firms may be required to disclose their role, including whether as principal or agent, to clients before executing orders and inform them if orders might be executed off-platform, including the associated risks.

• Conflict of interest during order execution: The FCA may mandate, at a minimum, a functional separation between firms' principal trading and client order execution activities. Additionally, the FCA intends to ban Payment for Order Flow (PFOF) for cryptoasset intermediaries, preventing firms from receiving payments, remuneration, or commissions from third parties regarding the execution of client orders.

• Pre- and post-trade transparency for intermediaries: The FCA proposes a proportionate approach to transparency requirements for intermediaries, including:

  • Post-Trade Transparency: Cryptoasset intermediaries should publicly disclose transaction details, including volume, price, and execution time, as close to real-time as possible.

  • Pre-Trade Transparency: Potential requirements may include publishing firm or indicative quotes for different trade sizes.

  • Client Access: Firms may determine client access to quotes based on commercial policy, ensuring it remains objective and non-discriminatory.

• Client categorisation: In traditional finance, COBS 3 categorises clients as "retail", "professional", or "eligible counterparty", matching protections to their financial expertise. Retail clients can request to 'opt up' to professional status, but the Consumer Duty Guidance prohibits firms from encouraging customers to seek 'professional client' status solely to bypass consumer protection. The FCA is considering whether crypto-specific rules or guidance on retail customer opting up practices are needed.

Cryptoasset Lending and Borrowing

The DP outlines the potential ban on crypto lending to retail consumers. As an alternative, the following risk mitigation measures are suggested:

• For cryptoasset borrowing, firms must:

  • comply with CONC standards, including creditworthiness assessments and forbearance for consumers in arrears or default;

  • obtain explicit consumer consent before collateral top-ups; and

  • limit automatic collateral top-ups during the loan term.

• For cryptoasset lending and borrowing, firms must:

  • require consumer consent before agreements, confirming risk awareness and asset transfer;

  • renew consent for major contract changes;

  • conduct appropriateness assessments of consumer knowledge;

  • provide a key features document outlining product risks;

  • prevent using their own platform tokens in crypto asset lending and borrowing to prevent conflicts of interest, caused by potential artificial price inflation or market manipulation; and

  • limit certain aspects of lending and borrowing to the use of qualifying stablecoins only.

The FCA has not addressed the issue of automatic collateral liquidation.

Linked to this, the FCA is considering banning/restricting use of credit cards to buy crypto, although regulated stablecoins (i.e. qualifying stablecoins issued by an FCA authorised stablecoin issuer) would be exempt from potential restrictions.

Staking

Despite the low risk with staking, the FCA is proposing some prudential requirements. It is suggested that firms will be made liable for losses suffered by retail consumers where the firms fail to adequately assess their technological and operational resilience and will need to hold sufficient capital to absorb any losses in this situation. In addition, to address safeguarding risk, the FCA is proposing the requirement for separate wallets for consumers' staked assets (in addition to requirements around record keeping and reconciliations). 

Defi

The DP suggests that truly decentralised finance activities, where there is no central controlling party, are not subject to regulation. However, if there is an identifiable controlling party involved, the full regulatory framework would apply to DeFi activities that pose similar risks as centralised services.

The FCA plans to collaborate with stakeholders to create guidance for DeFi, focusing on evaluating the levels of centralisation and decentralisation, understanding how decentralised elements align with regulatory boundaries, and identifying emerging industry practices that can facilitate the adoption of proposed regulatory obligations.

Next steps

The FCA is seeking feedback on the appropriate level of regulatory intervention needed to safeguard consumer protection, uphold market integrity, and foster competitive growth. Stakeholder engagement will be crucial in shaping new Handbook rules or revising existing regulations to effectively address the evolving landscape of the cryptoasset market. The period for feedback on the DP was short, closing on 13 June 2025.