Eitan Jankelewitz is a technology lawyer at the law firm Sheridans. He provides commercial legal advice to all kinds of technology businesses, including some operating in the bitcoin economy.
In this article, Jankelewitz explains how UK regulation applies to bitcoin and other digital currencies. He also describes the approach to compliance generally taken by UK businesses.
The UK, especially London, is considered a global centre for financial services and new technologies.
You might assume, therefore, that the UK would be a great adoptive home for bitcoin and other digital currencies. Digital currency is, after all, the ultimate example of a finance/technology hybrid. Well, you would be right.
The British public has shown keen interest in digital currencies – the London bitcoin meetup is possibly the biggest in the world and there are numerous other events and meetings being held in cities up and down the UK.
Britain is also home to some of the world’s most popular bitcoin products and services. Despite this, the UK’s government and regulators have been remarkably quiet on the subject of digital currencies, and have left the development and adoption of digital currencies largely unacknowledged.
There are three areas of regulation to consider when examining this subject: consumer protection; the prevention of money laundering, and taxation. Foreign regulations also have certain implications for those operating in the UK.
Consumer protection
In the UK, the Financial Conduct Authority (FCA) is the regulator with responsibility for ensuring that financial services are provided in a way that protects consumers and maintains the integrity of the market. The FCA regulates businesses that provide financial services or promote financial services (whether retail or wholesale).
In the last year, a number of bitcoin businesses have approached the FCA seeking clarification on the legalities of operating bitcoin exchanges.
However the FCA has not offered any constructive guidance or comment on the regulation of digital currencies. In fact, the FCA has gone as far as stating it does not regulate digital currencies and has no intention of doing so. The result is that bitcoin businesses in the UK are not obliged to register with or be authorised by the FCA.
The UK has a well-established tradition of self-regulation. Despite the regulator’s approach, a number of bitcoin businesses have told me that they act in accordance with FCA rules, even though they are not required to do so.
Without any formal guidance, businesses act on their own interpretation of what the rules ought to be. As a result, an unusual scenario has arisen: instead of regulators chasing after businesses and insisting on compliance, UK businesses are chasing after regulators and insisting on rules with which they can comply.
There was even one instance where, allegedly, the FCA, on discovering that a bitcoin business had managed to add itself to an FCA register, politely invited that business to de-register itself.
Prevention of money laundering
The prevention of money laundering is taken very seriously in the UK and indeed in many countries around the world.
In the UK, the Money Laundering Regulations 2007 set out who must assist the prevention of money laundering and provide steps on how this should be achieved. Customer due diligence is central to these regulations – businesses should know where money is coming from by identifying their customers.
The Money Laundering Regulations 2007 are enforced by a number of entities, principally the UK’s tax authority, the HMRC (HM Revenue & Customs), and the FCA, but also some others. For example, lawyers are obligated to conduct customer due diligence by the Law Society.
In the UK, however, there is no formal obligation to take any steps to prevent money laundering through dealings made in bitcoin. This is quite remarkable. Compare this to the position in the US, where businesses must comply with anti-money laundering regulations at a federal level and then essentially repeat this compliance in almost every other state.
Once again, UK businesses take regulation into their own hands. UK bitcoin businesses seem, for the most part, to all take some measure or another to try and identify their customers for the purposes of preventing money laundering.
It is fair to say that some businesses go above and beyond what would be required if their business was dealing with pounds sterling rather than bitcoin. The reason for this is simple: UK businesses don’t think that this status quo can be maintained for much longer.
If (or, indeed, when) UK bitcoin businesses are required to comply with anti-money laundering regulation, those businesses could be obligated to undertake customer due diligence on their entire existing customer base. This could be an overwhelming task for a company that has been in business for some years.
Businesses may eventually even be required to report all of their previous dealings as part of a suspicious activity report. It therefore makes much more sense to identify customers from the outset in order to be prepared for these requirements.
Taxation
Four or five months ago, after receiving a number of requests from bitcoin stakeholders about the VAT (value added tax) treatment of bitcoin, HMRC began to issue guidance in the form of a letter.
The guidance stated that bitcoin was to be treated as a single-purpose face-value voucher. This type of voucher is, as the name suggests, redeemable for just a single use. This means that at the time the voucher is bought, it is known whether or not VAT is chargeable on the goods or services for which the voucher can be redeemed. HMRC therefore charges VAT on the purchase of the voucher – they don’t wait around for the redemption.
If you know a little about bitcoin, you will know you can buy more than just one thing with it. It seems to me that someone at HMRC had simply misunderstood bitcoin, but the consequences were serious – anyone selling bitcoin or operating an exchange would have to charge VAT on the value of the bitcoin being sold. This meant that no UK exchange could be both compliant and competitive.
Along with a few others, I was lucky enough to be invited to HMRC to talk about this particular point. Following the meeting, HMRC agreed to withdraw this guidance and re-examine bitcoin to see how VAT should be applied to it.
For once UK businesses were happy to have no regulation. We were told that VAT would most likely be charged on bitcoin service charges, but not bitcoin itself. Therefore an exchange would have to charge VAT on its commission, but not on the bitcoins traded.
HMRC is continuing to consider how best to tax bitcoin and meetings with stakeholders are ongoing. I also understand that HMRC is considering all other aspects of taxation, not just VAT. Hopefully we will see some development in this area soon and a definitive position on how bitcoin businesses should account for tax.
Foreign Regulation
Just because there is so little regulation in the UK, it doesn’t mean that UK businesses aren’t affected by foreign laws. Regulations in the US have a habit of reaching beyond the borders of the 50 states.
In the US, operating a money transmission business is regulated by the Financial Crimes Enforcement Network (FinCEN) at a federal level, and then again at state level.
In order to be compliant throughout the US, money transmitters must comply with all sorts of customer due diligence obligations and maintain many expensive registrations in each state in which their services are available. Famously, on 18 March 2013, FinCEN extended the scope of this regulation to bitcoin exchanges and others buying and selling bitcoin or other digital currencies.
Unfortunately for UK businesses, this regulation has extraterritorial scope – it even applies to non-US businesses providing their services to US citizens.
Given the burden of complying with US regulation, most UK businesses simply close their doors to US citizens until they are ready to expand into the US market and have sufficient funds to undertake the compliance process. This involves geo-blocking US IP addresses, as well as any blocking any contact made through VPNs or TOR.
Conclusion
The lack of regulation in the UK has caused more problems than opportunities for bitcoin businesses.
Unable to be sure of what regulation is on the horizon and keen to avoid future liability, bitcoin businesses often find themselves taking more regulatory measures than regulated businesses.
On top of this is the biggest problem facing bitcoin in the UK – access to UK banking services. In short, there isn’t any. With the regulatory picture unclear, banks consider it too risky to offer bitcoin businesses a bank account.
In jurisdictions around the world, law makers and regulators are considering if and how to bring digital currencies under their regulatory frameworks.
Meanwhile the entrepreneurs, who can’t help but get started on their new businesses, are left second-guessing what form this new regulation will take and what effect it will have on their own particular business.
Until the inevitable question of regulation is settled, one way or another, digital currency businesses will be unable reach their true potential.