Discussions on regulating crypto asset activities

2025/06/21 10:37

Overview

The Financial Conduct Authority (FCA) of the United Kingdom issued a discussion paper on "Regulating Crypto-Asset Activities" (DP25/1) in May 2025, aiming to implement the crypto-asset regulatory legislation plan proposed by the UK Treasury in 2023 and build a safe, competitive and sustainable crypto industry ecosystem. According to the draft "Regulatory Activities Order" published by the Treasury in November 2024, the scope of FCA's supervision will be expanded from the current anti-money laundering rules, financial promotion system and consumer protection laws to crypto-asset trading platform operations, intermediary services, lending, pledge and decentralized finance activities, and promote the UK to become a global crypto-financial center by balancing innovation and risk, strengthening market integrity and consumer protection.

Although crypto assets have a high degree of recognition in the UK, the inherent high volatility, lack of valuation system and cross-border anonymity of the market make their risk level significantly higher than that of traditional financial products. FCA particularly emphasized that even if the new regulatory system is implemented, investors still need to be prepared to "lose all funds", and the crypto market cannot provide the same protection as the traditional financial market due to the lack of centralized issuers, mature risk settlement infrastructure and unified governance mechanism. Therefore, the core positioning of the new system is "risk prevention and control" - reducing systemic risks through rule constraints, rather than eliminating the high uncertainty of the market itself.

In the design of the regulatory framework, FCA closely benchmarks international standards, deeply participates in the rule-making of institutions such as the International Organization of Securities Commissions (IOSCO) and the Financial Stability Board (FSB), leads the implementation of IOSCO's "Crypto and Digital Assets Recommendations", and promotes peer review of the global regulatory framework. At present, discussion documents such as stablecoin regulation and market abuse system have been released. It is also planned to conduct consultations on the issuance of qualified stablecoins, asset security, behavioral standards, etc. in stages in 2025, in order to reserve innovation space for the industry in the way of "establishing a framework first and then making detailed rules".

For the possible impact of regulation, FCA not only pays attention to direct expenditures such as corporate compliance costs such as IT system upgrades, employee training, and governance adjustments, but also attaches importance to indirect effects such as changes in market structure such as cost transmission to consumers and the exit of small and medium-sized institutions. To this end, the regulator has pledged to maintain policy flexibility through mechanisms such as public solicitation of opinions and industry roundtable discussions. In the field of consumer protection, in addition to applying the Consumer Responsibility to enhance transparency, special rules will be added for the characteristics of crypto assets, such as requiring companies to conduct risk perception tests before user participation, clarifying asset ownership transfer terms, and prohibiting the provision of high-risk lending products to retail customers, reflecting differentiated prudent thinking.

Construction of a Regulatory Framework for Crypto-asset Trading Platforms

The Financial Conduct Authority (FCA) of the United Kingdom has adopted a balanced strategy of balancing market vitality and risk prevention and control in the construction of a regulatory framework for crypto-asset trading platforms (CATPs). The current crypto-trading market is highly globalized, and platform operators often assume multiple roles such as transaction matching, asset custody and even credit provision. Although this vertical integration model improves efficiency, it also brings complex conflicts of interest and systemic risks. Regulators are particularly concerned that the lack of constraints on platform proprietary trading may distort the market price discovery mechanism, while the popularity of algorithmic trading and high-frequency strategies has exacerbated market volatility, and retail investors' direct participation in transactions has further magnified the potential harm of information asymmetry.

In response to these challenges, the FCA has proposed a set of tiered regulatory solutions. At the institutional access level, services for UK retail customers must be provided through local authorized entities, but international platforms are allowed to access the global liquidity pool through a dual-track structure of "branch + subsidiary". In this division of labor model, the UK branch is responsible for core trading functions, and the local subsidiary handles customer access and compliance management. This design not only maintains the regulator's control over key links, but also avoids market fragmentation caused by excessive closure. In terms of trading mechanism specifications, platform operators are clearly prohibited from exercising order matching discretion, and all transactions must be automatically executed in accordance with pre-announced rules to eliminate the unfair advantages that may be brought about by human intervention. For liquidity providers such as market makers, platforms are required to establish transparent access agreements, disclose commercial relationships, and prevent market manipulation through false quotes.

Settlement and asset security are another regulatory focus. FCA emphasizes that trading platforms should not assume clearing functions or provide credit support to customers, and must maintain a risk-neutral position to avoid affecting the normal operation of the market due to proprietary positions or credit exposure. Taking into account the particularity of blockchain technology, the regulatory plan maintains a certain degree of flexibility in settlement arrangements, but requires platforms to clearly inform customers of the timeliness and responsibility division of asset transfers. In terms of transparency, it is planned to simultaneously implement the pre-trading order book information disclosure and post-trading transaction data disclosure system, but sensitive commercial information is allowed to be released with appropriate delay. It is worth noting that in view of the particularity of retail investors directly participating in transactions, regulators have given platforms more proactive monitoring obligations, including setting risk parameters and identifying abnormal transactions, in order to make up for the regulatory gap that individual investors' behavior is not subject to financial behavior rules.

The uniqueness of this regulatory framework lies in that it not only absorbs the regulatory wisdom accumulated in the traditional financial market over the past decades, such as mature practices such as market maker management and transaction transparency, but also fully considers the emerging characteristics of the crypto asset market such as 7×24 hours operation, smart contract settlement, and global liquidity pool. In the trade-off between risk prevention and control and market efficiency, the FCA has shown a clear "risk-based" orientation, imposing strict restrictions on proprietary trading, credit exposure and other activities that may endanger system stability, while adopting a moderately standardized strategy for market makers and algorithmic trading that help improve market quality. This differentiated regulatory approach reflects the regulator's prudent attitude in seeking a dynamic balance between promoting innovation and preventing and controlling risks.

Regulatory system for crypto asset intermediary services

The Financial Conduct Authority (FCA) of the United Kingdom has established a regulatory system that matches the risks for crypto asset intermediary activities, taking into account the different needs of retail and institutional clients. In the current crypto market, intermediaries play a key role in connecting investors and trading platforms. About 28% of UK crypto users participate in the market through payment or brokerage intermediaries, but such services are often accompanied by higher fees and potential information asymmetry risks.

The core risks of intermediary business are concentrated on consumer cognitive bias and lack of market transparency. Some intermediaries do not clearly distinguish between proprietary trading and agency business models, and the interface design is easily confused with the trading platform, making it difficult for retail investors to identify the essence of the service. The quality of order execution varies, and the dispersed liquidity leads to significant price differences for similar assets. In addition, some intermediaries have multiple businesses, such as engaging in proprietary trading and customer order execution at the same time, which may induce conflicts of interest. Of particular concern is the "payment for order flow" model, where intermediaries may harm the best execution interests of clients by directing client orders to specific trading platforms to obtain commissions. The FCA intends to explicitly prohibit this practice. In response to the above risks, the regulatory framework proposes a layered governance solution. In the order execution link, intermediaries are required to establish "best execution" standards similar to those in traditional financial markets, especially for retail clients, the "total consideration" (including fees and implicit costs) must be used as a measurement benchmark. Intermediaries are required to regularly evaluate the price data of at least three UK authorized trading platforms and review their execution policies annually. For cross-border business, overseas institutions that meet certain conditions are allowed to provide services through UK branches, but retail clients must establish relationships through UK legal entities.

In terms of transparency construction, it is proposed to require proprietary trading intermediaries to disclose key information such as trading volume and price in near real time, and explore the introduction of pre-trading transparency rules, such as requiring intermediaries to publish quotation ranges. Considering the liquidity differences of different crypto assets, regulators may exempt small-scale institutions or specific assets from some disclosure requirements. In terms of customer classification, the "opt-in" mechanism for retail customers to upgrade to professional investors will be strictly restricted to prevent intermediaries from improperly guiding customers to abandon protection measures.

The framework places special emphasis on the principle of technological neutrality. Regardless of whether centralized or distributed ledger technology is used, as long as the business is essentially the same, unified regulatory standards apply. The FCA will clarify the operational details through subsequent consultations, including how to adapt the existing Consumer Credit Manual's rules on credit assessment, forbearance arrangements, etc. to the crypto lending scenario. Overall, the new regulations attempt to strike a balance between protecting consumers and maintaining market competitiveness, requiring intermediaries to assume more information disclosure and compliance responsibilities while retaining space for business model innovation.

Risk Management in Crypto Asset Lending Market

The crypto asset lending market presents typical cyclical characteristics, from rapid expansion in the early stage to concentrated risk exposure in the later stage. This process reveals the unique systemic risks in this field. From the essence of the business model, its core feature lies in the complete transfer mechanism of asset ownership - investors transfer the legal and beneficial ownership of crypto assets to the platform in exchange for the fixed income return promised by the platform. In return, the platform realizes returns through diversified asset allocation strategies, including but not limited to reinvestment, participation in liquidity pools, and interaction with decentralized financial protocols.

From a regulatory perspective, there are three key risks in the current market: first, at the level of retail investor protection, there is a general cognitive bias towards the legal consequences of asset ownership transfer; second, in the mortgage lending business, the high volatility of crypto assets leads to the possibility that the margin call mechanism may trigger systemic risks; finally, there is a structural conflict of interest in the economic model design of platform tokens. In response to these risks, regulators are building a differentiated regulatory framework, including protective restrictions on the retail market and risk management requirements for institutional investors.

In terms of the innovative application of regulatory tools, policymakers are promoting the adaptive transformation of traditional financial regulatory rules. Specific measures include: establishing a solvency-based credit assessment system, implementing a standardized key information disclosure system, and introducing a capital buffer mechanism for technical risks. It is particularly noteworthy that stablecoins may receive differentiated treatment in the regulatory framework due to their price stability, which reflects the prudent balance between promoting innovation and preventing risks by regulators.

Restrictions on credit purchases of crypto assets

The Financial Conduct Authority (FCA) of the United Kingdom has noted that as crypto assets become more popular among consumers, the use of credit cards or other credit instruments to purchase crypto assets is growing rapidly. The latest survey shows that the proportion of British consumers who purchase crypto assets through credit cards or existing credit lines has increased from 6% in August 2022 to 14% in August 2024. This trend has raised regulatory concerns: the sharp fluctuations in the price of crypto assets may cause consumers to face debt repayment difficulties in a short period of time - when the value of assets falls sharply, consumers who rely on their appreciation to repay credit may fall into financial crisis, and even affect their credit scores due to overdue repayments, thereby restricting their ability to obtain credit in the future.

In the face of this risk, the FCA is considering implementing restrictive measures, including prohibiting the use of credit cards to directly purchase crypto assets and limiting the credit lines provided by electronic money institutions for such transactions. Regulators are particularly concerned about the protective effect of this policy on financially vulnerable groups, and have also noted that some payment companies have taken proactive measures to restrict related transactions. However, there are still crypto asset service providers in the market that promote credit purchase options, which may expose consumers to unnecessary financial risks. It is worth noting that the FCA has reserved exemptions for qualified stablecoin issuers authorized by it in the proposal, which reflects the regulator's intention to strike a balance between risk control and financial innovation.

At the policy-making level, the FCA recognizes that any restrictions will have a wide-ranging impact on market participants and consumers, and is therefore actively collecting industry feedback to assess the feasibility and potential effects of different options. This move highlights the UK regulator's forward-looking management of crypto asset market risks, with the core goal of preventing consumers from taking excessive credit risks due to the high volatility of crypto assets through prudent regulatory intervention, while maintaining the overall stability of the financial market.

Crypto Asset Staking Service Specifications

Crypto asset staking (Staking), as a key mechanism in the blockchain ecosystem, is undergoing a transformation from technical practice to standardized financial services. This process is accompanied by unique business model innovation and the evolution of risk characteristics, and a regulatory framework that is compatible with it needs to be established. The current mainstream staking services mainly focus on lowering the participation threshold, enabling retail investors to indirectly participate in blockchain verification work that originally required high technical thresholds through methods such as delegated verification and asset pooling. However, this convenience also brings new challenges - investors often lack sufficient understanding of complex smart contract terms, asset locking mechanisms, and income calculation methods, and technical failures or operational errors of service providers may directly lead to user asset losses.

In terms of business architecture, the rise of the liquidity staking model is particularly noteworthy. This model theoretically solves the problem of insufficient liquidity in traditional staking by issuing derivative tokens representing the pledged assets. However, in practice, price fluctuations of derivative tokens, delayed redemption and other issues may trigger a chain reaction, especially during periods of sharp market fluctuations. At the same time, some platforms have vague disclosure behaviors and fail to clearly inform users of the actual ownership of assets during the pledge period, which lays hidden dangers for potential disputes. The core of regulatory intervention lies in establishing transparent and accountable operating standards, including but not limited to specific requirements such as mandatory disclosure of key terms, standardization of third-party service provider management, and implementation of asset isolation and custody.

From the overall perspective of risk management, pledge services actually build a multi-level trust system: the technical level relies on the stability of the blockchain protocol, the operational level relies on the professional capabilities of the service provider, and the financial level requires a reasonable profit distribution and risk compensation mechanism. Effective supervision should cover these three dimensions at the same time, protecting retail investors who are at a disadvantage in information, and providing clear development expectations for innovative entities that operate in compliance. In the future, as the scale of pledged assets expands and the complexity of products increases, how to prevent systemic risks while maintaining technical neutrality will become an important topic for regulators and the industry to explore together.

Regulatory Path for Decentralized Finance (DeFi)

As an important innovation in the field of crypto assets, decentralized finance (DeFi) faces unique challenges in building its regulatory framework. Currently, the services that claim to be "decentralized" in the market actually present a spectrum of characteristics - from fully algorithm-driven to hybrid models with actual controlling entities. The Financial Conduct Authority of the United Kingdom adopts the regulatory principle of "substance over form", focusing on whether there are identifiable controllers or entities, including management key holders who can modify smart contracts, decision-making groups that centrally hold governance tokens, and development teams that provide key technical support. DeFi services operated by such entities, regardless of their technical architecture, will be regulated as traditional financial institutions, covering the entire business chain including trading, lending, and asset management.

At the level of specific regulatory implementation, regulators pay special attention to three core risk dimensions: first, technical risk. Smart contract vulnerabilities may cause user assets to evaporate instantly and be difficult to recover; second, governance risk. The decision-making mechanism of decentralized autonomous organizations may obscure the responsible parties; and finally, cognitive risk. Ordinary investors often find it difficult to understand complex mechanisms such as pledge and liquidity mining. To this end, regulatory requirements must ensure the transparency of information disclosure, the fairness of product design, and the effectiveness of dispute resolution mechanisms. It is worth noting that for protocols that truly have no central control entity, supervision will remain moderately tolerant, but it is required to meet basic anti-money laundering and consumer protection standards.

In order to achieve a balance between regulation and innovation, the UK adopts a progressive regulatory strategy. In the early stage, the regulatory boundaries will be clarified through industry dialogues, especially for cutting-edge issues such as the responsibility identification of governance token holders and the security audit standards of smart contracts. The regulatory sandbox mechanism will be used to test the feasibility of automated compliance solutions, such as using oracles to monitor on-chain activities in real time, or developing DeFi-specific "regulatory plug-ins". This flexible regulatory approach not only reserves space for technological innovation, but also prevents regulatory arbitrage through the principle of "same activities, same risks, same regulation". With the deepening of international regulatory coordination, the UK will dynamically adjust its policy framework to maintain its competitiveness in the global crypto asset field while maintaining financial stability.

Conclusion and Outlook

The construction of the UK's crypto asset regulatory framework marks that financial market governance is undergoing a profound paradigm shift. This systematic reform is neither a simple transplantation of the traditional financial regulatory model nor a laissez-faire attitude towards emerging technologies. Instead, it builds a regulatory system that is both principled and flexible by accurately identifying the unique risk characteristics of the crypto asset market.

In the design of the regulatory framework, the FCA demonstrates a hierarchical and progressive regulatory wisdom. At the basic level, it focuses on the trading platform as a market hub, and reshapes the robustness of the market infrastructure by forcing the adoption of non-discretionary trading rules and restricting proprietary account trading. This reform directly targets the most prominent systemic risk sources in the crypto market and lays a solid foundation for the entire regulatory system. The intermediate level focuses on regulating the intermediary service chain, taking order execution transparency as the core, and building a consumer protection mechanism throughout the entire transaction process. Particularly noteworthy are the special provisions for algorithmic trading and market making, which both recognize the technical characteristics of the crypto market and prevent market distortions that may be caused by new trading models. For high-risk businesses such as crypto lending and staking, the regulatory scheme adopts differentiated regulatory intensity. This hierarchical regulatory strategy not only reflects the risk-based regulatory concept, but also avoids the innovation suppression that may be caused by "one size fits all". In cutting-edge fields such as DeFi, regulators have shown rare policy flexibility. The regulatory principle of "substance over form" proposed by them not only ensures effective regulatory coverage, but also reserves experimental space for technological evolution. The unique value of this regulatory system lies in its dynamic adaptability. FCA has clearly established a policy feedback mechanism to calibrate regulatory intensity through continuous market dialogue. This design not only overcomes the defects of traditional regulation in responding to technological changes slowly, but also prevents the accumulation of risks that may be induced by "regulatory gaps". In terms of cross-border regulatory collaboration, the "branch + subsidiary" hybrid regulatory model proposed in the plan not only maintains the UK's regulatory sovereignty, but also maintains connectivity with the international market.

Looking to the future, the implementation of this regulatory framework will face three challenges: the challenge of rule adaptability brought about by technological iteration, the problem of regulatory coordination in the global market, and the delicate balance between compliance costs and innovation vitality. The FCA is aware of this, and the "gradual reform" path it emphasizes not only sets a clear regulatory bottom line, but also reserves space for optimizing rules based on practical feedback. This pragmatic and forward-looking regulatory philosophy may enable the UK to gain a first-mover advantage in the international competition for crypto asset regulation and provide a valuable institutional model for global crypto asset governance.

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Discussions on regulating crypto asset activities

Overview

Construction of a Regulatory Framework for Crypto-asset Trading Platforms

Regulatory system for crypto asset intermediary services

Risk Management in Crypto Asset Lending Market

Restrictions on credit purchases of crypto assets

Crypto Asset Staking Service Specifications

Regulatory Path for Decentralized Finance (DeFi)

Conclusion and Outlook

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