Cryptoasset Series - Part 1
Cryptoassets in Restructuring
New cryptoassets are being generated every day as technology continues to evolve and people identify new uses for the underlying blockchain technology.
As a result, we anticipate the use of cryptoassets will become ever more mainstream and an increasingly material asset class that needs to be considered in business restructurings.
Recognising that the level of individuals’ understanding of cryptoassets varies widely, Interpath’s Financial Services team will be releasing a series of articles with the aim of demystifying cryptoassets and looking at the expected challenges when dealing with these in a UK insolvency.
There are many sources and much commentary on this fascinating subject from a technical, legal and regulatory viewpoint. This series will focus on the practical aspects – in particular, some of the unique characteristics of cryptoassets compared to conventional assets such as securities, derivatives, and cash.
What are cryptoassets?
Cryptoassets are digital assets which generally utilise sophisticated cryptography in their generation and in transactions between parties. There are many different types of digital assets such as currencies, securities and tokens which act as digital stores of value.
Cryptography is not a new concept - even Julius Caesar and the gunpowder plotters used it when sending messages! - but with recent technological advances, the ways we can use cryptography to secure digital transactions has greatly improved.
Cryptoassets use peer to peer networking and a public distributed ledger to regulate the generation of new tokens, verify transactions and secure transactions without the intervention of any single middleman or “master copy”.
There are different cryptoassets which have developed using alternative versions of distributed ledger technology and associated cryptography. For example, Bitcoin (the most well know cryptoasset) was launched with a capped maximum supply of 21 million Bitcoin, with each single unit being awarded to the winner of each mining event. However, no matter what the computer algorithm is, the differentiating factor of cryptoassets is the distributed ledger technology which stores every confirmed transaction.
Banking technology expert David Walker will cover this technology in more detail in our next article.
What are the types of cryptoassets?
There is no agreed taxonomy for classifying cryptoassets. Regulators have started consulting with the market on how best to categorise these and some have adopted their own language.
The UK Financial Conduct Authority (FCA) has to date adopted broad classification categories in its Consultation Paper (CP 19/3) as outlined below.
Regulated tokens
e-money tokens
Fall within the definition of the Electronic Money Regulations 2011 as these are tokens which store monetary value electronically that represent a claim on the issuer which can be accepted by a person other than the issuer.
Security tokens
Have similar characteristics and are likely to be a digital form of a traditional security.
Unregulated tokens
Utility tokens
Exchanged for specific services. For example, a business may launch a cloud storage platform (e.g. Siacoin), which will involve a use of a utility token (e.g. SC token) to enable others to rent out unused hard drive space to users looking to store files, via an Initial Coin Offering (ICO).
Exchange tokens
Also known as crypto-coin, cryptocurrency or payment tokens, with Bitcoin as the first cryptocurrency followed by others such as Monero and Ether.
The FCA currently considers the regulatory treatment of any other token as unregulated unless they meet the definition of e-money tokens or security tokens.
However, as the crypto market evolves rapidly, we see new forms of assets continuously emerging such as stablecoins which tie their value to other more stable assets; platform tokens which support other dapps; or complex tokens integrated into defi projects or operating on the Internet Of Things.
As cryptoassets become more mainstream, many governments are considering the benefits of a regulated environment versus the freedom of encouraging businesses to prosper and the ramifications that some of the cryptocurrencies bring to the sovereign monetary system.
In the UK, the Bank of England sought feedback through a discussion paper on the benefits of a central bank digital currency (CBDC), whilst certain countries have already started implementing these.
A CBDC is just the digital form of GBP and would therefore be regulated by the country’s central bank (in the UK, being the BoE). However, any digital currency may not overcome the freedom of services offered by cryptocurrencies where there is separation between government and money. We would expect the UK to end up with a regulated CBDC as well as unregulated cryptocurrencies, where the latter may continue to be subject to value volatility.
What types of failure can we expect in cryptoassets?
So far, the most impactful failures in the cryptoassets world have been those of exchange platforms.
The two primary reasons for failure to date being either the theft of assets through hacks such as with Mt Gox in Japan, or the fraudulent activity of management such as Bitgrail in Italy.
With the FCA estimating in 2021 that 2.3m UK adults hold cryptoassets and a shift from gambling to alternative investment strategy being cited as the primary reason for doing so, the customer harm through exchange failures has only increased the concerns of regulators around the world with cryptoassets already linked to money laundering and illegal black-market dealings.
Other than exchanges, a number of other organisations within the cryptoasset service provider chain such as custodians, mining businesses, ICOs, operating trading platforms, crypto issuers, brokers/intermediaries and businesses that accept cryptoassets as a method of payment could collapse, which would affect thousands of consumers.
In the UK, whilst the issuer of a security token might not need to be authorised, the carrying on of regulated activities requires the company to be registered with the FCA. This is to ensure that consumers can identify if a cryptoasset is regulated.
We have recently seen how the powers of the regulator are limited when the FCA sought to take action against one of the world's largest exchanges, Binance.com, during summer 2021. Restrictions imposed on the UK FCA regulated entity, Binance Markets Limited, have had little effect as consumers have continued to be able to use the exchange's services through off-shore establishments.
The UK has also seen how cryptoassets owned by individuals can be seized to settle unpaid taxes, during matrimonial disputes or personal bankruptcy.
The Interpath team has the necessary knowledge and understanding of these unique assets to properly consider the options, risks and issues when handling cryptoassets within a restructuring scenario.
Equally, we can support parties to be proactive in understanding the risks to their cryptoassets that may arise in the event of a business failure and/or support those businesses in taking steps now, including the development of resolution plans, in order to minimise the potential harms that may arise in the event of a business’s failure.
If you would like to speak to us about any of the above issues, please get in touch with our Financial Services practice.
In our next article we will be discussing the details of technology behind crytpoassets with David Walker, co-author of Blockchain, Distributed Ledger Technology and Cryptocurrency.
