While still something alternative or niche a decade ago, there is little doubt that investments in the blockchain and crypto space have seen remarkable growth in recent years. Among the multiple ways to invest in this fast-growing area, this article focuses on the route that potentially gives you more control or involvement in your investments – purchasing shares in companies where blockchain or digital assets is core to their business (we will call them ‘blockchain businesses’ in this article).
After doing your research on what these game-changing technologies mean and how they work, and having found an exciting blockchain investment opportunity, here are five legal questions to ask yourself before putting your signature on the dotted line.
Here are 5 questions to ask before investing in blockchain businesses:
1. What am I actually investing in?
With growing popularity in making blockchain investments, the way in which this can be done has also increased – from directly purchasing digital currencies or tokens (such as NFTs), to investing in digital asset-linked financial products (such as ETFs and trusts), and to buying shares in publicly listed or private companies that are dedicated to blockchain technology and digital assets. Each form of investments comes with its own unique set of legal considerations, so it is essential to understand the differences between them and their implications on your investment. Before buying shares in blockchain businesses, some questions you need to consider include: how much time and resources can you devote to doing due diligence on the business? How much knowledge and bargaining power do you have in conducting negotiations? What legal documentation will be required to complete the investments? What are my rights and liabilities in the event the investments have gone wrong? While it would appear prudent to proceed only if you responded with a reassuring “no” to the above questions it does not mean the end of your investment plan – speak to a legal expert at an early stage to see how they can help.
2. Has the blockchain company been authorised/registered?
While there is no specific regulatory framework for blockchain businesses, authorisation may be required from the Financial Conduct Authority (FCA) if the company falls within its regulatory perimeter. One major regime is the Part 4A authorisation under the Financial Services and Markets Act 2000 (FSMA). If the activities carried out by the company is classified as a “specified activity”, it needs to be authorised under the FSMA. You should therefore check the Financial Services Register to see which companies the FCA authorises and what they are authorised to do. If you are investing in cryptoassets exchange providers or custodian wallet providers, you may also need to ensure that the business has been registered with the FCA pursuant to the Money Laundering and Terrorist Financing (Amendment) Regulations 2017, which sets out obligations of private companies exposed to the risks of money laundering. FCA’s Registered Cryptoasset Firms Register shows the cryptoasset firms that have been registered for these purposes. Therefore, always check that the blockchain businesses that you are planning to invest in are listed on the Register(s). Carrying on regulated activity without authorisation has serious consequences and is a criminal offence. As an investor, you risk losing some, or even all, of your money if the company is found to be unauthorised.
3. How is the company regulated and how will it be regulated in the future?
Just like investing in any businesses, before getting involved with investments in blockchain businesses, it is important to be aware of the applicable regulations and their implications on the risks and opportunities facing the company.
While the UK Government currently has limited regulatory oversight of blockchain businesses, it is already taking a number of steps to bolster the UK regulatory framework. For example, in the January 2021 consultation paper, HM Treasury proposed new regulatory regimes for cryptoassets, including introducing a new definition of “cryptoassets” and formally including them within the scope of the regulated activities under the FSMA. These initiatives are taken further in the more recent Financial Services and Markets Bill 2022-23, which is already approaching its final legislative stages at the time of this article. Earlier this year, HM Treasury has also published several papers introducing more specific regulations, such as the financial promotions of cryptoassets and their use within the financial services.
With cryptoassets featuring more prominently on the government’s regulatory agenda, it is expected that the regulatory landscape will continue to mature and grow in the near feature. Staying on top of the latest developments enable you to identify areas of potential benefit or harm, while riding on the government’s ambitious plans for the UK to become a global hub for digital asset technology.
4. Am I protected if the company goes out of business?
Notwithstanding the above authorisation regimes, many crypto-related activities are not regulated in the UK yet. Unlike other conventional investments, once your money has entered the crypto ecosystem, there are limited rules to protect it. Therefore, if you invest in any blockchain businesses, you may not be able to access the Financial Services Compensation Scheme, which provides compensation under certain circumstances if an authorised firm cannot pay claims against it, or the Financial Ombudsman Service, which settles complaints concerning authorised firms. Once again, before making investment’s in any blockchain businesses, check the Financial Services Register to see if it is authorised by the FCA – if it is not, you are likely to miss out on these statutory protections if the company goes out of business.
5. Should I get legal advice?
Depending on the size of your investment, it may be worthwhile to retain an experienced lawyer specialising in blockchain and cryptoassets to deal with the complexities and technicalities of investing in blockchain businesses. From due diligence to contract negotiations to regulatory compliance, a blockchain legal professional can provide expert insights, and help you avoid legal pitfalls and navigate the evolving regulatory landscape.
This blog was written by Grace Kung, Associate in our Corporate and Commercial team. If you are currently thinking of investing in a blockchain company, speak to Grace or a member of our team of blockchain and digital assets legal experts.