What do law firms need to know about cryptocurrencies in 2022?

The booming cryptocurrency market

Cryptocurrency, or virtual money, first became a thing in 2009 with the arrival of Bitcoin, and it has dominated financial headlines ever since. We now believe there to be more than 10,000 cryptocurrencies available globally, with more coming onto the market every day. Cryptocurrencies are not normally used in day-to-day purchases. No high street shop in the UK currently accepts cryptocurrency. They tend to be held as investments by people hoping and expecting their crypto assets’ value to rise.

According to CNBC, as we start 2022, the value of the global cryptocurrency industry currently stands at over $3 Trillion. Whilst cryptocurrency advocates see exciting and limitless opportunities for the new way of trading, its critics only see risk.

This blog outlines some of Brian’s key view son what law firms ought to know about cryptocurrencies as we start a new year:

• Why are law firms unlikely to act on cryptocurrencies in 2022?
• Cryptocurrency Risks for law firms
• What law firms need to know about cryptocurrencies and anti-money laundering (AML)
• Key UK cryptocurrency developments law firms should be aware of
• Definitions

Why are law firms unlikely to act on cryptocurrencies in 2022?

Brian Rogers, Director of Regulation for Access Legal said, “Law firms are unlikely to act on transactions involving cryptocurrencies due to the lack of a clear position from regulators over compliance, but more importantly, because some professional indemnity insurers are saying they will refuse to cover firms at renewal due to the very high risks in this area. Due to the uncertainty, I suspect firms will wait for regulators and insurers to ‘show their cards’ before taking a position on it.”

Cryptocurrency risks for law firms

The Financial Conduct Authority (FCA)  advise that anyone investing in cryptocurrencies, from a law firm or not, should make themselves aware of the following significant risks:

• Crypto assets are considered very high risk, speculative investments.
• Those buying cryptocurrencies are unlikely to have access to the Financial Ombudsman Service or the Financial Services Compensation Scheme if something goes wrong.
• Those investing in crypto assets should be prepared to lose all their money.
• The crypto assets service they are using may not be regulated.
• There is no guarantee that crypto assets can be easily converted back into cash, as it depends on the demand and supply in the market at the time.
• The FCA continues to receive high numbers of reports of scams involving crypto assets.
• If a cryptocurrency opportunity sounds too good to be true it probably is.
• The FCA has banned the sale of crypto derivatives to retail customers due to its concerns surrounding the volatility and valuation of the underlying crypto assets.

What is good about cryptocurrency investments?

It’s not all bad. There are a number of compelling reasons why people still want to invest in cryptocurrencies:

• Many believe cryptocurrency is the currency of the future and are therefore keen to get involved.
• The technology behind cryptocurrencies is a de-centralised processing system (a digital ledger) and can be more secure than traditional payment systems.
• Some are simply attracted because they have seen evidence of cryptocurrencies going up in value and people making money from them.

What law firms need to know about cryptocurrencies and anti-money laundering (AML)

One of the important things for law firms to consider when dealing with transactions involving cryptocurrencies is their obligation to comply with the Money Laundering Regulations. The fifth Anti–Money Laundering Directive ('5MLD') now has extended scope regarding the persons subject to anti-money laundering laws to include Virtual Currency Exchange Platforms (VCEP) and Custodian Wallet Providers (CWP).

The Money Laundering Regulations 2019 define crypto-assets as “a cryptographically secured digital representation of value or contractual rights that uses a form of distributed ledger technology and can be transferred, stored or traded electronically”.

Crytocurrency AML Red Flags For Law firms

The Financial Action Task Force (FATF) Report on Virtual Assets Red Flag Indicators states that “the misuse of virtual assets often relates to criminal activities, such as illicit drug trafficking, fraud, theft and extortion (including cyber-enabled crimes)”.

The following red flags are of specific relevance to law firms:

• The bulk of a client’s source of wealth is derived from investments in virtual assets, initial coin offerings (ICOs) or fraudulent ICOs, etc.
• A customer’s source of wealth is disproportionately drawn from virtual assets originating from other virtual asset service providers (VASPs) that lack appropriate anti-money laundering controls

Law Firms Must Record Their Cryptocurrency Decision

Any law firm dealing with transactions involving cryptocurrencies will need to update its Practice Wide Risk Assessments (PWRA), review and AML policies, controls and procedures. Firms should provide training to staff too of course. Even if a firm is not going to deal with cryptocurrency transactions it should make a note of this in its PWRA along with the reasons behind this decision and explain this decision to staff.

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How does cryptocurrency affect professional indemnity insurance for law firms?

It is apparent that some professional indemnity insurers have said that due to the very high risks related to the handling of transactions involving cryptocurrencies. firms that do so would be at risk of not being able to obtain cover at renewal. It Is therefore essential that firms consult with their insurers before they take on any of these transactions.

Key UK Cryptocurrency Developments law firms should be aware of

1. A new form of digital money is on the horizon
   Her Majesty’s Treasury and the Bank of England announced in November 2021 that in 2022 they will launch a consultation which will set out their assessment of the case for a UK Central Bank Digital Currency (CBDC), a new form of digital money for use by households and businesses for everyday payment needs. The idea is that it will sit alongside, rather than replace cash or bank deposits. The consultation, which is expected to take several years, will consider the merits of further work, a tech model and the main issues at hand and the benefits. This consultation will form part of a ‘research and exploration’ phase and helps to inform policy development over the next few years.
2. New authoritative guidance has been launched
   The Law Society Gazette reported, earlier in January 2022, the launch by the master of the rolls of a new edition of authoritative guidance on the legal and regulatory aspects of the technologies underpinning digital currencies. It has been drawn up by working group of experts to provide the legal profession with guidance on blockchain and distributed ledger technologies (DLT) covering the evolving commercial and technological issues and how they impact the law.

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Digital Money Definitions

• Cryptocurrency is virtual money secured by cryptography (digital code). It is meant to be impossible to counterfeit or double-spend. Cryptocurrency is sometimes referred to as: crypto assets, digital coins, peer-to-peer money, or decentralised finance.
• Bitcoin was the first, and probably most well-known cryptocurrency – alongside Ripple, Litecoin, ETH etc.
• Blockchain is the tech that enables cryptocurrency and it was invented for Bitcoin. It is a digital ledger and although it originated to provide cryptography-enabled record-keeping for Bitcoin and has gone on to enable the exchange of many other cryptocurrencies, and its use has flourished. Blockchain now offers many other data-exchange applications such as: smart contracts, property matters, refugee aid, election voting, and medical records.
• Satoshi – the smallest denomination of bitcoin (100 millionth of a bitcoin) – named after Satoshi Nakamoto one of the people involved in the development of bitcoin and designer of the first Blockchain database.
• Non-fungible tokens (NFTs) – cryptographic assets on a blockchain with unique ID codes.
• Virtual Currency Exchange Platforms (VCEP)
• Crypto asset ATM - internet-enabled kiosk where users can exchange deposited cash for Bitcoin.
• Initial Coin Offering (ICO) - a trading platform investors use to receive unique cryptocurrency “tokens” in exchange for monetary investment
• Initial Exchange Offering (IEO) - help to oversee the ‘token’ sale by making sure the project vetting process is scrutinized.
• VASP – Virtual Asset Service Provider - provides financial services related to an issuer's offer and/or sale of a virtual asset.

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*We are not FCA regulated, and our blogs and webinars on this subject are not intended to provide any financial advice whatsoever about cryptocurrencies. Neither will we recommend any particular type of cryptocurrency in any of our material.