Cryptocurrencies and blockchain for law firms

With cryptocurrencies edging into most financial conversations, Access Legal‘s regulatory director, Brian Rogers, explores the nuances of crypto regulation, and their implications for law firms.

Do you know your tokens, VAs, ICOs and VASPs? Our most recent thematic webinar provided attendees with an introduction to cryptocurrencies and blockchain – topics which are rising up the agenda for law firms (and their clients), but which are perhaps not as well understood as they should be. Here are some of the themes that we’ve addressed.

Although law firms are unlikely to get involved in the trading of cryptocurrencies, they are likely to receive instructions from clients who do or want to use such currencies in their legal service transactions, therefore they need to have an understanding of what cryptocurrencies are and the risks that come with them.

Some of the words and phrases used in relation to cryptocurrencies – very volatile, worthless, very high risk, lack of transparency, limited regulatory protections, and financial crime, for instance – show how risky these currencies are.

The Financial Conduct Authority (FCA) has been keen to point out that people investing in cryptocurrencies need to be aware of some key risks:

• Crypto assets are considered very high risk, speculative investments
• Those buying these types of crypto assets are unlikely to have access to the Financial Ombudsman Service (FOS) or the Financial Services Compensation Scheme (FSCS), if something goes wrong
• Those who invest in crypto assets should be prepared to lose all their money
• The crypto assets/services they are using may not be regulated
• There is no guarantee that crypto assets can be easily converted back into cash. Converting a crypto asset back to cash depends on the demand and supply in the market.

The FCA has received a high number of reports of scams involving crypto assets. The crypto asset marketplace is a target for fraud and scams, so people need to be extremely cautious before investing – if an 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. 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 5th Anti Money Laundering Directive (‘5MLD’) extended the scope of persons subject to anti-money laundering (AML) 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.” For the purposes of the 2019 Regulation VCEP activity covers:

• Peer-to-peer providers
• Crypto asset Automated Teller Machine (ATM)
• Issuing new crypto assets (Initial Coin Offering or Initial Exchange Offering)

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 are example red flags that could be 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 AML controls

Any law firm dealing with transactions involving cryptocurrencies will need to update its practice wide risk assessments (PWRA); review and update AML policies, controls and procedures; and, where appropriate, provide training to staff. Even if a firm is not going to deal with such transactions, it should make a note of this in its PWRA along with the reasons behind this decision.

Having said all of the above, some professional indemnity insurers have said that due to the very high risks associated with 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.

Join my monthly compliance webinar series to stay up to date with the latest legal regulation and what it means for your firm, and read more about cryptocurrencies and blockchain for law firms here.