Edition 3 - The global issue
Penningtons Manches Cooper’s Partner and crypto specialist, Charlotte Hill, talks about the long-term viability of the blockchain ecosystem and the trends and changes coming its way.
After more than a decade of being portrayed as the financial world’s Wild West, cryptocurrency is now firmly in the mainstream despite the recent collapse of several exchanges. With more businesses accepting cryptocurrencies such as Bitcoin and Ethereum as payment, it is only a matter of time before decentralised finance (DeFi) operates on a level footing with the traditional finance (TradFi) space of the financial services sector and beyond.
For Penningtons Manches Cooper’s crypto expert, Charlotte Hill, the key word is ‘accessible’. Despite its reputation as a complex technology, cryptocurrency is now straightforward to purchase: “Download an app and you can buy it instantly. There’s no market closing, so you can trade 24/7 – it’s there anytime, day or night.”
According to the last Wealth Management report by IT adviser Capgemini, 71% of high net worth individuals (HNWIs) have invested in digital assets (which include cryptocurrencies and non-fungible tokens, more commonly known as NFTs), and 91% of those are under 40. “I know 16-year-olds who are becoming wealthy traders overnight,” says Hill. “They’d never do that with stocks and shares.”
The high-performance DeFi market can be volatile, of course. In May and June 2022, it crashed spectacularly: cryptocurrencies lost approximately $1 trillion in value. In August, the value of Bitcoin slumped to £15,499 from a November 2021 peak of £49,838 and there have been several exchanges that have recently collapsed, with serious reports of frauds being alleged against the founders.
Despite the large losses, Hill believes this ‘crypto winter’ was ultimately a good thing. “It has given the industry a chance to calm down, reset and look at what works and what doesn’t.
“Blockchain [and crypto] will become more prevalent and mainstream as time goes on,” says Hill. “It is a fantastic piece of technology which is already revolutionising the way the modern world works.” She cites the way Ukraine has used donations in crypto to finance elements of its defence, bypassing costly FX charges and ensuring almost instantaneous receipt.
Hill sees ‘education’ as being the missing piece of the puzzle, which she says will help those who deal with cryptocurrencies to ensure “for an individual investor, there’s very little protection in the UK compared with say shares in a PLC”, says Hill. Why? Because assets, which are easily moved around in crypto, need to be frozen to preserve the asset and freezing can often be expensive. “It is time intensive to get this kind of case up and running and into court quickly. It needs to be a sizeable sum to make it worthwhile, unless a group action can be formed on behalf of a number of victims. “There needs to be much more protection in this area for consumers,” Hill urges. “But that also has to be balanced – it’s a nascent industry, so you don’t want to stifle the creativity of the underlying technology and its potential.” How can we help? Please contact * Charlotte Hill on +44 (0)20 7457 3107 or charlotte.hill@penningtonslaw.com that they understand the market and the risks when dealing with it. But even as crypto is becoming more widespread, there remain three significant challenges to its progress.
Cryptocurrencies have traditionally been ‘mined’ using a process known as ‘proof of work’, in which computers solve complex cryptographic problems. This is highly energy intensive and, as a result, crypto has become notorious for its carbon footprint – the Bitcoin network, for example, uses more energy each year than Argentina.
Efforts are under way to address this, however. The Ethereum blockchain, which includes Ethereum crypto – the second most popular cryptocurrency – recently switched to an alternative model – ‘proof of stake’ – which is predicted to reduce its energy consumption by 99.9%. It’s hoped that proof of stake will become the standard, leading to a more open and environmentally friendly industry.
Investors may think they can squirrel away gains in crypto holdings but tax collectors are increasingly savvy on the technology. “HMRC are relatively au fait with crypto and capital gains tax applies if you make a profit,” explains Hill. “But I think HMRC have got a long way to go when it comes to being able to audit the traders who are making 100 or 200, or even 1,000, trades a day, each time generating miniscule changes that affect the profit and loss.”
Due to the lack of regulation and its accessibility, the crypto sphere attracts its fair share of criminals targeting investors. In the UK, around £146 million was lost to crypto fraud in the first nine months of 2021, according to Action Fraud, as scammers look to exploit naïve investors keen to get involved in the Bitcoin boom.
In June 2022, for example, Santander warned that cases of ‘celebrity-endorsed’ scams – where famous faces are misused on social media to con people out of large sums of money – have risen 65% year on year, with the average value of the scam reaching £11,872. It can take time to locate and freeze fraudsters’ wallets on chain, and that at present “for an individual investor, there’s very little protection in the UK compared with say shares in a PLC”, says Hill. Why? Because assets, which are easily moved around in crypto, need to be frozen to preserve the asset and freezing can often be expensive.
The ownership of cryptocurrency can complicate the division of assets between two parties – particularly when one tries to hide large amounts. There is an uphill battle to retrieve those assets, or even prove they had them in the first place once they have been transferred out of a party’s wallet.
“Whereas a court can order a bank to freeze monetary assets in a bank account, if you hold crypto you can take it offline and off-chain,” says Hill. “And, if it’s a De-Fi entity, where nobody really knows where it is, there’s very little that we can do.”
In that event, Hill advises partners to find a way to value digital assets – and then seek to retrieve the equivalent of that value from the other party. Her tip for those going through divorce? “As soon as you know there’s potential crypto and it is likely to be moved to avoid detection, find a way to freeze it and protect it. Once it’s moved to a different wallet, it’s often game over.”
“It is time intensive to get this kind of case up and running and into court quickly. It needs to be a sizeable sum to make it worthwhile, unless a group action can be formed on behalf of a number of victims.
“There needs to be much more protection in this area for consumers,” Hill urges. “But that also has to be balanced – it’s a nascent industry, so you don’t want to stifle the creativity of the underlying technology and its potential.”
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