In a new report, the Treasury Select Committee said the "current 'wild west' situation" exposes retail investors to potential financial losses and leaves the market vulnerable to "manipulation". It described self-regulation within the crypto-asset industry as "clearly insufficient" and warned that a lack of regulation also means crypto-assets can be used to "facilitate the sale and purchase of illicit goods and services" and "launder the proceeds of serious crime and terrorism".
However, the Committee said greater regulation of crypto-assets could deliver "positive outcomes".
"The implementation of crypto-asset regulation in the UK may enable the market place to move to a more mature business model that improves consumer outcomes and enables it to grow sustainably," the Committee said. "The entry of institutional investors into the market would increase liquidity, which in itself could reduce some of the inherent risks that exist at present."
"If the UK develops an appropriate and proportionate regulatory environment for crypto-assets and if future innovations in crypto-assets proved themselves as beneficial to society and industry, the UK could be well placed to become a global centre for this activity, providing that the crypto-asset market adhered to high standards and was not associated with criminality," it said.
The Committee's report was published after it held an inquiry into digital currencies. The report called on the UK government to extend the existing Regulated Activities Order "as a matter of urgency" to enable the Financial Conduct Authority (FCA) to regulate the crypto-asset market more closely, including in relation to 'initial coin offerings' (ICOs).
"The development of ICOs has exposed a regulatory loophole that is being exploited to the detriment of ordinary investors," the Committee said.
"The FCA’s consumer warnings are a feeble corrective to advertisements – on social media, billboards, trains and taxis – that only emphasise the upside opportunities of crypto-asset investing. The advertisements for crypto-asset investing are clearly misleading to consumers and as crypto-asset activities fall outside the FCA’s regulatory perimeter, the FCA is restricted in actions it can take," it said.
"The FCA needs more power to control how crypto-exchanges and ICO issuers market their services, by bringing the activities they perform into the regulatory perimeter. Such a step would also provide investors with wider protections against mistreatment, including loss of deposits through fraud and hacking, or losing access to funds due to the loss of passwords," it said.
The government was also urged to prioritise the transposition of new EU anti-money laundering rules into UK law, even accounting for different Brexit scenarios. The Fifth Anti-Money Laundering (AML) Directive requires crypto-asset exchanges to comply with AML and counter-terrorist financing rules.
"The Committee urges the government to treat the transposition of the Directive as a priority, and to expedite the consultation process, which is currently not planned to finish until the end of 2019," the report said. "If the UK leaves the EU without a transition period in March 2019, the Committee would nonetheless expect the government to seek to replicate the relevant provisions of the AML Directive in UK law as quickly as possible. The Committee believes that the FCA should be the relevant regulator for supervising anti-money laundering."
Tony Anderson, a payments expert at Pinsent Masons, the law firm behind Out-Law.com, welcomed the Treasury Committee's report but said it will be important to see how its recommendations might work alongside other recent developments, including plans outlined by an MEP to include ICO’s within the EU's regulatory framework for crowdfunding.
"The report recognises the importance of co-operating with other jurisdictions within this space which will be crucial to controlling any regulatory arbitrage developing given the global nature of crypto-asset activities," Anderson said.
"We will also be very interested to see the stance taken by the Bank of England on these proposals, particularly if they encompass 'stablecoins' being pegged to sterling as a fiat currency," he said.
The Treasury Committee's report also addressed the subject of blockchain, the technology that serves to underpin the exchange of many crypto-assets.
The MPs questioned whether blockchain could serve as "a mass-market payments system" due to the "slow, costly and energy-intensive verification process" that is entailed in using the technology to transact.
They also said that while they are "supportive of good innovation", they do not think "blockchain should not be pursued for its own sake". Instead, the government and industry "should identify what problems exist and consider whether blockchain offers the most appropriate solution", they said.
"This is an important consideration," said Charlie Clarence-Smith, an expert in the regulation of crypto-assets at Pinsent Masons. "The nature of blockchain means that it may outperform existing databases where certain criteria are met, for example where there is limited trust between multiple parties; where there is a need to know the exact source of information, and the existing technology or process is inefficient and blockchain, even in its infancy, may provide scalable efficiencies. If any of the above criteria are missing the appropriateness of a blockchain solution should be questioned."
The Committee said it "recognises that blockchain technology may have the potential to solve problems caused by a lack of trust in data integrity and may be a more efficient method of managing certain types of data in the long term, offering higher levels of security than centralised databases", but said it had "not been presented with any evidence to suggest that universal applications of the technology are currently reliably operational".