Use of centralised P2P crypto lending platforms has surged over the past year. Amanda Smith looks at what direction the FCA may take in regulating the sector, and what that could mean for the crypto lending platforms themselves.

Loans on peer-to-peer (P2P) cryptocurrency lending platforms have been valued at USD 25-40 billion. With the acceleration of ownership of crypto, it's easy to see why use of P2P crypto lending platforms is so popular.

These platforms enable borrowers to receive loans in physical money, using their digital currency as collateral. By lending in cryptoassets rather than in cash, or lending cash via a non-UK website, this activity sits outside the FCA's perimeter.

Crypto lending enables holders of crypto to borrow money when needed, without having to sell their crypto. Indeed, it's likely that crypto lending will continue to grow, due to increasing demand from institutional investors to have exposure to digital assets such as Bitcoin and Ethereum.

However, the combination of a relatively unregulated market with the technically demanding nature of the sector means that things do go wrong. Even advocates of all things crypto admit that some cryptocurrencies and projects will fail, including lending platforms. How will the FCA respond to this given its consumer-focused approach in other lending sectors?

There are currently more questions than answers, but I believe it's useful to consider where the regulation of the centralised P2P crypto lending sector may go, and consequently, what crypto lending platforms need to think about when growing their business and planning for the future.

FCA crypto regulation is evolving

The crypto lending market remains mostly unregulated by the FCA. Consumers are unlikely to be able to seek redress from the Financial Services Compensation scheme (FSCS) when things go wrong and aren't able to rely on the Financial Ombudsman Service (FOS) to settle complaints or seek compensation.

At present, the FCA requires all crypto firms to be registered with the FCA and compliant with Anti Money Laundering (AML) regulations. The deadline for crypto firms to be registered with the FCA has recently been extended for the second time from July 2021 to 31 March 2022. This is due to the number of applications still pending review, with only five crypto firms successfully registered with the FCA by June.

According to the FCA, 'an unprecedented number of firms' have withdrawn their applications as they aren't meeting required AML standards. This might raise questions as to whether entities have the internal procedures in place to de-risk their crypto lending platforms for the benefit of both investors and consumers.

The FCA has indicated serious concerns, stating that crypto investors should be prepared to lose all their money. On 17 June, the regulator published its crypto asset consumer research, part of the FCA's strategy to develop its thinking on both the benefits and harms to consumers from crypto assets.

The report showed that estimated ownership is up to around 2.3 million, a 21% increase compared to last year. However, it also revealed that the level of understanding of crypto is declining, suggesting that some crypto users may not fully understand what they are buying. Research also showed that 10% of crypto holders have used their crypto assets to purchase other financial products, for example, a loan.

Crypto complaints rising

It's currently very difficult to assess the volume of crypto related complaints. However, according to research conducted by the law firm RPC via a Freedom of Information request, the FCA opened 52 investigations into crypto currency business in the last year, but that this is likely to just be the tip of the iceberg in terms of crypto-related activity that breaches regulatory rules or is illegal.

More notable was the increase in complaints to the FCA consumer helpline about cryptocurrencies: 343 calls in October 2020, almost twice the 176 calls it received six months earlier in April.

Crypto values, although extremely volatile, have been on an upwards trajectory. What will happen to complaints, or consumer harm, should the crypto bubble burst and values fall as fast as they have risen?

If the value of borrowers' crypto collateral dropped significantly, many consumers may find themselves over-leveraged, and have to repay whole or part of the loan. This could potentially raise affordability issues.

Equally, investors face the risk of their collateral dramatically reducing with any rapid devaluation. How will platforms keep both investors and borrowers happy in a falling market, and ensure the platforms' own financial stability?

What direction will FCA regulation take?

It's helpful here to look at what the FCA's approach has been when regulating other sectors where consumer borrowing takes place, for example, the high-cost short term (HCST) sector.

Here, the FCA has attempted to mitigate risk to the consumer by implementing affordability checks. Is this something that the FCA would consider for crypto-lending platforms?

Platforms would need to develop the systems and processes required to track, store and record customer data, including information about consumers monthly expenditures. This is a time-consuming and costly process, and would take considerable investment from management.

Would users feel affordability checks go against the raison d'etre of crypto - that of being a cheaper, more efficient and accessible way for consumers and investors to access and offer credit?

Given the rise in complaints to the FCA outlined above, will the FCA allow for redress claims where a consumer is out of pocket?

My experience in the HCST sector has shown the detrimental effect that a large number of claims can have on the resources and liquidity of a lending institution. This is especially the case when claims management companies get involved, contributing to the failure of several firms in the sector.

The impact of claims is much wider than any redress payments. The cost of the claims-management process, including system and platform development, training and personnel required to look back at records to adjudicate claims is significant.

The long-term impact for the crypto lending sector

It's worth noting that the FOS applied retrospective remediation in the HCST sector. The FCA started regulating the sector in 2014, but the FOS imposed the strict consumer protection standards introduced in 2014 to loans made prior to that date.

Does this mean that crypto lending platforms could be liable for redress claims for losses suffered by consumers now, should the FCA introduce stricter lending criteria to the sector in the future?

The innovation and advantages of P2P crypto lending platforms are undeniable, and present huge opportunities for borrowers and investors alike.

However, as platforms grow their business in a buoyant market, it's worth thinking about what systems and processes may need to be implemented at this stage to mitigate risks caused by less favourable market conditions and tighter regulation in the future.

For more information, contact Amanda Smith.

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