Are Crypto Investors Savvy or Suckers? The UK’s Tax and Financial Regulators Don’t Agree

Originally published in CoinDesk Magazine

Are crypto investors financially savvy investors who are capable of understanding the nuances of blockchain, Web 3 and decentralized finance? Or are they mostly vulnerable, uneducated speculators who are being taken advantage of?

The Financial Conduct Authority (FCA), the U.K.’s financial regulator, believes they are the latter, while the U.K.’s tax collection agency, HM Revenue & Customs, or HMRC, believes they are the former. While the agencies have issued a few helpful guidelines, their differing opinions underscore a fundamental inability to provide more sweeping and effective oversight that would protect consumers and ensure the industry’s development. Delays in finding such common ground are slowing progress on both fronts.

This post is part of CoinDesk’s Tax Week. Boaz Sobrado is a London-based fintech analyst and cryptocurrency enthusiast.

The FCA has found that most crypto investors have low degrees of financial sophistication and are naïve. Its research shows “a lack of awareness and/or belief in the risks of investing, with over four in 10 people not viewing ’losing some money’ as one of the risks of investing, even though as with most investments their whole capital is at risk.”

For that reason, it is pushing for rules to force crypto companies to add disclaimers to their marketing. In other words, the FCA believes retail investors are so simple-minded that it is requiring crypto ads to include a warning sign telling people “they could lose all their money.”

HMRC, on the other hand, assumes these same people are sophisticated investors capable of accurately keeping records of every single taxable event across a myriad of offshore exchanges, decentralized automated market makers, and lending and staking protocols.

Retail crypto investors are expected to calculate their total gains based on the numerous provisions around day trading rules, bed and breakfast exceptions and the overall resulting Section 105 cost basis. Moreover, investors should understand that lending crypto assets is sometimes taxed as a “disposal,” a tax paid on an investment at an interval (even though the same is not true for stocks) and that the profits generated from lending are sometimes taxed as income, but also occasionally as a capital gain.

HMRC and the FCA disagree on many things with regard to crypto assets. Fundamentally, HMRC views crypto as property, not financial instruments, and doesn’t think that interest received for lending can be classified as interest for tax purposes.

The FCA, on the other hand, views crypto assets as financial instruments and wants to regulate them as such. It has banned retail investors from accessing crypto derivatives on the grounds that they are “primarily used for speculative purposes akin to gambling.”

HMRC clearly disagrees, probably because gambling gains are not taxed in the U.K., as the tax authority has made it clear they consider derivative gains taxable. The guidance is still unclear, however, and crypto tax advisory firms debate whether crypto derivatives gains should be taxed as income or capital gains.

HMRC and the FCA didn’t have such a wide difference of opinion in the past. In 2014, HMRC’s brief on bitcoin and other cryptocurrencies stated that “a transaction may be so highly speculative that it is not taxable or any losses relievable,” and said that “gambling or betting wins are not taxable and gambling losses cannot be offset against other taxable profits.”

As the price of bitcoin grew from $400 in 2014 to $69,000 in 2021, the HMRC changed its opinion and decided that crypto assets were not gambling and thus taxable.

In the last few years, both HMRC and the FCA have clearly put significant effort into studying the cryptocurrency and decentralized finance ecosystem. Both agencies are starting to issue guidelines and regulatory statements around the topic. These statements serve their institutional interests and fit within their practice, but happen to contradict each other significantly.

U.K. retail investors need some protection, particularly against the blatantly illegal fraud and pump-and-dump schemes that are happening openly with impunity. But retail investors also need protection from overcomplicated tax rules. Decades-old laws should be updated for the realities of the internet age.