Consultation Response to the FCA CP25/40: Regulating Crypto-Asset Activities
Exponential Science, together with the UK Centre for Blockchain Technologies (UK CBT) and the MiCA Crypto Alliance, has submitted a detailed response to the Financial Conduct Authority (FCA)’s consultation paper CP25/40 on regulating crypto-asset activities.
Our response draws on extensive academic research in market microstructure, financial risk, volatility modelling, and crypto market design. It addresses structural conflicts of interest, retail protection, execution quality, transparency calibration, leverage risk, and systemic fragility. Across these themes, one central principle emerges: effective crypto regulation must reflect how these markets actually function, rather than relying on formal legal structure or mechanical rule application.
Below we outline the core insights from our submission.
Structure Matters More Than Location
The FCA proposes that crypto-asset trading platforms serving UK users should be authorised in the UK and maintain a meaningful operational presence. We support this direction. Effective supervision is difficult where platforms operate offshore while targeting domestic clients.
However, authorisation alone will not materially reduce risk unless it addresses structural incentives embedded within business models.
Crypto markets differ from traditional markets in one critical respect: many platforms combine exchange operations, proprietary trading, brokerage, custody, token issuance, and lending within a single corporate group. These vertically integrated structures create embedded conflicts of interest that can undermine price formation, execution quality, and client protection, particularly during market stress.
Conflicts in crypto are structural rather than incidental. Disclosure alone is insufficient where incentives are misaligned. Meaningful separation of functions, independent surveillance, and governance arrangements that genuinely constrain conflicted behaviour are essential if authorisation is to reduce systemic risk.
Retail Protection Through Admission Standards and Standardised Disclosure
We support the FCA’s proposal to restrict UK retail investors to crypto-assets admitted to trading on UK-authorised platforms and subject to compliant disclosure.
Research shows that low-liquidity, small-cap tokens are particularly vulnerable to manipulation schemes such as coordinated pump-and-dump cycles. Retail investors are disproportionately exposed to these dynamics due to information asymmetry and limited ability to assess execution conditions or token quality.
Requiring platforms to act as gatekeepers, supported by transparent admission and withdrawal policies, establishes a necessary baseline of market quality.
The proposed QCDD regime is functionally equivalent to the EU’s MiCA white paper requirement. Standardised templates are critical to avoid a “race to the bottom” in disclosure quality, where marketing documents replace substantive risk disclosure. Centralised repositories further enhance transparency, cross-platform oversight, and cross-jurisdictional operability.
Transitional arrangements are also important. A proportional implementation period enables firms to develop templates, processes, and systems that reduce compliance costs over time, while ensuring legacy assets are addressed in an orderly manner.
Best Execution in Fragmented and Volatile Markets
Crypto markets are highly fragmented. Liquidity depth varies widely across venues, and prices can diverge materially during volatility spikes. In this environment, mechanically applying traditional best execution concepts risks creating false assurance.
Execution quality depends not only on price, but also on liquidity depth, likelihood of execution, slippage, and settlement risk. Price discovery is often concentrated on a small number of dominant venues, and spot and derivatives markets interact strongly during stressed conditions.
Best execution guidance should therefore focus on execution governance and evidence. Firms should be required to demonstrate that their venue selection and routing arrangements perform effectively under stressed market conditions, not only in calm environments.
Similarly, requiring firms to check multiple price sources is a sensible principle. However, “three sources” should be treated as necessary but not sufficient. In crypto markets, wash trading, stale quotes, and thin liquidity can contaminate pricing signals across multiple venues. Reliability must be defined in terms of data quality, liquidity resilience, and outlier controls, rather than simple venue count.
Transparency and Threshold Calibration Must Reflect Market Reality
Pre- and post-trade transparency is essential for market integrity and supervision. However, transparency rules must be carefully calibrated to avoid discouraging liquidity provision, particularly in less liquid or highly volatile markets.
Poorly designed transparency requirements can widen spreads, reduce displayed depth, or push trading into less observable channels. The use of waivers and deferrals, where appropriate, helps protect liquidity while maintaining oversight.
The same principle applies to pre-trade transparency thresholds. Static, one-size-fits-all thresholds risk creating cliff effects and gaming behaviour. Crypto markets are heterogeneous and regime-dependent, with liquidity and volatility varying sharply across assets and over time.
Thresholds should therefore be adaptive, periodically recalibrated, and stress-tested. The objective should be to preserve market integrity and resilience, not to maximise disclosure mechanically.
Settlement and Blockchain Finality
We support the FCA’s flexible approach to settlement, allowing firms to choose between internalised and externalised models, provided responsibilities are clearly disclosed.
However, on-chain transactions introduce technical complexity absent from traditional finance. Many blockchains operate under probabilistic finality, meaning a transaction may appear confirmed yet remain theoretically reversible under certain network conditions.
Regulatory clarity is therefore essential. The FCA should specify the threshold at which an on-chain transaction is considered legally final for reporting and compliance purposes. Without a clear distinction between technical confirmation and legal settlement, firms may apply inconsistent risk thresholds, undermining predictability and supervisory consistency.
Leverage, Collateral, and Systemic Fragility
Crypto markets exhibit pronounced tail risk and liquidity-adjusted losses during stress. Over-collateralisation and additional collateral requirements for retail lending are therefore appropriate.
However, calibration must be conservative. Token-specific haircuts, dynamic margin requirements, and stress-based calibration are essential. Automatic liquidation mechanisms can amplify volatility and cascade effects if not carefully designed. Without conservative buffers and stress testing, over-collateralisation risks failing precisely when markets are most unstable.
We also strongly support the prohibition of proprietary tokens in lending and borrowing. Allowing platforms to use their own issued tokens as collateral creates circular dependencies between token value and platform solvency. During market stress, such structures can trigger rapid deleveraging and destabilising feedback loops.
These risks are structural and cannot be reliably mitigated through disclosure alone. Prohibition, applied to economically equivalent arrangements, is proportionate and justified.
A Consistent Theme: Aligning Regulation with Market Structure
Across all areas of the consultation, one theme recurs. Effective regulation of crypto-asset markets must reflect their structural characteristics:
- Vertical integration and embedded conflicts
- Fragmented liquidity and venue concentration
- Regime-dependent volatility and tail risk
- Automated trading and technological complexity
- Endogenous leverage and pro-cyclical feedback loops
Formal authorisation, disclosure, and transparency are necessary foundations. However, their effectiveness depends on calibration, governance, and alignment with underlying market dynamics.
The FCA’s consultation represents a significant step towards a more resilient and credible UK crypto-asset framework. Our response seeks to ensure that implementation is technically robust, evidence-based, and proportionate to the structural realities of these markets.
As regulatory regimes evolve across jurisdictions, alignment between the UK framework and international standards, including MiCA, will remain critical for maintaining competitiveness, interoperability, and market integrity in a borderless technological environment.
