Outlier Ventures is a UK-based venture capital firm that has been focused on blockchain and crypto since 2013. Chris Donovan, head of legal at the company, spent some time with host Ian Taylor to discuss the regulatory and VC environment for crypto in the U.K.
Their main focus right now is running various accelerator programs and identifying early-stage projects operating in the space that they believe have a great deal of potential, which they help to get set up and accelerate toward their first round of investment. Outlier is active in the community and takes a big role in advocating for what they are doing collectively in the space and with all of this technology.
The U.K. has taken a piecemeal approach to crypto regulation. One such move was the ban on the sale of
cryptocurrency derivatives and exchange-traded notes to retail investors. It’s an example where things don’t go as well as they could.
(3:16) “And I think a lot of people in the industry in relation to that ban were a little bit disappointed that it kind of came across more as a knee-jerk reaction to the space and some of the developments in the market rather than a more considered and proportionate approach, which I think we would all advocate for when it comes to regulating our space,” said Chris.
The U.K. is taking a slightly different tack than its European neighbors with MiCA, which is a sweeping attempt to govern nearly all aspects of crypto assets that aren’t already sitting within the current rules. There are some merits to this approach, as it brings harmonization, at least potentially, and it gives businesses looking to operate and unlock that market some certainty about operating in the region. For example, if they are authorized or are conducting themselves in accordance with the regulations in one member state, then they are able to roll out their products and access customers throughout all EU member states.
There are equally some onerous components as well, said Chris, pointing to stablecoins as an example because they will face a great deal of scrutiny and administrative burdens in the event that MiCA is brought into force as is.
(5:01) “Looking at it from the UK perspective, and the idea that they are at least purporting to take a more nuanced approach, that does have some advantages because it isn’t a one size fits all policy. It allows them perhaps to be a little bit more receptive to specific circumstances and certain nuances into how our sector develops,” said Chris.
The U.K. has been relatively forward-thinking in that there is a well-defined regulatory parameter for how these assets are actually dealt with from a regulatory perspective. The FCA has been quite proactive in implementing some clear guidance for firms, and it is more nuanced than some other jurisdictions.
(6:02) “I think more generally there’s an expression, at least in principle, of a desire for the regulation to be proportionate and to be forward-thinking and proactive rather than reactive,” said Chris.
A consultation is currently underway about stablecoins and whether or not there should essentially be a new category added for them to sit alongside the existing three categories in the U.K., which are security tokens, payment/money tokens, and unregulated tokens, which is the bucket that catches just about everything else, said Chris.
(7:09) “On balance, there have been some elements that are a little bit more reactive and that ban of the sale of crypto derivatives and ETNs to retail investors is one of them…But then I think perhaps there is an acknowledgment that a more sensitive approach perhaps is starting to trickle down through government and also will have an effect as to how the FCA actually develops its approach for the next 12-18 months,” said Chris.
Outlier is in the early stages of becoming a visa endorsing body. This designation would allow them to issue innovator and startup visas to entrepreneurs who are looking to set up a new business from the U.K.
(10:47) “And I think that’s become even more relevant post-Brexit when we are attempting to chart this new course. And I think it is extremely important that we are able to ensure that when these very talented founders are evaluating where they would like to set up shop…that actually the UK is right up there if not the first destination of choice if possible for these projects,” said Chris.
(12:11) Outlier works with about 50 projects every year that they are scanning rapidly. That number will probably continue to rise. UK-based teams are increasingly becoming the minority, and that is something that the Outlier team wants to change.
There are things U.K. regulators could focus on to try and make the region a more attractive jurisdiction for crypto and blockchain startups in a post-Brexit world. For instance, the industry is going through some consultation processes at the moment.
(14:08) “One thing the U.K. has historically done very well is leverage the sandbox infrastructure to great effect. And I think that there’s never been a greater synergy for that type of regulatory experiment than with our technology,” said Chris.
One area that would benefit very strongly from a sandbox approach is DeFi, which has been building on fintech innovations that we’ve seen over the last 10-15 years but in a decentralized context. Were regulators willing to update sandbox regulation to allow businesses to experiment more with those technologies, such as lending and leverage within the sandbox, the U.K. would do very well in attracting some of these very exciting new protocols to establish themselves in the region.
There are also many projects experimenting with leveraging decentralized technology to try and tackle AML and KYC processes. There’s a lot of possible efficiencies and innovations that could be leveraged in that area. The complexity is matching up an electronically validated identity with organizations under the existing AML and KYC regulatory framework.
(16:11) One final area is the new data economy and the idea of these decentralized platforms that collect and leverage very large data sets from decentralized communities globally. The industry is still very aligned with the EU on the data protection front, e.g., GDPR, but we also now have a license to think about and whether small adjustments could be made to ensure that it is consistent with these new technologies.
(17:34) The amount locked in DeFi has been growing at an exponential rate of late, having gone from USD 20 billion locked at the start of the year to USD 40 billion six weeks later. From a VC investment perspective, which has also been extremely busy, half of the investments have gone to DeFi and fintech projects. The U.K. certainly has extremely strong fintech credentials, and it seems to be a sensible space from a regulatory perspective for making it easy for businesses to set up shop here.
There are other jurisdictions that have been more proactive and quick in assessing the end-to-end regulatory environment for businesses like the ones that come through Outlier’s accelerator. Switzerland, aka Crypto Valley, is a good example, as well as Singapore, which is a good alternative to projects that find Switzerland to be too expensive and time-consuming to set up there.
(19:20) “Our in-house view would be that there’s no reason why the U.K. certainly couldn’t be as competitive as Singapore and Switzerland in the future and perhaps should be,” said Chris.
VC Investment Flow
(20:18) VC investment has been skyrocketing in the space through 2020 despite the COVID difficulties. It tapered off a bit at the beginning of the year but since then the growing interest in the DeFi space has propelled new investments.
Globally approximately USD 2.7 billion was raised through 2020 across more than 580 different transactions or investments. Most were equity-based, while some were token-based and others were a hybrid of the two. As alluded to, DeFi made up almost half of that amount at USD 1.6 billion, followed by the NFT space.
(21:15) From a geographic perspective, the majority of investments went to businesses located in North America, at USD 1.1 billion. Meanwhile, Europe attracted USD 716 million worth of investments and the U.K. got about 20% of that at USD 140 million.
(21:42) “We would certainly like to see in the future that share particularly of the European investment pie but also global investment pie for the U.K. increasing dramatically. And I think that if the UK does some of the correct things over the next six to 12 months…it is in a very good place to potentially do that and build on a lot of its previous successes in technology and VC and financial and associated professional services sectors,” said Chris.
Globally the regulatory picture feels as though it’s at an inflection point. Regulators will be forced to confront these new technologies because they have shown to be useful but also because market conditions mean they are getting too big to ignore in many ways unless they want to be like the U.S. and stick their heads in the sand.