Commercial Awareness Update – W/C 20th January 2025

SAFETY FIRST – AI AND INVESTMENT UNDER THE ONLINE SAFETY ACT 2023

As the US presidential inauguration draws closer, media giants such as Meta and X are aligning their platforms with the incumbent president’s policies, such as Meta’s removal of independent fact-checkers, seemingly to promote free speech and condemn censorship.

Although the UK aims to distinguish itself from the EU as a more attractive candidate for AI investment, the recently passed Online Safety Act 2023 (OSA 2023) may deter potential investors from the market.

Even though the UK has not explicitly been named, tech companies have expressed distaste for the region for entrenching censorship, posing a challenge to the government.

The Online Safety Act 2023 – Protection or censorship?

Passed in October 2023, the OSA introduced several key reforms imposing duties on U2U platforms to reduce the risk that users will encounter illegal content, both human and AI-generated.

Unlawful content and activity covered under the Act range from child sexual abuse to racially or religiously aggravated public order offences, among others.

The Act’s primary purpose is to protect children and other vulnerable people who use these platforms and give all users more control over the content they see, balancing free speech with user safety.

Despite growing calls from US-based media companies to reduce regulation, the UK government, in its forthcoming bid to attract AI-related investment, insists that the OSA 2023 still allows free speech to a very high degree while emphasising that its protections are non-negotiable.

As the fully government-backed OSA 2023 is relatively new legislation, it is unlikely that attracting investment alone can cause Parliament to backpedal.

However, this raises questions about the future of these companies’ presence in the UK as the outcome of any discussions between the government and company executives could set the tone for future investments in the UK as either an innovation-friendly or an unfriendly territory.

The future of AI investment in the UK – Broader implications

• The economy: The government argues that increased AI-related investments would not only set Britain apart as a key player in the AI revolution, encouraging further investment but would also create many new jobs across the country. Alternatively, critics of AI argue that it would do the opposite, rendering many jobs obsolete and adversely affecting marginalised groups who rely on such employment.
• Creativity under AI: While it may increase jobs in some sectors, it is notably a thorny issue for artists and creatives who are at risk of having their work misappropriated by generative models which use existing content to create their own, raising concerns over copyright and intellectual property rights. The government is conducting an open consultation on the matter, which seeks to create a mutually beneficial arrangement to enhance AI’s abilities and benefit creatives.
• Environmental impact: Data centres are notorious for their high energy and water consumption, which could not only strain national resources but also harm local environments, creating potential shortages and exacerbating climate concerns.
• Data security: AI is available to the general public through models like ChatGPT, which can assist with a variety of daily tasks and is used in several industries, such as finance, legal, medical, and educational, to name a few. Though these tools are helpful, the lack of transparency surrounding data retention poses significant issues related to data security, particularly for personal or other confidential information.

Law firms and AI

Law firms are uniquely positioned regarding the legal and economic impacts of AI, being users, proponents, and, in any litigation proceedings against AI technology, opponents of it.

A report by Thomson Reuters found that about three-quarters of the top 20 UK law firms actively encourage using AI in their operations. While 65% of these firms use third-party AI tools, 35% have created their AI for internal use. Many firms with AI technology have dedicated AI teams, highlighting the potential to create employment that the government advocates for.

Like many other industries, law firms are revolutionising how they operate, recognising that AI is necessary to commercial competition as it boosts productivity and ensures that clients receive cutting-edge service.

Also, the debates surrounding the fair use of AI have opened up a new realm of litigation, with many top law firms establishing new departments specifically for technology and AI legal experts.

The way forward for investment

It is undoubtedly in the UK’s best interest to remain firm on online safety laws while appreciating that AI is crucial to innovation. Any steps to secure investment must maintain the delicate balance between preserving individual freedoms and safeguarding vulnerable people.

• By Natasha Saeed Ikramullah

THE COLLECTIVE INVESTMENT SCHEME CRYPTO EXEMPTION

AND CRYPTOASSET STAKING

The inevitable rise of cryptocurrency has led us to an innovative mechanism known as cryptoasset staking. This method allows those with such assets to earn rewards by securing and validating blockchains.

The Collective Investment Scheme Crypto Exemption (The Exemption) plays a crucial role in shaping the legal landscape for cryptoassets, including those used in staking.

Cryptoasset Staking

Cryptoasset staking is holding a cryptocurrency on a proof-of-stake (PoS) blockchain. In a PoS blockchain, the creator of the next block is chosen via various combinations of random selection, wealth, or age, which is the stake.

The indicated practice is employed to help validate transactions, and the staker collects rewards, which, in most cases, are disbursed in the same cryptocurrency.

Staking is vital for maintaining blockchain decentralisation and security. Nonetheless, it increases exposure to risks such as the loss of staked assets, mainly due to market volatility and network vulnerability.

The Collective Investment Scheme Crypto Exemption

The Exemption is a regulatory framework that clarifies when cryptoassets could be considered part of a Collective Investment Scheme (CIS). A CIS merges several investor funds for collective management.

Without the Exemption, cryptoasset schemes could face regulatory oversight, such as consumer protection rules and licensing requirements from the Financial Conduct Authority (FCA).

The Exemption, therefore, permits specific cryptoasset activities, such as individual staking, to fall outside CIS regulations, doing away with applicable unwieldy rules if cryptoassets were pooled into collective funds or managed by an institution.

However, if staking is organised through a managed fund or a pooling platform, cryptoassets may fall under the CIS regulations. In this case, the Exemption proves inapplicable, and the stakeholders must face the complexities of collective investment rules, such as the requirement for authorisation by the FCA.

In addition, the Exemption promotes cryptoasset innovation while ensuring investors are not exposed to undue risks under existing financial regulations, thus simplifying the engagement in staking, and the Exemption and cryptoassets are therefore interrelated as they strongly influence the regulatory classification of cryptoassets.

Arguments for and against the Exemption

Proponents argue that the Exemption staking catalyses innovation and economic growth within the cryptocurrency sector. By providing regulatory clarity, the Exemption paves the way for individuals and institutions to engage in cryptoasset staking, fostering a sense of optimism about the future of cryptocurrency.

There is also the argument that the Exemption helps to avoid the imposition of ‘outdated’ laws on surfacing technologies. Further, the Exemption enables the sector’s development to align with decentralised standards, which helps the UK maintain its competitive edge in the global crypto market.

The Exemption can clarify the taxation of staking rewards. Since individual staking activities fall outside traditional investment rules, holders may be subject to simplified tax treatment. However, challenges remain regarding the taxation of staking rewards as the tax classification of cryptoassets continues to evolve.

The Exemption supports financial inclusion by providing individuals with no access to traditional investment vehicles, an alternative way to participate in decentralised finance. Staking allows these individuals to earn rewards and gain exposure to the growing crypto sector without needing extensive financial expertise.

Opponents argue that the Exemption could lead to regulatory arbitrage, where less scrupulous actors exploit the lack of oversight to run high-risk or fraudulent staking schemes.

Critics suggest that the Exemption reduces consumer protections, as individual stakers may not have sufficient recourse if something goes wrong. The lack of consumer protection through traditional financial regulations could leave some investors vulnerable to significant losses if the value of their staked assets declines sharply.

While the Exemption increases opportunities for retail investors, it also exposes them to the inherent risks of cryptocurrency markets. Cryptoasset staking offers the potential for high rewards but is also subject to extreme market volatility.

There is also the argument that the Exemption creates regulatory uncertainty. As the cryptoasset space evolves, whether certain staking activities will always qualify for the Exemption remains unclear. This ambiguity can make it difficult for stakeholders to anticipate regulatory changes and plan their strategies accordingly.

Moreover, some worry that the Exemption creates unequal market conditions, as institutional investors may have greater access to the benefits of staking, while smaller retail investors may not fully understand the associated risks.

Impact on the legal sector

The CIS Exemption is crucial in shaping the legal framework for cryptoasset staking in the UK. By providing flexibility for individual stakers and fostering participation in the crypto ecosystem, the Exemption helps drive innovation and economic growth. Conversely, it introduces regulatory challenges, including concerns over consumer protection, tax treatment, and potential abuse.

As the legal landscape around cryptoassets continues to evolve, it is essential for UK regulators, legal professionals, and market participants to carefully monitor and adapt to ensure that the benefits of the Exemption are balanced with adequate safeguards for investors, providing a sense of reassurance about the commitment to investor protection.

The relationship between cryptoasset staking and the Exemption highlights the ongoing balance regulators must strike between encouraging crypto sector innovation and maintaining consumer protection.

As a result, the continuing debate between proponents and opponents of the Exemption will play a key role in determining the future direction of cryptocurrency regulation in the UK.

• By Aqua Koroma