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Can the UK government implement this law? How is this different from what the Chinese government did years ago, banning Bitcoin?

Sure. They are regulating it into compliance.

It is different from Bitcoin mining in that it is pushing everything into the financial system. I didnt look deep into it but I imagine they will outlaw self custody wallets and force it to be with exchanges.

I am thinking of unintended consequences. What are the potential setbacks of this law, both to the British economy and crypto users?

Things will be pushed offshore from the UK. Similar what the US experienced over the last 4 years when it took an anti-crypto stance.