Modchips are illegal in the United Kingdom. They can be used for purposes such as running homebrew code on a console, bypassing region restrictions which will allow you to play imported games and bypassing security measures intended to stop copies of games from being played. It is just the last feature that has made modchips illegal in the UK. The other abilities that modchips provide have kept them legal in other parts of the world.
Whether modchips should be illegal or not is confusing. When you buy a console you are buying a computer and should be allowed to modify it any way you like. The ability to run homebrew adds new life to a console and doesn't keep it locked to commercial games and other things. It also does allow consumers to protect an investment in a game by booting (or assisting in booting) backup copies. However, they do bypass security measures aimed at protecting copyright which is why they are condemned by the gaming industry.
Perhaps the legality of modchips should be assessed by how they are advertised. If a dealer were to advertise them as a means to commit piracy, then perhaps that should be seen as breaking the law. You will find however that modchips are advertised mostly as being able to boot backup copies and also advertised for their other abilities. Either way, making them completely illegal is a bad way to deal with the problem.
Source:
GamesIndustry.biz