• Giorgi Asatashvili

The FCA Ban on Crypto-derivatives - Is It Worth it?

The FCA’s ban of Crypto-derivatives is the result of the FCA's hard work in its mission to regulate the crypto-market. The FCA claims that, in the long term, the ban will be beneficial. In its view, volatile and unstable crypto-derivatives pose a significant risk to consumers, and this can be solved by prohibition. While the booming crypto-world may see the ban as a significant blow, it can set an example for other countries that wish to introduce new crypto regulations. This article discusses the arguments for the ban, as well as the opposing view expressed by cryptocurrency supporters.


At the start of 2021, the UK Financial Authority (FCA) banned the sale of crypto-derivatives to retail consumers. The ban, which entered into force on the 6th of January 2021, applies to derivatives and exchange traded notes (ETNs) that refer to unregulated transferable crypto assets.


Derivatives are contracts that acquire their value from other financial instruments or assets, and include futures, options and contracts for difference. ETNs are defined as unsecured debt securities that provide returns based on the performance of a specific asset or index. The ban prohibits both derivatives and ETNs that refer to the ‘decentralised tradeable tokens’, like Bitcoin and Ethereum, which are not considered ‘specified investments’ or e-money. The ban does not prevent the direct trade of crypto assets, nonetheless it restrains it by prohibiting more complex exchange methods.


The FCA’s decision


The regulation of crypto-derivatives and ETNs is the FCA’s response to the problems that consumers encounter when dealing with cryptocurrencies. The popularity of Bitcoin and other tokens increased the number of websites that offer easy-get-rich schemes, and these include serious risks of fraud. The proliferation of crypto-derivatives and ETNs may increase consumer harm if they derive their value from cryptocurrencies issued for the sole purpose of defrauding consumers. The FCA believes that new rules will help consumers save around £75m to £234.3m annually.


The FCA justified the ban with several arguments that were criticised by the crypto-community. It claims that the ban will promote effective competition between UK firms, which in turn will serve the interests of consumers. Indeed, the lowering of conduct standards, manifested in the offer of inappropriate products or services on the basis of an asset’s nature, may harm consumers and their trust toward companies. The prohibition may, to some extent, reduce the income of UK firms which were reliant on crypto assets, but the FCA sees no other alternative measure that can protect consumer interests, and cause less harm to competition at the same time.


Another justifiable reason, in the eyes of the FCA, is the risk of fraud. Although the prevalence of financial crime, together with market abuse, have been reducing over the years, they remain a serious concern and web fraud is a major problem.


Web fraud and Cryptoassets


Online scammers target consumers who use internet search engines to look for investment opportunities. They may offer high or realistic returns depending on their purposes and target audience. Fraudsters promote crypto-investments with different adverts placed on social media and other websites. After clicking on an advert, the consumer moves to the full article that uses the images of celebrities and their quotes. Consumers who are interested may be lured into buying non-existent crypto assets, or making investments in real cryptocurrencies through a fraudulent company.


Some pages require the consumer’s contact details, which may be followed by persuasive phone calls, convincing the consumer to invest and become a victim of fraud. The FCA believes that the prohibition will have a preventative function. “As the sale of derivatives and ETNs that reference certain types of cryptoassets to retail consumers is now banned, any firm offering these services to retail consumers is likely to be a scam”.


Many believe that the ban will not be effective against the fraudsters. Scammers and opportunistic merchants use every platform to grow and expand their networks. These people can move to non-UK exchanges and still deceive UK consumers. An alternative is to go after the real criminals, shut down their networks, and impose responsibility on the online platforms that allow eye-catching deceitful adverts.


The question of value


The FCA also highlighted that unregulated crypto assets have no intrinsic value and that they differ from other assets that can function as money or bring future cash flows. Most significantly, the fact that crypto assets have a complex and opaque nature raises questions as to their value, which makes them unreliable investments for retail consumers in the eyes of the FCA. The FCA admits that consumers can pay with cryptocurrencies and exchange them for fiat currency, but it emphasises that companies price their goods and services in fiat currency, and convert the price into cryptocurrency at the time of sale. Accordingly, fiat currency remains the basis for exchange.


The high degree of volatility of cryptocurrencies prevents them from becoming a standard of value. Low volatility is required for them to be accepted as a means of payment. Instead, their frequent fluctuation makes them susceptible to speculative behaviour that undermines their reliability. The current practice does not indicate that, in terms of a store of value, the cryptocurrencies have equal standing with other assets, such as gold. The FCA has observed that consumers can assign subjective valuations to cryptocurrencies, but it is impossible to value them reliably or consistently.


The FCA also determined that crypto-derivatives do not meet any legitimate investment need. It is possible to use crypto-derivatives for hedging purposes in the crypto asset market, but such cases are quite rare. The data collected by the FCA suggests that the primary function of crypto-derivatives is speculation that resembles gambling. Crypto-derivatives allow the consumers to prevent the risk of crypto asset theft or encrypted key loss, but the risk associated with unregulated crypto assets remains, and the FCA has reservations about considering them as investments.


Freeing the market


As usual, free-market supporters protest decisions that interfere with the free choice of consumers, one explicit reason for this being that people do not appreciate being told how to manage their finances. Consumers have expressed that they are keen to shoulder the responsibility for the consequences of their actions.


According to the FCA, the prohibitive policy is justified by the crypto-asset volatility and misinformation, is beneficial for consumers and does not infringe their rights. It is true that consumers should be responsible for their decisions, but crypto-derivatives create insurmountable information asymmetries. Retail consumers are incapable of realistically evaluating the value of such products, which precludes them from making informed investment decisions, as per the FCA.


Crypto-derivatives are innovative products and can play a positive role in the crypto-market development. Despite that, the FCA suggests that due to the harm they may inflict on retail consumers and competition, crypto-derivatives are not supportive of innovation. The FCA instead welcomes innovation that enhances the effective functioning of markets and is in the interests of consumers, such as improvements introduced by the distributed ledger technology.


The representatives of the crypto world only partially agree with the FCA’s arguments for the ban. They argue that, as time lapses, cryptocurrencies will become more reliable and widely accepted. The FCA ban may have a minimal effect on the exponential growth of the crypto market, but the prohibition applies to the products that are profitable due to their connection with cryptocurrencies. Some crypto experts argue that the booming crypto industry requires a proper regulatory framework, and the ban is only an escape from the real issues.


Conclusion


The FCA’s purpose of saving consumers from unreliable, volatile and poorly understood derivatives may seem apparent, but the real concern seems to lie elsewhere. In most cases, the cryptocurrencies are not backed by liquid assets, which creates the risk of a sudden depreciation of value should a crisis strike. The existence of a large number of crypto-derivatives may significantly worsen the crisis, which will overburden the system. It may also likely that the effects of the 2008 crisis still haunt the UK authorities, leading them to target crypto derivatives in this way, which could also act as an example for other countries that see themselves in a crypto limbo. What is certain, is that the crypto markets will undergo many changes, and the FCA just served as a pioneer of many regulations to come.


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