The Financial Conduct Authority (FCA), the conduct regulator for 58000 financial services firms and financial markets in the UK, has proposed a ban on the sale of crypto derivatives and Exchange Traded Notes (ETNs) referencing specific types of crypto assets to retail consumers. The regulators’ one of the major tasks is to protect customers viz-a-viz promoting a healthy competition among the different financial service providers. As per the FCA’s statement, the products are not suitable for retail consumers who find it difficult in assessing the value and risks of derivatives or ETNs. The other reason cited was the extreme volatility in the instrument, which can result in retail investors suffering harm from sudden and unexpected movement in the prices in these products. If the proposals of the FCA get through, it will mean that ban will be imposed on the sale, marketing and distribution to all retail consumers of all derivatives along with the ETNs that originate from the unregulated transferable crypto-assets by firms acting in, or from, the UK.
Crypto Derivatives a kind of Derivatives
An underlying asset derives the value of the derivatives. It is mainly used by traders to hedge other investments or to lock in profits when trading in volatile markets. Cryptocurrencies are the instruments being used by technical or advanced users who have a better knowledge of trading. Also, the traders use the instrument to speculate on the prices, taking the benefit from the changes in the price of the underlying cryptocurrency, which are highly volatile. Similarly, the crypto derivatives too do not have any direct or inherent value for themselves and their value is derived from the expected future price movement of the underlying cryptocurrency. The most common form of cryptocurrency derivatives now is Bitcoin futures, as its underlying holds over 50 per cent of the entire cryptocurrency market cap. Bitcoin is one of the largest blockchain networks, while some other major cryptocurrencies include Ethereum, Litecoin, Ripple, XRP, EOS and Tether etc. Altogether, there are over 1600 known cryptocurrencies, which keeps on adding every day.
Cryptocurrency is commonly known as the digital asset or the next evolution of money, it uses cryptography to secure digital exchange of financial transactions, and its value gets defined by what the public market determines it to be. The instrument can self-manage the whole process of creation and distribution. This capability to manage by itself is based on an intricate system, which is called blockchain technology, to keep the monetary system properly functioning. The internet-based medium of exchange happens between peer-to-peer, and the transaction gets confirmed via mining or crypto coin mining, a process where transactions for various forms of cryptocurrency are verified and added to the blockchain digital ledger. The miner must authenticate the information and update the transaction after every deal. Regardless of the transaction size, every movement of the cryptocurrency gets permanently recorded on the blockchain. While there has been lots of skepticism about the instrument, it has been gaining ground over the years because of its inherited properties like security, acceptability, limited supply, portability and ease of divisibility.
FCA’s has also proposed to ban Exchange Traded Notes, they are the unsubordinated, senior unsecured debt securities sold by finance companies that trade on exchanges and have a maturity date and are backed only by the credit of the issuer. They are equally risky for the retail investors not only because of their credit risk but because of liquidity due to lack of trading volume.
Cryptocurrency and regulations in the UK
The UK till now has been having a restrained cryptocurrency regulation, with the instrument not holding a legal tender and the exchanges dealing in cryptocurrency having a registration requirement. As far as the taxability is concerned, it depends upon the activity and the concerned party for the income generated from cryptocurrencies, while the Value Added Tax (VAT) is chargeable from suppliers for any goods or services sold in the UK in exchange for cryptocurrency, business have to follow the corporate tax laws for the profit and losses in cryptocurrency.
Very recently it was being considered that the next evolution of money has matured enough and will soon be in the mainstream with crypto exchanges announcing their idea of allowing customers to pay for items on their credit card using cryptocurrency instantly.
Now why the regulator is concerned about the crypto derivatives? The FCA’s proposal of banning these products are not apprehension based; rather, it has estimated a £75 million to £234.3 million a year of potential benefit to retail consumers with its proposal. The major drawback of the instrument is that because of their anonymous and borderless nature of the transactions, they have become a form of financial crime. Also, despite firm security, the currency is highly susceptible to theft, and there have been frequent cases of them being stolen. But the primary concern of the UK regulator is the complex nature of the leveraged derivative which holds excessive risk for the retail clients. The regulator will be coming up with a consultation paper (CP) on a potential ban on crypto derivatives and the new rules from it will be replacing the final regulation of crypto-based contracts for difference (CFDs). The CFDs allow the trade in the cryptocurrency without owning or purchasing it, giving a chance to profit whether the price goes up or goes down.
It could also be the fallout of tech giant Facebook’s plan to come up with its cryptocurrency named Libra, slated to be launched by the end of June 2020. The UK regulator and the government which were already grappling with the question of cryptocurrency regulation and its extent, are forced to take a closer look and its inherited potential risks. The development has made the regulator anxious as it could trigger lots of concerns related to its operations, and they have already started a discussion with the company on its proposed crypto-currency introduction.
It’s not only the UK regulator which has come into action with the Facebook’s announcement of entering the cryptocurrency market, but the regulators across the globe have expressed concerns over the potential risks by this cryptocurrency project. Japan, which has a progressive regulation for the cryptocurrency, has also warned of legal issues regarding Facebook’s planned cryptocurrency. While regulators in Europe and India are scrutinizing the proposed cryptocurrency, Group 7 (G7) members are reconsidering organizing their task force. Demand has been raised by the US lawmakers, to the Facebook for freezing the project pending its appropriate evaluation. Facebook though is taking steps to comply with regulators around the world, but the global applicability of the tender is likely to go through profound restrictions from the Bank for International Settlements and the International Organization of Securities Commissions, given the various antitrust roadblocks the company is facing. Bank for International Settlements has already warned that lawmakers will be having an edge in certain decisions of this kind of projects.
Crypto trading exchanges
Kraken Futures is licensed by the FCA to provide regulated products and services. It is having around 20 currencies being traded either directly for one another or crypto-to-crypto. The regulators’ proposals seem to have not much impact on the crypto trade and the major cryptocurrencies have been holding firm. At the exchange on 4 July, 2019 (3.20 PM GMT), Bitcoin USD (BTC USD) was up by 4.65 per cent, Bitcoin EUR (BTC EUR) was up by 4.85 per cent, Ethereum USD (ETH USD) was up by 1.23 per cent, Ethereum EUR (ETH EUR) was up by 1.23 per cent, Litecoin USD (LTE USD) was up by 2.63 per cent, Litecoin EUR (LTE EUR) was up by 2.38 per cent.
The proposed ban on the cryptocurrency and the ETNs, based on the unreliability of valuation and extreme volatility is indeed going to help the retail investors, as they have an inadequate understanding of the product and get lured with hopes of high return. Government of UK has long been considering the issue, and it has been on the agenda of the regulator always, now being perused proactively. Earlier this year it had constituted a Crypto-assets Taskforce, which not only included the FCA and the Bank of England but all senior leaders from government and representatives from HM Treasury, which will alert market participants to relevant issues. Coming soon, all cryptocurrency exchanges will be required to register with the FCA from January 2020, and they will also be bound to perform customer due diligence and submit suspicious activity reports, after the adoption of the fifth Anti-Money Laundering Directive. The regulation is required to address the consumer protection as well as money laundering; however, it had some inherited positives that cannot be denied, like its functioning or transaction not requiring any intermediary, which is must in traditional currency transaction. Cryptocurrencies also enable more international transactions, even in the less advanced nations were the other financial medium has not much evolved. While, there are negatives erupting from this digital currency, there do exist few tangible impacts on the economy too.