UK regulator takes hardline approach on cryptoassets

The UK regulator says it wants to stop the sale of bitcoin derivatives to the general public. The proposed ban is too broad, unfair and will be ineffective, say critics.

On 3 July the UK’s Financial Conduct Authority (FCA) released a consultation paper, proposing to stop the distribution to retail clients of derivative investment products based on cryptoassets like bitcoin.

The ban would cover futures, options and contracts for difference (CFDs), which are bets on the future price of an asset, struck between clients and CFD providers.

The regulator also wants to stop the sale to retail clients of exchange-traded notes (ETNs), which are tracker products.

The FCA is inviting feedback on its proposal during a three-month comment period.

European retail investors can easily bypass these restrictions

The proposed FCA ban goes further than restrictions brought in by Europe’s Securities and Markets Authority (ESMA) last year.

ESMA, the European Union’s securities market regulator, limited the leverage on EU-based cryptocurrency CFDs to 2:1, when sold to retail clients.

However, European retail investors can easily bypass these restrictions and gain access to much higher levels of cryptocurrency leverage via the unregulated derivatives market.

Trading platforms such as BitMEX, based in the Seychelles but run out of Hong Kong, or Deribit, based in the Netherlands, offer clients up to 100 times leverage via perpetual bitcoin swaps.

On its website BitMEX says it complies with the corporate law of the Seychelles. Deribit doesn’t mention its regulatory status on its website, but says it collects personal data in order to comply with regulations regarding Know-Your-Customer (KYC), Anti-Money Laundering (AML) and the prevention of terrorism.

Currently, such unregulated derivative markets generate much higher levels of activity in cryptocurrencies than regulated derivatives exchanges.

For example, on 4 July BitMEX reported volumes in its perpetual bitcoin swap of over $5bn during the preceding 24 hours.

By comparison, the Chicago Mercantile Exchange (CME), a large regulated bitcoin futures exchange, traded around $400m in bitcoin contracts on July 2, the last full trading day before the US Independence Day holiday.

The FCA’s proposed ban of the sale of cryptoasset ETNs may be seen as more controversial.

ETNs are listed on stock exchanges and  to are designed to track the price movements of an underlying asset, such as a cryptocurrency.

The major European cryptocurrency ETN provider, XBT, has around $1bn in assets under management, up 273 percent since the beginning of the year.

XBT’s tracker products are listed on Sweden’s Nasdaq OMX exchange but are available to retail investors in the UK.

Hargreaves Lansdown, for example, a leading provider of self-invested pension plans (SIPPs), offers its clients the ability to buy XBT’s bitcoin tracker within their retirement savings accounts.

The euro-denominated listing of XBT’s bitcoin tracker is up 86.6 percent in the last 12 months, reflecting the recent rally in the price of bitcoin.

The FCA said its proposed ban would prevent harm to consumers

In its consultation paper, the FCA justified the scope of its proposed ban by saying it would prevent harm to consumers, despite the fact that some investors in ETNs and derivatives had made gains during the last cryptocurrency bull market, which ended in December 2017.

“We recognise some clients realised profits over the period we examined. However, we consider the significant variance in client outcomes is consistent with our policy analysis. That is, the value of these products in the short run is highly unpredictable and prone to extreme volatility due to the nature of the underlying assets,” the FCA said.

“We do not believe that the profits experienced from November 2017 to March 2018 suggest likely future consumer benefit,” the FCA added.

The UK regulator also dismissed any investment case for holding cryptocurrencies like bitcoin, arguing that such tokens are essentially worthless.

“Prices are driven by speculation about future supply and demand for the token, rather than by any underlying value. They promise no future cash flow and have no physical use,” the FCA said.

“Even if the supply of one such exchange token is genuinely limited, the supply of others is potentially infinite and they are substitutable, implying that the value of any single such currency will fall to zero over time,” the regulator added.

The consultation process is likely to be a marathon, rather than a sprint

Following news of the proposed ban, Coinshares, the owner of XBT Provider, issued a note to its clients in which it encouraged them not to overreact.

Coinshares said in its note that the outcome of the consultation process is still uncertain and that the process is likely to be a marathon, rather than a sprint.

The regulator is also not requiring the sale of existing holdings in its ETNs, Coinshares said.

BitMEX, Deribit and Hargreaves Lansdown did not respond before our publication deadline to requests for comment.

“We don’t think this ban should apply to serious financial products like futures”

Timo Schlaefer, chief executive of London-based Kraken Futures, queried the scope of the FCA’s proposed ban. Kraken Futures is authorised and regulated by the FCA. Schlaefer said he thought the FCA had failed to distinguish between different types of derivative.

“Your chances of making money through CFDs if you’re a retail investor are bleak,” Schlaefer told New Money Review.

“Futures are different from CFDs—for a start, you don’t trade against the CFD provider, you trade against someone else on the platform,” said Schlaefer.

Schlaefer told New Money Review that the bid-offer spreads charged by CFD providers were substantially higher than the fees payable by futures users.

“We compared the fees for trading cryptocurrencies using futures and CFDs and found futures fees were ten to fifty times lower than the CFD fees. We therefore don’t think this ban should apply to serious financial products like futures at all,” Schlaefer said.

Schlaefer said the impact on Kraken Futures of a proposed ban on the sale of cryptocurrency derivatives to retail clients would be limited, since 99 percent of its trading volumes come from professional investors.

However, he questioned the efficacy of the proposed ban.

“I don’t think you protect retail clients by pushing all of them offshore”

“Crypto is a very global market and perhaps unlike what regulators have seen before,” he told New Money Review.

“It’s quite a hurdle for someone sitting in the UK to trade equities in China. But the same person can set up an account to trade on an unregulated cryptocurrency platform in ten seconds, with no questions asked.”

New Money Review verified this by opening accounts on both Deribit and Bitmex within a few seconds using just an email address. This granted immediate access to leveraged trading in bitcoin (subject to an initial deposit of cryptocurrency as margin).

“I don’t think you protect retail clients by pushing all of them offshore,” said Schlaefer.

“It’s a double standard to deny people access to complex but fair markets”

Marian Muller, a compliance consultant working with cryptocurrency exchanges, said any FCA ban would create an uneven playing field and unfairly restrict retail investors’ access to the cryptocurrency market.

“While this proposal does not come as a surprise to anyone in the industry, I personally think access to markets should be democratised,” Muller told New Money Review.

“It’s a double standard to deny people access to complex but fair markets due to ‘consumer protection’, when there are no similar restrictions on rigged, unfair markets such as sports betting and online gambling,” Muller said.

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