As of January 6, 2021, crypto-based derivatives and exchange-traded-notes (ETNs) will be banned from being offered to retail investors in the UK.
Crypto Based Derivatives and ETNs
A derivative is a financial product which ‘derives’ its value from another asset – such as cryptocurrencies. The most common example of this is the growing popularity of Bitcoin futures.
While the underlying asset may not be a security, derivatives are viewed and regulated as securities. As such, this brings them under the purview of regulatory bodies such as the Financial Conduct Authority (FCA).
An ETN, on the other hand, is an unsecured debt security issued by a bank. These financial instruments are built to provide investors with exposure to certain assets through tracking ‘benchmark indices’.
Why Are They Banned?
There is no single reason behind the FCA’s decision to ban such products. The FCA purports that investors do not have the ability to, “reliably assess the value and risks of derivatives and exchange traded notes that reference certain cryptoassets.” It provides the following examples as to why it believes this is the case.
- Nature of the underlying assets, which have no inherent value and so differ from other assets that have physical uses, promise future cash flows or are legally accepted as money
- Presence of market abuse and financial crime (including cyberthefts from cryptoasset platforms) in cryptoasset markets
- Extreme volatility in cryptoasset prices
- Inadequate understanding of cryptoassets by retail consumers and the lack of a clear investment need for investment products referencing them.
No Inherent Value
If the ban on crypto-derivatives comes across as harsh, then the FCA’s stance on intrinsic value of cryptoassets is equally so; “…we think unregulated cryptoassets have no inherent value. They differ from other assets that have physical uses, promise future cash flows or are legally accepted as money.”
Popular cryptocurrency exchange, Kraken, recently released a report on the intrinsic value of Bitcoin. We took a look at this report and highlighted some key takeaways as to why Bitcoin does indeed provide strong, albeit unique, value.
Is That an Echo?
Interestingly, much of the rationality behind this decision by the FCA is reminiscent of sentiment shared by the Securities and Exchange Commission.
The battle for a Bitcoin based ETF has been going on for years in the United States now, with the SEC shutting down each attempt. Much like the FCA, the reasoning behind each denial typically consists of the following points.
- Market immaturity
- Insufficient valuation methods
- Custodial risk
Although an ETF has been consistently shut down by the SEC, regulators within the United States do appear to have a more open-minded stance, with regards to approving certain crypto-derivatives. This has been made evident through various offerings of Bitcoin and Ethereum futures contracts. Products such as this can be found through various companies, such as,
Mulling it Over
It should be noted this was not a hasty decision by the FCA. The process which led to this conclusion took place over the course of a year as the regulator mulled over the risks and benefits.
The initial proposal for this ban was put forth in July of 2019. In the time since, the FCA opened up the proposal to a commentary period from the public, which resulted in hundreds of submissions. Clearly, there were not enough convincing arguments to sway the FCA’s original decision.
While this decision was made under the pretense of protecting investors, there has already been an outcry by many, denouncing the decision.
“The FCA has delivered a significant blow to UK investor freedom. Through banning the trading of crypto derivatives, we can expect UK trading space to move elsewhere. The demand for these securities continues to rise, with crypto derivative volumes reaching new highs this summer. It’s a lost opportunity for the UK…We certainly believe there should be measures to protect consumers, but this move disregards the rising demand among retail consumers to participate in the cryptocurrency space.”
Financial Conduct Authority (FCA)
The FCA is a financial services regulator based in the United Kingdom. Since its formation in 2013, the FCA has worked to develop and enforce regulations, which ensure fair and transparent capital markets.
Chief Executive, Nikhil Rathi, currently oversees operations at the FCA.