Since the start of October, bitcoin has been on a meteoric rise once again. This culminated in the cryptocurrency topping its previous 2017 high of just under $20,000 earlier this month, and is currently trading around the $19,300 mark.
Inevitably, the renewed price attention means that more everyday investors are getting involved in the world of crypto. Preempting this, the Financial Conduct Authority in October announced that it would be placing a ban on the sale of crypto derivative products to retail investors from 6 January 2021.
Its reasoning was that these products aren’t safe enough to be considered a legitimate investment for retail traders, as the underlying asset might prove too difficult for them to value or fully understand. But with the popularity of jumping on the bitcoin bandwagon continuing to rise, some experts think that removing this avenue might actually achieve the opposite of making crypto safer.
Reasons to be careful
Without the ability to invest in regulated exchange-traded notes (ETNs) linked to crypto assets, consumers are now faced with limited options if they want to get in on the bitcoin game. In being forced to buy the coins themselves, for example, more investors will now be responsible for managing their own crypto storage — meaning they’ll have to remember the keys to their offline storage known as a “cold wallet”, or lose access to their investment forever.
They could also be exposed to a higher risk of cyber crime by owning the coins themselves, rather than turning to an intermediary brokerage like Revolut or eToro to store their crypto for them. At least with ETN providers, the underlying bitcoin is managed in a brokerage account with higher security levels than the regular layperson.
The flaws in storing all your crypto with an exchange have been seen before, with one exchange having lost track of millions of dollars worth of bitcoin in 2019 when its founder died unexpectedly and took the keys to its cold storage to his grave.
Imogen Jones, an associate at law firm Collyer Bristow who specialises in cryptocurrencies, told the Fintech Files that while most of the FCA’s thinking makes sense, the ban could leave retail investors without a credible way to hedge their bets or leave them at risk of getting stuck with an illiquid asset.
“We’re still going to have derivatives [available to] investment firms and professional customers, but retail customers could be in a worse position because they either can’t hedge their bets, or can’t get out because they’re not liquid,” she says.
In 2017 when bitcoin’s price bubble popped and the market was still relatively in its infancy, the lack of crypto products meant that many retail investors owned the coins themselves and were left unable to sell their crypto because very few willing buyers were left on the exchanges. It created a major liquidity problem, which in part could now be exacerbated by the removal of retail access to ETNs should the bubble pop for a second time.
“I don’t think people necessarily understand the volatility always, though maybe I’m not giving people enough credit,” says Jones. “But you know that if you’re getting into it, you can’t necessarily get out, and you can’t always sell huge parts of bitcoin.
“If you sign up for Coinbase, it says really strongly in their terms and conditions that they don’t guarantee you being able to sell it out easily, and they can’t guarantee what demand will be there [if it does pop].”
It’s a millennial’s world
The FCA’s interim executive director of strategy and competition Sheldon Mills said at the time that the ban was announced that the regulator’s decision “reflects how seriously we view the potential harm to retail consumers in these products”.
He said the price volatility of cryptocurrencies, combined with the “inherent difficulties of valuing crypto assets reliably” and an “inadequate understanding of crypto assets by retail customers” placed retail investors at high risk of losses when buying derivatives.
However, research conducted by the FCA in preparation for this decision showed just months earlier that the majority of crypto-asset owners in the UK are “generally knowledgeable about the product”, volatility and the lack of regulatory protections available to them.
So why did the FCA choose to ignore its own evidence? Well, part of the concern lies in how crypto derivatives have been marketed and whether that audience understands what they’re getting into.
“There has been a lot of advertising on social media, on Instagram, in newspapers and outdoor advertising, and it is being marketed particularly at young individuals,” Jones says. “[Cryptocurrencies are] now being packaged up into derivatives, which are obviously complex financial products, with the underlying asset being incredibly volatile.”
So what now?
As of 6 January, anyone who already holds a derivative product as a retail investor can keep it. But brokerages won’t be able to sell the products to new consumers, meaning the firms that became prominent crypto-derivatives providers in the UK such as eToro and Plus500 will have to focus solely on marketing professional and institutional investors.
“I’ve read quite a lot of commentary from some firms who have said that they wish that the FCA had regulated it rather than banning it,” adds Jones. “I can understand that, but I think also the market doesn’t really want to be hugely regulated and there’s always backlash in crypto [against] any regulation that anyone puts in… so I’m not sure if that would settle the [debate] either.”
Further reading
Financial News’ former fintech correspondent Ryan Weeks reports that with just weeks to go until UK crypto firms must be registered by the FCA or cease trading, the regulator has approved only four companies.
The boss of Germany’s audit watchdog has been dismissed with immediate effect, after he admitted to buying and selling shares in Wirecard while the regulator was in confidential talks about the company.
Mastercard has lost an appeal to stop a £14bn class action suit against it — one of the first of its kind in the UK — from going ahead.
And British fintech’s got a new lobby group, Siftedreports, after some startup founders thought existing bodies weren’t getting political enough.
To contact the author of this story with feedback or news, email Emily Nicolle