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Why is the UK thinking of banning crypto derivatives? Why is the UK thinking of banning crypto derivatives?
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Why is the UK thinking of banning crypto derivatives?

Why is the UK thinking of banning crypto derivatives?

Cover art/illustration via CryptoSlate. Image includes combined content which may include AI-generated content.

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Britain’s foremost financial watchdog, the Financial Conduct Authority, is contemplating a blanket-ban on cryptocurrency derivatives for retail traders as early as 2020, The Economist reported.

The meeting comes on the heels of a statement released in early July by the FCA proposing a ban on crypto derivatives—high-risk assets where “retail consumers might suffer harm from sudden and unexpected losses,” the regulatory body said.

Thursday, the FCA held a consultation on the matter, purportedly in response to recent market “tantrums,” said the Economist, such as September 24th’s liquidation of $643 million long contracts on Bitcoin derivatives giant BitMEX. A final outcome is expected in early 2020.

The Economist: crypto not fit for currency or derivatives

“It would take an earthquake for the FCA not to press ahead” with the ban, wrote the Economist, consistent with the publication’s classically liberal economic outlook. Justifying its assertion, the paper wrote:

“But crypto-monies are not legally recognised currencies. They do not reliably store value, rarely serve as a unit of account and are not widely accepted. Peddlers of crypto-derivatives, the FCA says, cannot claim their wares are needed for hedging purposes.”

Clearly misunderstanding the nature of derivatives, the London-based publication seemed to be well off the mark in its reasoning for calling the prospective ban a done deal. Derivatives need not reliably store value, serve as a unit of account, or be widely accepted. Wheat, one of the longest-traded derivatives in the history of modern markets, would not meet any of The Economist’s qualifications.

Simply, derivatives are securities derived from underlying assets including stocks, bonds, commodities, interest rates, and currencies (including cryptocurrency). Their use in hedging risk, as The Economist pointed out, may be one of the core functions of the asset-class. Yet, the trading of derivatives for speculation, by institutional and retail traders, is as common a purpose.

Further, the FCA’s claim, as purported by The Economist, that “peddlers of crypto-derivatives” cannot claim their wares is now inaccurate due to the recently launched Bakkt futures contract—which expressly mandates the physical settlement of Bitcoin contracts. The contracts are a “good hedge” in the eyes of the U.S. Securities and Exchange Commission, according to Genesis Capital CEO Michael Moro.

FCA says crypto too volatile, incomprehensible, cannot be valued

While The Economist may have been a little laissez-faire in its assertions, the FCA’s earlier statement did provide the following reasons for contemplating the ban:

  • inherent nature of the underlying assets, which have no reliable basis for valuation
  • the prevalence of market abuse and financial crime in the secondary market for crypto-assets (e.g. cyber theft)
  • extreme volatility in crypto-asset prices movements
  • inadequate understanding by retail consumers of crypto-assets and the lack of a clear investment need for investment products referencing them

But, many of these claims are questionable.

The value of a derivative, as the name suggests, is derived from the expected value of its underlying asset. For all intents and purposes Bitcoin is the only substantive cryptocurrency derivative, and admittedly as a nascent asset its market paradigms are still developing. So, it may be said it has no reliable basis for valuation—but probably no less than gold.

The value of gold, perhaps Bitcoin’s closest real-world equivalent in the derivatives market, is decided primarily by public sentiment, inflation rates and interest rates of fiat currency, and mining costs, which affect supply and demand. One could argue Bitcoin’s value is derived by the same variables, perhaps with the exception of mining (though halvings and Bitcoin’s finite supply are factored into its valuation by many analysts).

Addressing the FCA’s concern around “cyber theft,” according to the National Crime Agency of the U.K., financial crime losses in Britain total around £190 billion annually—roughly 170 times more than the value of cryptocurrency stolen globally in 2018, $1.7 billion.

Bitcoin is comparably volatile to oil, one of the most the most commonly traded derivatives in the world, and may be on track to be less volatile within years if its current trajectory continues.

As for consumer education posing a risk to the public, this may be one of the FCA’s more flimsy points. According to the FCA, the ban could save retail consumers £234.3 million a year in losses, roughly 1.5 percent of what Britons spend on gambling annually.