Buying and selling derivatives is an increasingly popular way to invest in cryptoassets. These "cryptoasset derivatives" are financial instruments (ie contracts) of which the value is determined by reference to the value of a cryptoasset or collection of cryptoassets. However, the growing demand does not correspond to an understanding of the associated risks, according to the UK’s Financial Conduct Authority (FCA). In particular, the FCA is concerned that the complexity and relative obscurity of cryptoassets pose a significant risk of harm to certain investors.
What is the proposal?
As anticipated in the Cryptoasset Taskforce report of October 2018, the FCA is consulting on a proposal to ban the sale, marketing and distribution to retail clients of derivatives and exchange traded notes (ETNs) that are based on unregulated transferable cryptoassets.
Retail clients are essentially individuals who are not investing professionally and are likely to have limited understanding of the risks and limited capacity to absorb potential losses – in other words you and me.
The proposed ban would apply to products sold, marketed or distributed in or from the UK to retail clients. It would also apply to EEA firms selling to UK retail clients, including where the client actively seeks out the products ("reverse solicitation"). However, UK retail clients could still seek products from a non-EEA firm via reverse solicitation.
Which products are caught?
The proposed ban applies to derivatives and ETNs that refer to “unregulated transferable cryptoassets”. Essentially, the underlying cryptoasset must have the following characteristics.
- It must be capable of being traded on or transferred through any platform or other forum, and must not be limited to being transferred in exchange for a good or service.
- It must not be “electronic money” or a “specified investment” (eg a security token), given that the UK already regulates the sale, marketing and distribution of financial products based on these assets.
The definition proposed by the FCA would exclude products based on utility tokens, which are typically limited to being transferred on a private network for goods or services, and security tokens, which qualify as specified investments. It may also exclude products based on “stablecoins”, which some regulators have suggested could be considered e-money (as recently discussed by the FCA).
However, the definition is likely to cover products that refer to Bitcoin, Ethereum, XRP (Ripple), and other exchange tokens. Retail clients would no longer be able to buy derivatives (e.g., futures, options, contracts for difference) that refer to these cryptoassets.
Why is the FCA intervening?
The ban is intended to protect consumers from risks of market abuse, financial crime and financial loss due to extreme price volatility resulting from a perceived lack of transparency in the market. The FCA is also mindful that many retail investors seeking exposure to cryptoassets may be relatively young and inexperienced.
On the other side of the (bit)coin, the FCA acknowledges risks that the ban could negatively affect consumer behaviour. Consumers may be encouraged to “opt up” to professional client status in order to circumvent the ban, thereby opting out of various consumer protection rules. The ban may also encourage consumers to invest directly in the underlying cryptoassets, which the FCA has concerns about, but not yet any powers to regulate.
