UK Financial Conduct Authority bans sale of ‘cryptoasset’ derivatives

From the 6 January 2021, the United Kingdom will have banned the sale of ‘cryptoasset’ derivatives products to retail customers, according to an announcement published by the country’s Financial Conduct Authority. The move comes amid growing suspicion over cryptocurrency and their derivatives around the world, so while this development in the U.K. will turn heads, countries around the E.U. and the rest of the world are likely not far behind.

Those that ignore the directive are committing a criminal offense, carrying a maximum penalty of 2 years imprisonment and/or an unlimited fine.

Here’s why that’s a great thing for Bitcoin.

FCA consultation process ends in ban

The move was announced by the Financial Conduct Authority, representing the conclusion of more than a year’s worth of consultation on the proposal, which was instigated by the U.K.’s Cryptoassets Taskforce in 2018. Though the consultation process yielded 97% responses in opposition, the FCA is adopting the rule changes.

“We consider that retail customers cannot reliably assess the value and risks of derivatives and exchange traded products that reference certain cryptoassets,” says the report.

The reasons for this finding are listed as:

  • 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 the secondary market for cryptoassets
  • extreme volatility in cryptoasset prices, and
  • inadequate understanding by retail consumers of cryptoassets and the lack of a clear investment need for investment products referencing them

What does the ban address?

The ban applies to derivatives based on cryptoassets which are not regulated by the FCA.

The FCA does not provide a hard and fast definition of ‘cryptoassets,’ but offers a general definition in the consultation documents: ‘cryptoassets are a cryptographically secured digital representation of value or contractual rights that is powered by forms of DLT (distributed ledger technology) and can be stored, transferred or traded electronically.’

The guidance uses the term ‘token’ to differentiate between ‘cryptoassets.’ It acknowledges that for the FCA, ‘cryptyoasset is a broad term that captures the different types of tokens. It is also a neutral term that does not denote a direct comparison with fiat currency.’

Whether a cryptoasset is regulated or not (by the FCA’s definition) will depend whether it is classed as a ‘security token,’ an ‘e-money token’ or something else. Under the FCA’s definition, a security token are akin to investment instruments, such as shares or units in a collective investment scheme. E-money tokens use the definition set out in the Electronic Money Regulations 2011, meaning it only applies to electronically stored monetary value which is not accepted by any person other than the issuer.

 If it doesn’t fall within the definition of either of those categories, then it is not regulated and therefore the ban applies to derivatives based on that currency. The FCA specifically points to BTC, Litecoin and ‘equivalents’ as cryptocurrencies which are ‘usually decentralised and designed to be used primarily as a medium of exchange’.

Given the state of the ecosystem, this is a great thing. The report says: “As the sale of derivatives and ETNs that reference certain types of cryptoassets to retail consumers is now banned, any firm offering these services to retail consumers is likely to be a scam.”

It also only bans the sale of derivatives to retail customers by firms carrying on business in the U.K. What this means isn’t defined exhaustively, but the FCA guidance recognizes that many exchanges can claim to be ‘decentralised’ and it can be difficult to work out where the business activity is taking place. It does say that not all of a business’ activity needs to take place in the U.K. in order to be caught by the ban.

FCA misses opportunity for regulation

Given the loose terminology used by the FCA, it can be difficult to determine what kind of digital assets they are attempting to address in the ban.

There is only a small selection of digital asset that are currently regulated by the FCA, with only two narrow categories of assets which are regulated and a determination that anything falling outside those categories is not regulated. Because it is the ‘unregulated’ kind which are the subject of the derivatives ban, this means it catches a huge number of digital assets-based derivatives.

Anything that curbs speculation is bound to be a good thing for the digital asset community, though by excluding by default anything which does not fall within either of the two mentioned categories is a missed step which could have gone further in regulating a market desperately in need of it.

As it stands, Bitcoin SV clearly doesn’t fall within the FCA’s regulatory remit, but it also doesn’t neatly fall into the ‘unregulated’ category either. In discussing the issues posed by the ‘unregulated’ kind of asset, the FCA points to four broad reasons why it has stepped in and banned the sale of derivatives based on the ‘unregulated’ kind. As one of these reasons focuses on issues with sale of derivatives specifically, the three that are most relevant are listed below, along with an application of those concerns to Bitcoin SV:

1. 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

The FCA’s main concern here is that the lack of intrinsic value means that the price of ‘cryptoassets’ is dependent on speculation, therefore, volatile. In the case of Bitcoin SV, the massive scalability of the platform means that enterprise adoption will continue to pick up steam and as that happens, the intrinsic value is in writing to the blockchain, and the scalability means that the cost of doing so will remain low, and consistent.

2. Presence of market abuse and financial crime (including cyberthefts from cryptoasset platforms) in cryptoasset markets

This area also doesn’t apply to Bitcoin SV in the same way it does to many other digital assets.

Bitcoin SV is, by design, open and transparent. It is not intended to obscure its transactions on the blockchain; rather, its blockchain is open and can be used by law enforcement as an immutable evidence trail. This is the original design of Bitcoin by Satoshi Nakamoto.

In terms of market abuse, Bitcoin SV has been the target of delisting attacks by the exchanges within the ecosystem which have been the subject of ongoing criminal prosecutions and civil suits. To the extent that there is abuse within the market, it is in direct opposition to Bitcoin SV.

3. Extreme volatility in cryptoasset prices

This is another clear example of where the FCA could not have been considering Bitcoin SV in either issuing the guidance or in delineating between regulated and unregulated assets. Bitcoin SV is not speculative: its value comes from its use, and BSV scales in such a way that the cost to merchants for transacting on the chain is negligible and stable. This removes much of the volatility that marks the likes of BTC and other altcoins. You can see this already by noticing that the market value of Bitcoin SV over time does not follow the same waves that virtually every other digital asset does.

The FCA’s conception of ‘cryptoassets’ seems to treat it as synonymous with all digital assets, but from the reasoning given by the FCA discussed above, it is clear that digital assets of Bitcoin SV’s kind—are not being appropriately grappled with. While derivatives as tools of speculation are not a part of the philosophy of Bitcoin creator Satoshi Nakamoto, the FCA’s guidance is yet another example of a regulator missing the opportunity to not only clamp down on the harmful elements within the digital asset community, but to put in place cogent regulation surrounding non-speculative, pro-government and pro-transparency assets like BSV.

The irony is that the one digital asset that welcomes regulation is the one which has apparently not been considered by regulators in this instance.

Learn more about the stream of groups that have turned the industry into a minefield for both naïve and experienced players in the market in CoinGeek’s Crypto Crime Cartel series.

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