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Summary
- The Financial Conducts Authority has banned the sale of cryptocurrency derivatives to retail investors
- It also came out with its final rules regarding the sale of derivatives and exchange traded notes relating to certain types of crypto assets.
- Significant price volatility has been observed in Bitcoin, one of the most popular cryptocurrency assets, which has gained prominence in recent years, leading to heavy losses to investors.
In a rude shock to many enthusiasts of cryptocurrencies like Bitcoin, the Financial Conducts Authority (FCA) has banned the sale of crypto- derivative products to retail investors in the United Kingdom. The rules were announced on 6 October 2020 and they have mentioned that the ban will be applicable from 6 January 2021 across Britain. The regulatory body has warned the UK investors to be wary of any crypto derivative scams. Experts feel the main reason behind such a decision is that cryptocurrencies’ price volatility.
The FCA noted that there are no reliable basis upon which these cryptos- assets can be valued, poor understanding among people regarding the working and nature of crypto-assets.
It is worth noting here that in recent times many investors have lost a significant amount of money trading in crypto currencies, which has made them one of the riskiest assets in the world. The introduction of crypto- derivatives could have made this asset class a little less volatile and would have brought back many investors who had stopped investing in it.
New FCA rules
The FCA has pointed out five major reasons that make crypto- derivatives ill fit for retail investors.
- Crypto- currencies do not have a reliable basis on which they can be valued.
- The cryptocurrency trading can be prone to threat of market abuse and financial crimes, which make this asset class more vulnerable than others because of its peculiar characteristics.
- There is extreme volatility in trading of cryptocurrencies that have been observed in recent times, which implies that the volatility in their derivative instruments would be far more volatile.
- Investors don't have an inadequate understanding of these complex crypto- assets, which could result in taking ill-informed decisions.
- FCA said that there is no genuine investment need for retail investors to invest in these derivative instruments except for speculative gains, which the regulators intend to actively discourage.
The regulator also estimated that retail investors could save as much as £53 million due to this ban.
Risks around cryptocurrencies
Cryptocurrencies possess different characteristics compared to other conventional currencies and investment vehicles. They offer technical complexities, and their basic constitution makes them one of the riskiest financial asset classes.
Like Bitcoin, Libra, Ether, Ripple, and a host of other crypto- currencies have now started to trade across the world as investment products, inviting people to put their hard-earned money in them. They do promise good returns, but a study of their price performance over the past few years reveal extreme volatility associated with these currencies, leading to thousands of investors losing money in the process.
Cryptocurrencies can be traded either at a spot exchange or in a derivatives market. In the spot market, they are traded as assets while in the derivatives market as contracts.
Derivatives, even on instruments like equity and bonds, are highly complex in nature, where retail investors find them difficult to trade. Thus, derivative instruments on crypto currencies are certainly far more intricate.
The knowledge and efforts required to understand the movement of cryptocurrencies and their derivatives is very complex and very few people would be able to possess and practice.
The Performance of bitcoin against USD over the past one year
Source – Thomson Reuters
Bitcoin, the most prolifically traded cryptocurrencies, has seen extreme volatility in trading against the US Dollar in the past year as enumerated in the above chart. As on 8 October 2020 (1.05 PM GMT+1) the currency has been trading at $10,603.95 per unit of Bitcoin cryptocurrency.
Outlook
Bitcoin and other such cryptocurrency types have seen a zealous promotion in the recent past to make them more popular amongst investors. However, they do not easily confirm the basic definition of a currency. Sovereign backed currencies, on the other hand, have gone through generations of evolutionary development and have proven themselves to be deposits of wealth and have been used by central banks and governments to generate healthy returns in every part of the world.
Cryptocurrencies remain a mystery, and their establishment as a formal asset class is still in doubt as many countries including that of developing countries like India and China have refused to support them. Further, derivative instruments on such assets generally have no more value than merely being a speculative tool. Its contribution to the economic development of a country is doubtful and is susceptible to manipulations.
