Updated: Nov 26, 2021
As more of the world’s financial markets accept cryptocurrency derivatives, is it time for the UK’s Financial Conduct Authority to unban them? This week, We Respond to Joshua Oliver's article about the next step in the future of finance.
Responding to Joshua Oliver
Asset Management Reporter at the Financial Times
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The UK is “out of step” with most major financial markets - so says Joshua Oliver of the Financial Times. This was his reaction to the plethora of bitcoin-derived ETFs that have recently been launched in the United States for the first time. Back across the pond, however, the Financial Conduct Authority (FCA) remains steadfast in its October 2020 ban of crypto derivatives.
ETFs (or Exchange Traded Funds) are a type of security which track the price of an asset - and although they only track changes in price, they can be traded on the stock market just like stocks and bonds. In this case, we’re talking about securities that track the prices of bitcoin futures.
The unprecedented launch of these ETFs in the US brings the world’s largest financial market in line with other countries such as Canada, Germany and Brazil, and arguably leaves the UK behind. Post-Brexit, the UK wishes to be seen as a 'global Britain'; a place where innovation can occur, now outside of the caricature of the bureaucratic machine that is the European Union. The EU, however, has introduced no such prohibition and in consultation for the move; one for which 97% of respondents were opposed. At face value, this seems to be less like a supported move and more like diktat from an out of touch regulator.
Is it really that simple though? As pointed out by Oliver in his article, the claim of crypto ETFs is that they are a safer means of getting exposure to cryptocurrencies, an alternative to purchasing coins directly through exchanges such as Binance and Coinbase. ETFs are highly regulated, allowing regulators to protect against price manipulation as well as monitor the performance of the ETF. Additionally, crypto exchanges and wallets are more vulnerable to hacking and theft, which ETFs protect against.
The FCA, however, claims that consumers have an "inadequate understanding and a lack of clear investment need" for ETFs and, as Oliver shows, the FCA cites that "significant price volatility, combined with the inherent difficulties of valuing cryptoassets reliably, places retail consumers at a high risk of suffering losses from trading,”.
On the other hand, as Ian Taylor pointed out, this seemingly contradicts a study the FCA themselves published, which shows that almost all crypto-holders are knowledgeable about cryptocurrencies and understand the risks involved. Notwithstanding this evidence, it must be remembered that the consumer base for cryptocurrencies may only partially coincide with the consumer base for crypto ETFs. Many potential consumers may be driven away from cryptocurrencies due to the difficulty of accessing them directly.
All of this would change with ETFs where, suddenly, popular stock and instrument trading platforms such as Plus500, Trading 212, or even Hargreaves Lansdown could allow the trade of crypto ETFs. This would say goodbye to the lengthy process of opening an account with a dedicated crypto exchange. With public understanding of cryptocurrencies falling, ease-of-access to crypto opens the door to ignorant consumers harming themselves financially due to lack of understanding.
This is compounded by the complicated nature of the ETFs themselves. Contrary to what may seem logical, the underlying asset of the majority of ETFs is not bitcoin itself, but rather bitcoin futures - contracts allowing for assets to be bought at an agreed price, but transacted at a later date. As these futures expire, they must be rolled over to the next batch of futures to ensure the continuity of the ETF. This involves transaction costs and management fees, all of which come out of the ETF's value. As of November 1st, the value of bitcoin has risen by 120% year-on-year - but Solactive, an index provider, suggests futures have made 13 percentage points less than this.
Additionally, there are limits on the number of contracts one party can buy in order to prevent a monopoly of the market: an issue with bitcoin futures due to the limited market size. After buying a specific number of contracts, companies can buy unlimited futures if they have a longer time horizon. If bitcoin's price is expected to rise over the longer term, the price of a longer term futures contract rises above that of short term contracts, in a contango. As the ETF is rolled over, this incurs a higher cost as the fund is effectively selling low and buying high. For bitcoin ETFs, these extra costs can be up to 10% annually.
All of this added complexity to the already complex blockchain will further confuse the average lay investor - a significant number of whom only get their information from non-expert acquaintances and the internet, on sites such as Reddit. Complexity decreases knowledge, which increases personal financial risk - something which the FCA should absolutely be regulating.
Despite all these potential drawbacks, the FCA made a mistake when banning crypto derivatives. Consumers are still able to purchase them, albeit overseas in other financial markets. This is less safe for consumers as rather than being able to provide oversight, the FCA must take a back seat as people take 100 times leverage on investments in markets with poor regulation. It would be better if the FCA allowed heavily regulated ETFs that are safe for consumers and do not, as Oliver reminds us, push investors "down riskier paths". They've already admitted that they cannot regulate bitcoin exchanges like Binance, so why not allow an asset that it can regulate? Especially one that is so popular and that is backed by a multi-trillion dollar market.
Written by Max Vorster
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