FCAs Crypto Ban is Unlikely to Work

Racehorses, Betfair and Unintended Consequences

I’ve been involved in Crypto and Blockchain space for six years now. For good or for worse, I have spent most of my career working on non speculative uses of crypto e.g. payments, enterprise applications, e-commerce and such. I have seen crypto do an enormous amount of good for humanity in emerging markets in particular and elsewhere too - and all this while I have argued that well designed regulation is a positive force for digital asset/crypto markets.

For the very same reason, I am also part of the global crypto analyst community from the traditional banking world that opposed India’s crypto ban, China’s crypto ban and now the UK’s crypto derivatives ban. and I have never seen a crypto ban of any sort work and I have seen crypto bans prove rather counterproductive. Let’s explore the latest in the ban-series.

First the news:

UK's FCA bans retail crypto derivatives after year-long consideration

See the link here: FCAs Ban. This is what we know.

  1. It’s well intentioned and aimed at protecting retail customers.

  2. It was well managed through a systematic and well researched consultation process.

  3. It was motivated by a long series of online and offline of consumer complaints from retail customers who were trading some of the highest risk instruments currently accessible to retail anywhere in the world.

  4. It’s consistent with restrictions on other (non crypto) leveraged financial instruments such as CFDs but inconsistent with one of our £10.5bn industries ( read on to break suspense ).

  5. Much of the reasoning cited by the FCA (lack of quality market data and indices) is also rather reasonable although we won’t go into how important that argument is in the context of JPMCs recent $920m fine for manipulating the most liquid market into the world served by the highest quality market data sources.

Why Won’t It Work?

Derivatives contracts are funny creatures. They can morph into things that don’t look like derivatives at all. However, I won’t even go into the arbitrage argument here. We have much more important arguments to ponder.

1. Grandma Isn’t Trading Onshore Anyway

Thanks to Coindesk and Noelle for this valuable piece of data. Kraken Futures, which is fully UK regulated and imposes low leverage limits on retail customers is quite further down in terms of market share compared to much bigger venues that are not. Coinshares which will be hurt the most isn’t on the table at all.

The implication is, this well intentioned measure will penalise regulated venues and push volumes to unregulated venues. Does that help or hurt consumer protection is anybody’s guess.

2. Reverse Solicitation

First, the FCA generally has no jurisdiction on a crypto derivatives exchanges that’s based outside the UK. If a UK customer decides to trade 100x monthly SushiSwap futures on an exchange based in Timbuktu which is not actively marketing (you’d have to ask a lawyer what market is and is not) its services in the UK, then there’s not a whole lot the UK regulator can do about it.

This legal defense is known as “reverse solicitation”. It’s not the exchange that’s soliciting the customer, it’s the customer soliciting the exchange. There are a few prongs that are required to be met for reverse solicitation to apply but much of it relies on the debate around what constitutes marketing and what doesn’t.

3. Crypto Onramps to Offshore Venues

The other lever a regulator has is fiat onramps and offramps. The regulator can certainly close fiat onramps to noncompliant exchanges. However, a consumer that’s truly committed to attempting Seppukku on 100x sushi futures can always buy sushi on a compliant onshore spot exchange and move his sushi to a wallet on an offshore noncompliant exchange for trading such high risk instruments.

Indeed, no regulator can protect a customer hell bent on hurting herself from herself. By banning regulated access (which is the only one a regulator can ban), the only thing a regulator can achieve is to incentivise the consumer to hurt herself somewhere else.

A section for boomers

According to the FCA’s estimate, if unsophisticated retail customers are denied access to high risk instruments, such customers might save £53mn in losses (on regulated venues). Crypto critics and blockchain trolls will argue that retail consumers have few economic reason to trade 100x Quarterly Sushi token Futures any more than she has a valid economic reason to trade 100x leverage coal futures, Baht/GBP futures or electricity futures. They are probably correct. Highly leveraged derivatives on highly volatile assets are best left to institutions who aggregate and hedge risk for retail with well paid experts and machinery and capital requirements.

However, leverage and margin limits solve precisely that issue. Further 2x/3x crypto futures can be a very valuable hedging instrument for retail crypto traders.

Not just that one man’s speculation is another man’s hedging but let’s look at the sort of economic activity we actually allow and promote in our country. We live in the country of racehorses and epic sports betting. We are legendary gamblers and it’s one of the traits that made Britannia Rule the seas for at least four centuries, and then run global investment banking for at least one. When asked to stop, we tend to simply gamble elsewhere (e.g. in shadow banking instead of banking).

Now let’s compare that £53 mn with the £10bn that the gambling industry makes in the UK and the 100,000 jobs it sustains.

Now let’s say we ban the gambling industry in the UK… which doesn’t even pretend to hedge any risks (maybe apart from racehorse risk) and … If you think I am Going all Pirates of the Caribbean on this? Well here we go with more data.