Op-ed

The Case for a Cryptocurrency CFDs Ban

The former Director of Abide Financial and current Head of Compliance at Coinbase UK shares his views on crypto CFDs

It hasn’t been an easy few years for retail derivatives firms in the EU. With binary options for retail clients being banned outright and swingeing cuts made to the permitted leverage across CFDs in multiple asset classes, it is no wonder that numerous CFD and Spread Betting firms are reporting large reductions in transaction volumes and profits.

At the same time as customers have fled from equities and indices because of the higher margin they have to stump up, interest in crypto CFDs has grown as, even with leverage limited to 2X, the volatility of the underlying asset has kept alive the possibility of large gains (or losses) relative to the investment made, at least in these markets.

The CFD route is simpler for clients too, as purchases are made and profits settled in the normal account currency, with no need to engage with bitcoin addresses, key storage and the other trappings of the spot cryptocurrency infrastructure.

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A picture of Mark Kelly, Head of Compliance UK at Coinbase
Mark Kelly, Head of Compliance at Coinbase UK

FCA’s Review of Cryptocurrency CFDs

However, this benign environment for Crypto CFDs is under threat, at least in the UK, as the FCA has announced on multiple occasions that they are considering a complete ban on Cryptocurrency CFDs for retail investors.

While this has been greeted with disappointment by some smaller investors with large risk appetites (and their vendors), there may be an upside in the curbing of the downward price pressure which has seen the cryptocurrency market capitalization slashed by over 80% in the past year.

For CFDs, even without leverage, have an attribute which is not shared by spot cryptocurrency trades, which is the ability to sell what you don’t have, ie to take a short position in the hope and expectation of a fall in price, and then to make money proportionate to that fall. Add in leverage and you have a mechanism almost designed to produce exaggerated movements on the back of the slightest bit of adverse news.

This effect is not new. The European Short-Selling Rules were brought in to counter just this same effect in exaggerated dumping of banking and other stocks at times of greater volatility. Going back even further, US rules have long been in place to prevent the short sale of stocks except when the previous market movement was an uptick.

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Both of these regulatory mechanisms were introduced to dampen exaggerated market movements which would otherwise contribute to damaging volatility in the asset (and losses to regular investors due to possibly predatory shorting of the stocks). Wouldn’t it have been nice to have some such brakes on the price of Bitcoin and other similar assets over the past 12 months?

Banning the ability to take a short position via CFDs would at least mean that only holders of coins and tokens could sell those tokens. It could be seen as a necessary step in the maturing of the crypto space, just as the above-referenced measures were put in place during the development of more traditional markets.

Offshore Migration

Of course, in practice retail derivatives firms have found that the more restrictions get imposed on their products, the more their business will migrate to offshore unregulated entities. Increased regulation doesn’t change the risk appetite of retail investors.

Those who prefer to play at the more speculative end of the market will follow the riskier products offshore – if they do so they won’t struggle to find providers willing to give them products with a leverage of up to 100X.  What are regulated UK and EU firms to do should the expected ban come into force?

Recognising that they will inevitably lose some clients to the offshore “wild west”, they could still look to facilitate their other clients’ experience of acquiring and holding spot cryptocurrency, perhaps by white labelling a solution from a cryptocurrency exchange, or providing a pass-through mechanism to avoid their client having to onboard separately (and fund another trading account).

In any case, it should be possible to insulate such clients from having to learn about key management and bitcoin addresses, while still giving the exposure they want to the ups and downs of crypto assets which, even without leverage, are likely to be a thrilling enough ride for the foreseeable future.

Mark Kelly is the Head of Compliance at Coinbase UK.

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