How crypto firms and retail traders in the UK might get around the new derivatives ban

Last week, the Financial Conduct Authority announced a ban on the sale of cryptocurrency derivative products to retail investors.

The move came despite the fact that 97% of the 527 respondents to the regulator’s year-long consultation on the ban — a roster including trade bodies, exchanges and individuals — opposed it.

A key question now is where ordinary investors seeking leveraged or tax-efficient exposure to cryptocurrencies will turn. And how will UK-based crypto derivatives trading platforms react?

Whether they stay or leave, UK-based crypto-derivatives platforms are likely to lose at least some UK-based retail customers. Crypto founders and professional service providers in the sector are convinced that UK-based retail investors will now flock overseas or to unregulated trading venues like decentralized financial service (DeFi) platforms. 

Escape to the EU?

The ban may inspire some UK-based crypto firms to head for the exits once it takes effect on January 6 — which happens to be about a week after the UK’s transition period with the European Union (EU) comes to a close.

“There’s probably going to be some opportunities for regulatory arbitrage, for entities to go to Europe and continue what they’re doing,” George Morris, a partner at the law firm Simmons & Simmons, told The Block.

The EU’s newly proposed crypto regulations may make the move even more compelling. Chris Tyrer, head of Fidelity Digital Assets in Europe, described the UK’s ban as curious “given that we’ve seen European regulators move towards clearer regulation” through the recent publication of the Markets in Cryptoassets proposals.

Based on the draft MiCA framework, the EU appears to have no plans to ban crypto derivatives. That might draw UK businesses that offer crypto derivatives to Europe, where they could take advantage of particularly friendly regulatory environments in Switzerland, Malta or Gibraltar.

Firms for which derivatives aren’t the primary focus may not leave the UK, but will likely lose business. The investment platform eToro, for example, has 16% of its UK clients’ cryptocurrency positions in derivative products. The company would not specify what that amounts to in fiat terms, but those accounts will have to be closed or shifted into different investment products by the time the ban comes into effect on January 6.

Edward Drake, eToro’s head of compliance and operations, said the company is confident it will be “less affected by the new legislation than many others in the market and that our clients will continue to enjoy uninterrupted access to crypto as real assets.”

DeFi detour

If UK traders still eager to buy and sell derivatives are left without traditional options, they may turn instead to decentralized ones.

That’s why executives at KR1, a blockchain investment company listed on the London-based stock exchange Aquis, see the derivatives ban as a good thing.

KR1 has invested $100,000 in Vega, a pre-launch decentralized network that promises to facilitate “fully automated, end-to-end margin trading and execution of complex financial products.”

Vega, which will join a plethora of new DeFi protocols that have emerged in recent months, raised $5 million in a seed round led by Pantera Capital in October 2019. Its co-founder Ramsey Khoury is also a co-founder of Chainspace, the sharding start-up that Facebook acquired ahead of the public launch of the Libra Association and the wallet service Calibra (now known as Novi).

What is to stop retail investors flocking to venues like Vega, which in some ways fall outside the scope of traditional financial regulation? For now, not much, according to KR1’s chief executive George McDonaugh.

Policymakers around the world have yet to specifically address DeFi activities, which range from the decentralized trading of tokens to more complex transactions like the kind Vega envisions. Even the new EU proposals steer clear of the larger topic.  

“The ban will push [derivatives trading] into the more decentralized realm and people will have to try a lot harder to find it,” McDonaugh added.

Vega, which is aptly based in Gibraltar, did not respond to a request for comment.