In a bid to foster a safe and regulated trading eco-system, the European Securities and Market Authority has reiterated its warning to investors about the risks involved with trading in crypto-assets.
The past few years have been characterized by the exponential popularization of crypto-assets as investment vehicles. Bitcoin, Etherium, Ripple, Tron, Monero and Dogecoin are just a few of the cryptocurrencies that have disrupted traditional investment practices around the world. With the rise of a new generation that is desperate to break out of traditional investment practices, trading of crypto-assets has become the new norm.
In total, there are currently over five thousand crypto-assets that have been introduced into the global market and this is something that the ESMA is concerned about. Unlike fiat currencies, stocks and Contracts For Difference, trading of crypto-assets is not regulated in the European Union. In the event that an investor loses their capital while trading crypto-assets, it is unlikely that the ESMA will be in a position to offer the investor any resolve. There is a proposal by the European Commission to regulate the crypto-asset market but this has not yet been assented into law. Therefore, if an entity in the EU suffers damages as a result of trading in crypto-assets, they would not be able to enjoy any protection by EU law.
In 2020, the U.K.’s Financial Conduct Authority (FCA) took definitive action to completely ban the sale, marketing and distribution of crypto-assets in the UK. The FCA claimed that it was necessary to take such stern measures to protect the public from the dangers surrounding these unregulated markets. This move was driven by evidence on a ‘significant scale’ that the FCA claims to have acquired during their investigation. Their analysis of the said assets revealed the following potential dangers especially to retail investors:
- Crypto-assets are unregulated therefore prone to manipulation and abuse by unknown parties. The anonymous nature of transactions carried out using cryptocurrencies has made it difficult to prosecute financial crimes.
- Retail investors are not in a position to fully appreciate the intrinsic value (or lack thereof) of crypto-assets. Valuation of most cryptocurrencies is fairly subjective.
- Cryptocurrencies are extremely volatile so it is likely that even experienced traders could lose all of their capital because of unpredictable changes in price.
- Unlike stocks, commodities and other regulated CFDs, there is no clear need for retail investors to partake in crypto-currency exchange.
The risks of trading in crypto-assets can perhaps be illustrated by reviewing Bitcoin’s performance within a period of four years.
Before you even consider becoming an investor, it would also be wise to verify that the broker you have selected is reliable and has the appropriate licenses to provide a trading platform. If you are looking for reliable information that would help you choose a safe broker or trading platform, TradingGuide.co.uk compiles user data and rates these kinds of FCA regulated platforms based on actual user ratings. While these brokers are reliable, there is still a very high risk of swings in crypto so be careful.
Its price has gone from $922 to $19,000 down to $3,500 and then back again to an all-time high of around $57,000. It is unlikely that volatility of this scale would be experienced on any FCA-approved trading instrument. Other than speculation, it is difficult to substantiate the causes of such extreme fluctuations in price and most traders are often caught unprepared, leaving them exposed to huge losses.
With the contraction of the global economy and fewer opportunities in employment, many have diverted their savings into crypto-assets hoping to make ends meet through capital gains. Some traders take part in the markets by buying the actual crypto-asset through specialized cryptoexchange brokers while others trade in their derivatives such as CFDs which gives them access to leveraged trading. The latter is often preferred as it allows the trader to go long or short on any instrument without actually taking ownership in the asset. While leveraged trading appears to be lucrative, it takes a lot of hard work and patience to turn a profit.
A survey carried out by the FCA in 2020 revealed that most cryptocurrency owners have an in-depth understanding of these types of assets and the risk associated with trading them. It would therefore come as a surprise that the FCA still decided to go ahead with the ban without considering how it would affect investors during the COVID-19 pandemic.
It is interesting to see that Germany has taken a completely different route when it comes to legislation around crypto-assets. Instead of banning crypto-assets, the Federal Financial Supervisory Authority (BaFin) has made provisions for such instruments as a new financial service. Tax brackets were even created for persons and corporations transacting in crypto-assets of different value.
It appears that the FCA made this decision without looking at the role that crypto-assets play on the world stage. Such financial instruments may be termed ‘disruptive’ but lots of countries are gradually adopting crypto-assets into their financial eco-systems as they simultaneously come up with policies to regulate their use.