Investment management consultant MATTHEW FEARGRIEVE explains the FCA's new warning about the risks of investing in Bitcoin and other cryptocurrencies, and considers its implications for the future of crypto in the UK and beyond.
The price of Bitcoin has slumped 28 per cent since Friday’s all-time peak, as the UK’s financial regulator warned investors betting on the cryptocurrency that they “should be prepared to lose all their money“.
In a statement posted to the markets yesterday (11 January), the UK’s Financial Conduct Authority (FCA) said that consumers investing in crypto should be prepared for massive losses. The statement says:
‘The FCA is aware that some firms are offering investments in cryptoassets, or lending or investments linked to cryptoassets, that promise high returns. Investing in cryptoassets, or investments and lending linked to them, generally involves taking very high risks with investors’ money. If consumers invest in these types of product, they should be prepared to lose all their money.’
The volatile nature of these “cryptoassets” was highlighted again yesterday (11 January) as Bitcoin dropped 28 per cent from Friday’s record high of US$42,000, having doubled its value in under thirty days.
Despite the closing price of US$30,200 yesterday, Bitcoin is still only at its lowest level since the 1 January.
The FCA statement asserts that the “significant price volatility in cryptoassets, combined with the inherent difficulties of valuing cryptoassets reliably” put investors at high risk of financial loss.
The FCA’s warning comes only a day after new UK regulations came into force requiring cryptocurrency firms to comply with anti-money laundering rules. All UK crypto platforms must register with the FCA under regulations to tackle money laundering. Operating without a registration is now a crime in the UK, punishable by financial penalties and/or imprisonment.
Curb your Enthusiasm: Crypto Hype and Regulatory Backlash
Notwithstanding these new crypto-specific AML regulations, the FCA’s statement of yesterday makes plain the watchdog’s concern that some crypto firms promising high returns may not yet face any formal regulation in the UK beyond basic money-laundering requirements.
This growing regulatory pressure on cryptocurrencies is seen by many as a worrying development, one that will lead to significant drags on value, together with operational problems such as those currently being experienced by thousands of users of the leading Bitcoin exchange Coinbase.
Yesterday’s statement will be of particular concern to the growing number of crypto brokers and exchanges in the UK, and the thousands of financial advisers who will have felt emboldened by the growing size of institutional allocations to Bitcoin to recommend cryptocurrency as a punt for their customers.
The FCA statement makes clear and deliberate reference to crypto investment firms which may be overstating potential payouts, or understating the risks, entailed by investing in cryptoassets.
The UK regulator’s statement yesterday is the latest – and most explicit – manifestation of growing concern amongst its chief staffers that the explosion of interest in crypto during the Covid-19 lockdowns of 2020, fuelled by institutional investors and hedge funds, together with stuck-at-home retail investors with time on their hands, is ballooning into one big systemic risk that the regulator barely understands and is, so far, regulated in the UK only by anti-money laundering rules and by little else.
The FCA banned the sale of derivatives and exchange traded notes that reference certain types of cryptoassets to retail consumers in October 2020, after months examining consumer risk in the sector. In February 2020, the watchdog probed Sipp providers over their exposure to cryptocurrencies. And in 2019, it had canvassed the views of financial advisers in a targeted survey about their interest in cryptoassets.
As the popularity of cryptocurrencies grows, the FCA has urged consumers to understand what they think they are investing and the financial risks involved, given they are unlikely to be protected by UK schemes that help investors reclaim cash when companies go bust, up to a maximum of £85,000.
The FCA says in its statement that the complexity of some services and products linked to cryptoassets makes it hard for consumers to understand the full risks. There is no guarantee that cryptoassets could be converted back into cash, putting consumers at the mercy of supply and demand in the market.
As posters advertising Bitcoin have started popping up on the London transport system (see our earlier blog here) there is growing concern that retail investors may be being seduced by false promises of easy returns. The FCA warns that “consumers should be wary if they’re contacted out of the blue, pressured to invest quickly or promised returns that sound too good to be true“.
The worry is that ordinary consumers are being taken in by glossy marketing that hypes the meteoric rise of bitcoin, and investing in cryptoassets without first grasping that they are a relatively highly complex and high risk alternative asset class, compared to the equities and bonds that comprise the vast majority of savings and pension plans in the UK and worldwide. Many consumers will be misled by their advisers, and many will not have been informed that cryptoassets should only be a small proportion of a portfolio.
What next for Crypto in the UK and beyond?
For many crypto sceptics, the FCA’s latest intervention will only reaffirm their long-held concerns about the viability of Bitcoin and other cryptocurrencies as a stable, long-term asset.
The parabolic curve in prices over 2020, that is being sustained to some extent in January, is still haunted by memories of the crash of 2017. Many investors big and small, and many market commentators, are thinking ‘this time it will be different’, whilst others still find it hard to ignore the fact that the asset is still extremely volatile.
In my previous Bitcoin-sceptical blog (here), I was similarly conscious of the 2017 high, and then the big slump that followed. I have an innate conservative streak that kicks in to regulate my impulses when I see hot money pouring into something. The problem I have with public advertisements that encourage buying cryptocurrency is that they are promoted by big players who always hype a product that they want to sell at inflated prices to an ignorant retail consumer base.
This is a reservation that the FCA quite naturally shares.
I have shared my personal experiences as an account holder with Bitcoin exchange Coinbase. The ongoing service failure at Coinbase, that the Californian company (which is FCA regulated in the UK) has blamed on increased Know-Your-Client and anti-money laundering regulations, as well as a big increase in crypto traders over 2020, will increase the concerns that financial regulators have about the operational soundness of crypto systems, and the extent to which they need to be controlled within legislative frameworks.
The unhappy experience of Coinbase users compounds two of the three biggest drawbacks of Bitcoin and cryptocurrencies: one operational, the other regulatory. The third being, of course, its infamous volatility.
These three primary sources of risk for any investment in cryptocurrency will no doubt exercise the FCA over the course of 2021, irrespective of prices. Its statement yesterday will raise many a flag with regulators in other financial centres worldwide. Crypto investors should expect, and be ready for, curtailment of prices when the regulatory burden hits.
When it does, likely in late 2021 or early 2022, there is a significant prospect of mainstream assets - equities and bonds, staple investments of the ordinary consumer - trading at normalised levels once again. A high and sustained price trajectory for Bitcoin over 2021 and into 2022 is by no means assured.
MATTHEW FEARGRIEVE is an investment management consultant. You can read his blog here and here, and see his Twitter feed here.
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