Cryptocurrency prohibition

It is likely that all our readers have heard of cryptocurrency, probably in the guise of Bitcoin. This cryptocurrency and its compatriots such as litecoin, ether and dogecoin (which started as an internet joke about a dog), are increasingly in the news, usually because of large surges or drops in value.

The principles underlying cryptocurrency currently seem strange to a casual observer. Essentially, coins are created when a large number of computers are set to work authenticating batches of transactions through a series of puzzles. Whoever solves the problem first through this ‘mining’ process is rewarded with coins.

Like a cross between bingo and who wants to be a millionaire, only a lot more complex and potentially a lot more rewarding, the whole concept is a bit hard to fathom … and harder to take seriously. But take it seriously we must, not least because many people consider that it is becoming more mainstream. In February 2021, Elon Musk announced that people would be able to buy a Tesla vehicle using Bitcoin. The value of Bitcoin soared. In May, he announced in a Tweet that he had changed his mind. The value of Bitcoin and other cryptocurrencies fell as hundreds of billions of dollars in value were wiped off the entire crypto market in a single day. The power of Twitter? Or a sign of inherent lack of stability in cryptocurrency?

Environmentally unfriendly

Talking of power, and just at the time when governments and the world of banking and investment are visibly moving in the direction of sustainable investing, it is noteworthy that cryptocurrency is a major contributor to the world’s carbon footprint. Some climate change experts reckon Bitcoin alone could accelerate global warming above 2 degrees within thirty years. It is all down to the vast amount of electricity needed to keep all those mining computers chugging away to solve the puzzles.

According to the latest calculation from Cambridge university’s Bitcoin Electricity Consumption index, Bitcoin mining alone consumes 133.68 terawatt hours a year of electricity. That is more than Sweden, at 131.8TWh of electricity usage in 2020, and around half as much as the UK.

This adverse impact on the environment was the reason that Elon Musk gave as the reason for his change of mind.

Regulatory concerns

Amid all this hooha, enter the FCA stage left, also taking cryptocurrency seriously (cryptoassets is the regulator’s preferred label).

The FCA has viewed the rapid rise, and just as rapid fall, of cryptocurrencies with an increasing degree of alarm. On 18th June 2021, the regulator published an update to its guidance for consumers, leaving no doubt as to where it stands. The opening paragraph includes the following statements:

  • cryptoassets are considered very high risk, speculative investments
  • if you buy these types of cryptoassets, you are unlikely to have access to the Financial Ombudsman Service (FOS) or the Financial Services Compensation Scheme (FSCS) if something goes wrong
  • if you invest in cryptoassets, you should be prepared to lose all your money

This follows consultation in 2019 that resulted in the publication of a policy statement in October 2020 – PS20/10: Prohibiting the sale to retail clients of investment products that reference cryptoassets.

The policy statement included new finalised rules that came into effect on 6 January 2021. The rules can be found in COBS 22.6 and are intended to prevent harm to retail clients. They stem from the regulator’s belief that retail clients are unlikely to be able to reliably assess the value and risks of derivatives and exchange traded notes that reference certain cryptoassets. This is due to the:

  • nature of the underlying assets, which have no inherent value and so differ from other assets that have physical uses, promise future cash flows or are legally accepted as money
  • presence of market abuse and financial crime (including cyberthefts from cryptoasset platforms) in cryptoasset markets
  • extreme volatility in cryptoasset prices
  • inadequate understanding of cryptoassets by retail clients and the lack of a clear investment need for investment products referencing them

Implications for advisers

As advisers engage with ever younger clients, there is a need to understand the generational differences that those clients present. Back in March, the Financial Conduct Authority (FCA) published research findings into better understanding investors who engage in high-risk investments like cryptocurrencies and foreign exchange.

The findings reveal there is a new, younger, more diverse group of consumers getting involved in higher risk investments, potentially prompted in part by the accessibility offered by new investment apps. However, there is evidence that these higher risk products may not always be suitable for these consumers’ needs as nearly two thirds claim that a significant investment loss would have a fundamental impact on their current or future lifestyle.

The high volatility that cryptocurrencies have shown to date makes a significant loss a real possibility. And the FCA’s research found that these younger investors may have the lowest levels of financial resilience making them more vulnerable to investment loss.

Despite that, some younger clients, who have moved past the online investment apps to engaging with an adviser, may still be interested in such investments and advisers need to have a sufficient knowledge and understanding of cryptoassets to be able to have a sensible discussion with the client.

Ultimately though, recommending investment in most cryptoassets or products linked to cryptoassets to a retail client is prohibited. Specifically, firms must not:

  • sell a cryptoasset derivative or a cryptoasset exchange traded note to a retail client; or
  • distribute a cryptoasset derivative or a cryptoasset exchange traded note to a retail client; or
  • market a cryptoasset derivative or a cryptoasset exchange traded note if the marketing is addressed to or disseminated in such a way that it is likely to be received by a retail client.

“Marketing” includes, but is not limited to, communicating and/or approving financial promotions.

Important Note: ATEB news is intended to provide general information ONLY. The content, including any views expressed or guidance provided, does not replace the need to comply fully with FCA Rules and Guidance. Unless you have discussed news article content with ATEB, and specifically how it relates to your circumstances, then ATEB disclaims all liability and responsibility and actions arising from any reliance placed upon it. For the avoidance of doubt therefore, any reliance you place on such information without our consultation is at your own risk.

ATEB Compliance offers compliance and regulatory advice.

ATEB Suitability provides report writing software for the financial services market.

Our View

The rapid ups and downs of cryptocurrencies such as Bitcoin and the difficult to understand mechanisms underlying these, mean that the whole area is a bit like the wild west currently. Governments, regulators and central banks across the world have expressed concern about the risks involved in these unregulated currencies. The UK government, like some others, is not against the concept of a digital currency but simply believes there needs to be more transparency, controls and protections in place. There is even talk of the UK issuing its own digital currency. Meantime, the Government is currently consulting on stable tokens as a means of payment. If the Government’s proposals are adopted, the FCA will consult on rules applying these proposals. It would mean stable tokens used for payment and services would in the future become regulated giving consumers protections under the rules. Until then we believe that it is appropriate to limit the potential harm to retail clients by the new rules the FCA has put in place.

Action Required By You

Even though advisers will not be recommending cryptoasset related investments, it is important to gain a degree of knowledge and understanding so as to facilitate discussions with clients when required.
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About the Author

Technical Manager - Often referred to as the Oracle or the Sage, Alistair has a wealth of financial services experience. He is our go-to Technical Manager and enjoys nothing more than a complicated conundrum. Feel free to test his renowned knowledge by getting in touch.

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