What are derivatives and contracts for difference? These terms are used to describe and classify financial trading products used in traditional financial markets to represent a physical asset or commodity. These instruments can allow investors exposure to an asset class without having to physically own them to profit from their movement in price.
Example #1: Oil
You're an investor who thinks the price of oil is cheap right now, and you want to make an investment because you think the price of oil will go up in 12 months. Now you can structure your investment in a few different ways.
The Hard Way: You buy a barrel of Oil, take delivery of said barrel, store the barrel in a suitable storage area, then sell it back on the open market in the future, assuming someone wants to buy it back from you for a higher price.
The Easy Way: You buy a contract for a different "CFD" on a trading platform. This contract for difference "CFD" allows you to speculate on the price of oil for the short or long term whether you think the price will go up or down. Each platform is different and will charge different fees for opening a trade, closing a trade, and holding the trade open for a long period. As well as never having to actually touch the oil yourself, you can gain additional "leverage" or "margin" which allows you to multiply your potential profits. Adversely, your losses can also multiple when your trade goes against you.
Derivate products like CFD's are used all the time in different markets such as Foreign Exchange, Commodities, and even Stocks and Shares in companies all over the world. What they represent is a "bet" on the price of a physical or real-world asset and its value to two or more market participants at any one time.
Now, this is where it gets tricky.
"What is a crypto derivative and why are they banned by the FCA?"
The FCA believes that all crypto and digital blockchain assets:
-have no reliable basis for valuation.
-are susceptible to market abuse and financial crime in the secondary market (eg cyber theft).
-experience extreme volatility in crypto-asset price movements.
-inadequate understanding of crypto-assets by retail consumers.
-lack of legitimate investment need for retail consumers to invest in these products.
The FCA believes that having a second layer trading instrument such as a "CFD" with extra "leverage" onto a crypto-asset that is already volatile), is not suitable for retail investors. Over 520 individuals and firms (including coinpass) were surveyed about the potential ban of Crypto-Derivatives and 97% voted against the ban. We believe the ban would hamper crypto-asset innovation, and simply drive users to trade on platforms in unregulated countries where the retail users have no protection or guidance.
These crypto-derivative products are still available for professional investors and traders on certain regulated platforms in the UK but won't be available for retail investors after January 6th, 2021.
However, regular crypto-trading venues such as coinpass.com that offer "Spot-Trading" markets with easy buying and selling options are still 100% safe, secure and legal to use. Only platforms exposing retail clients to dangerous levels of leverage like "100x margin" will be included in the ban.
At coinpass, we support the decision of the Financial Conduct Authority, but also believe that this blanket ban will hamper innovation in the digital-asset space and also won't provide suitable protection for retail investors. There are many platforms in other countries that will low, or no protections for users depositing funds which only pushes the problem outwards instead of developing markets to become more secure, and safe in the UK.
If you liked this article and want to learn more, check out some more of our articles on our blogs or join our Facebook Group to connect and learn about other like-minded investors and traders.