The U.K.’s Financial Conduct Authority (FCA) recently proposed that companies stop promoting crypto as inflation resistant. This proposal has received support from members of the U.K. digital asset community.
Even though the argument that limited-supply cryptocurrencies can firmly hold against inflation may be theoretically valid, industry observers warned it could mislead investors due to limited data and the asset’s volatility.
In response, the FCA issued new strict rules to govern crypto promotional material. These rules include banning free non-fungible tokens (NFT) giveaways and airdrops.
The guidance also requires stablecoin issuers to “demonstrate claims of stability or links to a fiat currency” and not use any term that could mislead consumers.
“We also expect firms to consider the potential harm to consumers and be confident that any claims made by the issuer are genuine,” reads the guidance.
Breaking down crypto as an inflation hedge claim
Economist at U.K.-based crypto index trading Trakx Ryan Shea agreed with the proposal, highlighting that the inflation narrative may have been harmful to crypto investors. Some people might have bought into crypto during the bull run in anticipation of rising inflation, only to lose money in the subsequent crypto winter.
“In a strict sense, the FCA is correct.”
Ryan Shea, economist at Trakx
“Cryptocurrencies are not inflation-protected in the same way as an index-linked Gilt or an inflation-protected Treasury bond, whose value mechanically increases in line with the specified inflation index,” said Shea.
Shea pointed out that cryptocurrencies are not designed to move one-to-one against inflation. The inflation narrative is more medium-to-long-term, and it is driven by the anticipation of a significant increase in fiat currency supply observed over recent years.
Head of research at CoinShare, James Butterfill, explained how crypto, in theory, could act as an inflation hedge.
Cryptocurrencies such as Bitcoin that are in fixed or limited supply might share similarities with gold. However, Bitcoin is still relatively new, with limited available price data.
“Due to bitcoin’s relatively short existence, we have to rely on the fundamental concepts of what it represents as an asset, so theoretically, it being of limited supply while being priced in U.S. dollars, it should act as an inflation hedge,” said Butterfill in an interview with CoinDesk.
Crypto proponents insist that the crypto market can be an alternative to a centralized fiat banking system. Bitcoin’s supply is halved every four years by the programming code. It is different from the ever-increasing supply of fiat currency, which they maintain can be inflationary.
Rating agency S&P Global debunked this argument. The agency did not deny it could “theoretically be a hedge against inflation,” but the track record for crypto is “too short” to prove the claim.
According to its findings, the historical correlation between the daily returns of S&P BDMI (its crypto index) and the U.S. two-year and 10-year breakeven inflation expectations is only 0.10.
There is also no consistent pattern in the correlation between the rolling three-month returns for S&P BDMI and 10-year breakeven inflation expectations. Therefore, there is little connection between the crypto market and inflation expectations.
To validate the inflation hedge narrative, a strong correlation of at least 0.75 is necessary. Despite the average eight percent inflation measured by the consumer price index, Bitcoin’s market value dropped by over 70 percent last year, per Statista.
Cryptocurrencies also appear to be influenced by borrowing costs and often move in the opposite direction of the U.S. two-year Treasury yield. The two-year is more responsive to interest rate expectations than longer-term bond yields.
The new crypto promotional guide
The FCA issued strict new rules for crypto promotions once the proposed laws for the industry were finalized, according to recently released documents.
These new rules will classify crypto as “restricted mass market investments.” Any advertisements related to crypto must include clear risk warnings.
Under the new guidance, crypto companies are required to enforce a 24-hour cooling-off period for new investors before they can place their money into chosen assets. Incentives such as “refer a friend” or “new joiner bonuses” are also prohibited.
The U.K. government plans to regulate crypto through the Financial Services and Markets Bill as part of the post-Brexit financial strategy. The bill will grant The FCA the power to set rules for the sector.
The FCA also opens the guidance for public feedback to ensure the crypto firms thoroughly understand the implications of the new regulation on crypto asset promotions. The deadline for feedback is August 10.
Crypto firms should carry out “adequate due diligence and have sufficient evidence of the underlying crypto asset to ensure the financial promotion is fair, clear and not misleading.” This includes the claims from stablecoin firms regarding stability or links to a fiat currency.
According to Diego Ballon Ossio, partner at Clifford Chance law firm, promotions that mention bitcoin or other coins could be used as inflation hedges are “imprecise marketing slogans.” This inadequate investment advice could mislead investors. It is “understandable” that the FCA is banning this type of promotion.
“I think the specific reference to ‘inflation resistant’ in this context is simply an example,” said Ballon Ossio. “The general point is that firms must think about their statements and make sure that they do not mislead.”
The proposed rule is part of FCA’s commitment to reduce and prevent serious harm as the estimated crypto ownership in the U.K. has doubled from 2021 to 2022. Recent survey findings from the association revealed that 10 percent of 2,000 participants claimed to own crypto.
“It is up to people to decide whether they buy crypto. But research shows many regrets making a hasty decision,” said FCA’s executive director of consumers and competition Sheldon Mills. The proposed rules will give people “the time and the right risk warnings” before putting an investment.
The new guidance will come into effect on October 8. Registered crypto firms will be able to approve their own advertisements for a limited time under a temporary exemption. Firms that fail to follow the new rules can face up to two years of imprisonment, a fine or both.