Regulatory Frameworks for Non-Custodial Derivatives – A Comprehensive Guide

What are Non-Custodial Derivatives?

Crypto non-custodial derivatives are decentralized financial contracts that are tradable and whose value is determined by the cryptocurrency. The non-custodial derivatives allow users to keep the private key, giving them complete control over the contract. These instruments enable users to bet on the future price movements. 

The non-custodial derivatives are used for a number of purposes, such as engaging in arbitrage contracts, hedging against price fluctuations, and many others. These derivatives play an important role in the cryptocurrency market. Here’s why.

Understanding the Regulatory Framework

Cryptocurrency regulations are issued by respective governments, and they decide how to shape the digital asset functionality in their respective markets. The crypto market fluctuations had adversely affected many users. 

The absence of regulation led many crypto companies to run scams and Ponzi schemes. Therefore, countries all over the world decided to protect investor interests and implied restrictions on crypto assets.

Regulations Implied in Corresponding Countries for Derivatives

The crypto regulations across the world are implied to harmonize the investment environment and enhance security and transparency. 

United States

The regulatory framework of the United States is designed by the Securities and Exchange Commission and the Commodity Futures Trading Commission. All crypto assets are considered securities by the SEC and hence operate in accordance with rules and regulations while ensuring market integrity and investor protection. 

However, the CFTC considers crypto assets as commodities and oversees the trading, especially futures and market swaps. Another division, the Financial Crimes Enforcement Network, takes care of the Anti-Money Laundering (AML) regulations. They consider cryptocurrencies to have transmittable value but don’t consider them legal tender. 

As per the Internal Revenue Service (IRS), cryptocurrencies are like any other financial assets, and thus income from them would be taxable. However, the IRS also doesn’t consider cryptocurrencies as legal tender. The crypto exchanges, on the other hand, are considered legal and regulated by the Bank Secrecy Act. 

European Union

The EU (European Union) has designed a comprehensive regulatory framework called Markets in Crypto Assets (MiCA) regulations. These guidelines ensure transparency, market integrity, and consumer protection. 

The cryptocurrencies are considered Qualified Financial Instruments (QFI). All investments that use cryptocurrencies are allowed to hold, trade, or provide services with them. Crypto exchanges in EU holding a QFI license can operate freely. 

However, the EU is looking to further legislation to contain the risks posed by the segment. 

United Kingdom

Financial Conduct Authority (FCA) takes care of the regulation of crypto assets in the United Kingdom. Cryptocurrencies are imposed by strict AML regulations, and the sale of crypto derivatives to retail customers is banned. 

The treasury in the UK is expanding the regulatory framework, seeing the hype and expansion of the crypto segment. The Financial Service and Market Act (FSMA) would oversee the crypto assets and future regulations. 

Australia

In Australia, cryptocurrencies are identified as non-financial property. Therefore, crypto or digital assets can’t be used as payment options. They cannot be used as a unit to measure and compare the value of goods and services. 

The crypto exchanges in Australia are overseen by the Australian Transactions Report and Analysis Center (AUSTRAC) to ensure KYC procedures. The exchanges will now be required to obtain a license to operate. The exchange will also be obligated to report any breach of security in compliance with anti-money laundering laws. 

India

In India, cryptocurrencies are not considered legal tender but rather virtual digital assets, or commodities or securities. This means that cryptocurrencies can be used as payment methods. Since 2022, trading cryptocurrency for profit has been legal and taxable. The operation of cryptocurrency exchanges in India is also permitted, but with caution. The country has not passed any specific rules against derivatives.

Challenges in Trading Crypto Derivatives

Trading non-custodial crypto derivatives has both advantages and disadvantages. We have discussed several merits already in the article; here are a few challenges. 

Future Prospects of Non-custodial Derivatives

The future of derivatives is consistent with trends that support long-term growth and institutional adoption. Along with that, technological advancements and increased demand for self-custody risk management. 

The derivatives market is transparent, efficient, and provides full control to users. With improved regulatory practices, innovation in the non-custodial derivatives market will drive a more resilient global financial system. The days ahead for derivatives seem bright and with fewer challenges.