European Regulator Calls for Reduced Leverage in Crypto Trading

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On Thursday, May 25, the European Systemic Risk Board (ESRB) recommended EU authorities curb leverage trading in crypto. The move will help maintain the sanctity of financial stability. This comes as an effort to address the rising concerns over the risks associated with cryptocurrency trading.

Over the past few days, there has also been a growing interest in digital assets and their volatile nature. As a result, it prompts regulators to prioritize investor protection.

Concerns Over High Leverage Trading Prompts EU Regulator Recommendation

In recent times, traders in the crypto industry have been exercising caution and steering away from leverage. Even so, Bitcoin’s Estimated Leverage Ratio has slid from 0.195 to 0.239 in a month. This indicates that more traders are enduring risks by getting into high-leverage derivatives trading. This comes at a time when Bitcoin is trading at around $26,000.

The price follows a trying 18 months for the industry, where we have seen Bitcoin drop as much as 77%. In the same period, Luna collapsed, and FTX fell into bankruptcy.

“Systematic risks could arise quickly and suddenly,” the ESRB said in a report. “If the rapid growth trends observed in recent years were to continue, crypto-assets could pose risks to financial stability.”

The ESRB has called for stricter measures to manage the risks of leveraged trading. Leveraged trading allows investors to amplify their exposure to digital assets, which may also increase the potential for substantial losses. The likelihood of failure comes from the higher risks associated with amplified market movements.

The EU regulator’s recommendation aims to safeguard investors and ensure market stability.

The crypto-asset market has few links with traditional finance and the real economy. Yet, given its exponential growth, there’s a risk of contagion. Our report calls for close monitoring and identifies ways to better understand potential contagion channels https://t.co/I4VvpZTcHL pic.twitter.com/uZmhyBMTe7

— European Systemic Risk Board (@ESRBofficial) May 25, 2023

There is also the worry that inexperienced investors may not fully comprehend the risks involved and could suffer severe financial losses.

The Recommendation Likely to Impact the Cryptocurrency Market and Traders

High leverage has been vital in crypto trading, attracting both professional traders and retail investors seeking substantial gains. As such, the proposal to curb leverage in crypto trading could impact the market. If the recommendation is implemented, speculative enthusiasm may dampen and potentially stabilize the market.

By reducing leverage, investors could adjust their strategies and risk appetites, which could lead to decreasing trading volumes. Additionally, with stricter regulations, cryptocurrency exchanges and platforms may face increased scrutiny and must change what they offer users.

Calls for Global Cooperation in Regulating Crypto Leverage

The EU regulator’s recommendation also prompts the need for global cooperation in regulating cryptocurrency leverage. The crypto market operates on a global scale. As such, when there are not enough regulations, there could be some level of inadequacy in investor protection.

Therefore, having similar levels of regulation across jurisdictions would assist in creating a level playing field. As a result, there would be consistent protection for traders across the borders.

EU watchdog calls for curbing leverage in crypto trading

— unfolded. (@cryptounfolded) May 25, 2023

The ESRB’s call for regulation speculates on stricter regulations, which can play a pivotal role in protecting investors, reducing excessive speculation, and enhancing some growth in the space. With ongoing considerations and potential implementation of the measures, we are yet to see some maturation and regulatory alignment in the cryptocurrency industry.

While it may seem like these changes may bring about some short-term challenges, they may contribute to a more sustainable and secure crypto trading environment in the long run. The recommendations are not currently binding. However, they will likely inform the EU’s future work on a new version of its markets in crypto asset regulation (MiCA).