To say that cryptocurrencies have become a craze is no understatement. The industry as a whole has increased its market capitalization multiple times over. Bitcoin, which was worth 5c, when it was first traded in 2010, until recently was valued at over $4,000. Consequently, this tide of interest has pushed up everything in this blue ocean, with even minor cryptocurrencies experiencing gains of over 1000 percent.
If this isn’t sufficient testament you can watch the Bitcoin movie on Netflix. And should that be convincing, you can join the hundreds of other ICOs that have popped up all over the globe, also trying to cash in on the craze.
However, despite the hype and skyrocketing value, should you want to start your own cryptocurrency brokerage, there are a number of significant challenges that you will need to overcome. To help direct you on your path to millions lets address a number of those core issues.
Cryptocurrency trading is not the same as forex
Similar, but not at all the same, trading cryptocurrencies are distinctly different from trading national based currencies or ‘fiats’. If you pair off any two national currencies you will get a trading chart that reflects high levels of volatility, essentially getting something that looks like this chart on the AUD/NZD currency pair.
With little volatility, the trading is almost constantly in the ascent, guaranteeing that if you put in a buy position, you are going to win. No science awards for this trader. This becomes a significant issue when you are the broker and a number of your traders have all put in a buy position, with leverage, and then hold that position for an extended period of time.
The consequence being, you may not have the funds available to cover the payment when these clients decide to sell.
#GDAX (#Coinbase) will not reverse margin & limit trades that were caused by a 99% drop in #Etherium/#ETH yesterday https://t.co/EQuJaSWwR1 pic.twitter.com/DOGTnCnX2Q
— Alex Melen (@amelen) June 22, 2017
Despite the swelling interest in cryptocurrencies, compared to the $5.1 trillion of foreign currency that is traded every day, the daily trading volume of cryptocurrency is relatively small at $2 billion. This limited level of participation causes low liquidity and enormous spreads.
And it’s at execution that matters really start to get murky. Not only is execution difficult due to limited liquidity, but also more critically, a broker is limited in where it can get a trade to be executed. As all the major cryptocurrencies reflect a bull market, this means that as a broker it is not feasible to be a market maker as the odds are steadily against you.
For the same reason, neither are you likely to find a liquidity provider who will be willing to manage those risks for you. Instead, a broker will need to go to a cryptocurrency exchange, where each buy position is matched to a counter sell position.
This will continue to be a problem until cryptocurrency trading is firmly established within mainstream financial trading. But until this point, the limited level of trading frequency and volume will serve to diminish liquidity, making it difficult for brokers to facilitate execution.
Yet therein lies the next problem – while people do short cryptocurrencies, those traders have only been successful when those markets have been in periods of volatility. Those periods of volatility tend to be short lived and the overwhelming number of orders is buy positions.
To mitigate this risk exposure, an exchange may choose to only pair off two different cryptocurrencies against each other. This guarantees high volatility and the ability to provide regular execution.
The missing ingredient in this market mix is regulation, and the formal recognition that regulation would provide, would work wonders towards bringing cryptocurrencies further into the mainstream as a medium of exchange.
The problem is cryptocurrencies and its underlying block-chain technology represent a new paradigm of financial exchange, making it difficult to define for the purpose of regulation. Are they currencies? A piece of software? Or are they more like equity? And if they are more like equity, shouldn’t they just be regulated like any other security?
Thus, as is the nature of bureaucratic policy changes, it is lethargic and painfully slow in keeping up with market developments. Those regulatory bodies that have been more proactive in their response are primarily in Asia. Japan recognized Bitcoin as a legal currency for financial transaction in April, with the consequence of pushing the coin to unprecedented highs at the time.
While other Asian regulatory bodies, such as China, India and the Philippines are well on track towards monitoring the dealings of cryptocurrency exchanges, making these locations ripe for opening a broker service.
In Australia, Bitcoin exchanges will be regulated under the supervision of AUSTRAC, the country’s financial intelligence agency. Interestingly, this developed as part of the government’s reforms against money laundering and counter-terrorism financing laws. In contrast, the U.S. Securities and Exchange Commission (SEC) have been slow to weigh in.But how a regulation authority like the SEC treats cryptocurrencies is important. It is likely to affect both the value of cryptocurrencies and stabilize the industry, enabling it to thrive in a jurisdiction with enormous financial impact.
While there are certainly many dollars, or at least tokens, to be made in the cryptocurrency arena, much of it remains to be unchartered territory. Our advice on starting your own cryptocurrency brokerage is to tread carefully, consult from industry experts, expect the unexpected and be adaptable.