During a strategy meeting in early 2013, a product manager in my team at Leverate made a tongue-in-cheek suggestion: “why don’t we become the first technology company to allow brokers to offer Bitcoin trading?”. I chuckled. Bitcoin was still largely an esoteric concept. Interesting discussion for geeks, definitely. But not something worthy of a serious business discussion.
Just 6 months down the road, Bitcoin got its media breakthrough and officially became part of the zeitgeist. Dogecoin, Litecoin, Zerocoin and others joined the general crypto buzz. I developed a genuine interest in cryptocurrencies and became passionate about the value that they bring to the world: cheaper transactions across borders, fairness, transparency, global financial inclusion and above all: a huge ground for new business models and innovation. I found myself in circles of techy libertarians who believe that cryptocurrencies are the true capitalistic dream.
Over non-stop media buzz and with BTCUSD rate around 1200, all retail brokers who are our clients developed interest in Bitcoin. Those who understood the power of trends for their online marketing believed it was urgent to add it to their offering. From social trading to these new currencies- the retail FX market absorbs new ideas and quickly evolves to meet the needs of traders worldwide. We responded rapidly by including Bitcoin and Litecoin in all of Leverate’s products, from social FX platforms to binary option platforms. Hundreds of brokers who use the Leverate platforms and products now faced a new business decision: should they add Bitcoin to their offering to traders? What are the risks and opportunities in doing so?
The answers were definitely not out there, since no FX broker really offered Bitcoin trading at the time. The only place that allowed people to trade Bitcoins at the time were the Bitcoin exchanges like Mt. Gox (Japan) and BitStamp (Slovenia), who act as risk-free middlemen between buyers and sellers, and collect a transaction fee from both sides. After several in-house meetings about our “Bitcoin guidelines”, I realized: we were among the first companies in the world to face the difficult questions about retail trading in Bitcoin and other new currencies. Our clients were looking up to us for some guidance as to how to offer these new and exciting instruments.
In this article, I will try to offer my perspective on the different questions brokers face:
- What business potential does cryptocurrency trading offer to FX brokers?
- What are some risks in offering cryptocurrency trading?
- How can brokers manage these risks better?
- How should brokers go about choosing a liquidity provider and feed provider that meets their needs?
- What are broader technology needs that broker should consider around Bitcoin trading?
THE BITCOIN BOOST: CUSTOMER ACQUISITION AND RETENTION
Two obvious opportunities that Bitcoin offering can bring are improved customer acquisition costs (CAC) and increased engagement from existing traders.
Most retail brokers today see themselves as a gateway to the world markets, or “supermarket for securities”, and tend to expand their offering to respond to trader demand. Recent examples are the celebrated IPO’s of Twitter and Alibaba, in which media buzz has created many strong opinions among new traders and existing traders. Whether based on wild speculation or solid fundamentals, opinions create demand for trading, and competitive brokers must offer these new stock CFD’s to capture new opportunities. This is also the case with Bitcoin.
For the marketing department of any broker, a Bitcoin offering is a unique product with strong demand among some traders. This helps smart marketing teams to run successful campaigns and decrease the customer acquisition cost (CAC). It also provides an interesting opportunity to experiment with new keywords, content and channels.
From the engagement perspective, Bitcoin allows brokers to promote a unique product that most experienced traders have an opinion about. In 2014, Leverate clients used LXCRM (smart CRM solution for FX brokers) to run dozens of campaigns and send direct messages to traders that might find interest in their new Bitcoin offering. The traders often express their opinion by buying or selling, and the broker earns satisfied customers who might otherwise switch to another broker to trade Bitcoin.
THE DATA CHALLENGE: IS YOUR FEED PROVIDER SAFE?
In the world of stocks mentioned above, competitive brokers have learned to act quickly and easily expand their offering to include hot new instruments. In the case of Bitcoin, I argue that brokers must rely on more innovative algorithmic feed solutions, for two main reasons.
The first reason is technical: the few LP’s for Bitcoin and other cryptocurrencies are completely new. In fact, they exist outside the traditional exchanges, LP’s and overall banking system. Protocols are often only partly documented, and the technical skills required to locate, pull and distribute a Bitcoin price feed are much greater than with regular FX pairs.
The second reason is related to actual market data: between these few LP’s, there could be a visible difference in Bitcoin-USD price. This is due to the relatively low liquidity in Bitcoin and the different policies of each exchange (LP). As an example, restrictions on USD withdrawals in Mt. Gox in August 2013 have created the following situation: Mt. Gox quoted BTCUSD at 118.00, while Bitstamp quoted at 102.00.
Under these conditions, brokers who don’t monitor the data closely and don’t take a real-time algorithmic approach to quotes might suffer serious losses. I have come across several brokers in the market who insisted on implementing in-house connections to the Bitcoin exchanges. However, they didn’t consider that scalpers (traders who mostly trade on short term arbitrage opportunities) know very well how to take advantage of their poorly implemented Bitcoin offering. These brokers were wildly exposed due to delays, spikes and poor decisions around the terms offered to their traders (trading terms should be closely related to your data feed and will be discussed in the next part).
Algorithmic feeds (such as Leverate LXFeed) don’t only offer Bitcoin as an additional instrument that runs seamlessly into the broker platforms, but also contain built-in controls that maintain high data quality and protect the broker from malicious behavior.
TRADER TERMS: WHAT’S YOUR RISK TOLERANCE?
The next challenges in offering Bitcoin trading lie in the trading terms offered to clients. Here are some important decisions retail brokers need to make around Bitcoin:
- Instruments: will Bitcoin be offered against the USD only (BTCUSD), or also against other major currencies (BTCEUR, BTCJPY)?
- Leverage: despite a trend towards increasing volumes and decreasing volatility, Bitcoin is still an extremely volatile instrument. Intra-day movements of 10-15% are not rare, and therefore the decision on leverage is key. Low leverage (1:1) might not be attractive to traders, and high leverage (1:100) introduces a financial risk and can lead to very sophisticated manipulations (such as an attempt to influence the global Bitcoin exchanges in order to make a profit on the leveraged position). For these reasons, most brokers in the market today choose to treat Bitcoin as a CFD and not a currency, and put leverage in the range of 1:10 to 1:25.
- Spread: high volatility usually implies high spreads at LP’s, and that’s exactly the case with Bitcoin. All brokers should make important decisions around spreads, such as spread size and type (variable or fixed). Spreads must be correlated to current market conditions around Bitcoin. This is true to every instrument, but remember again that market conditions in Bitcoin are very dynamic.
- Commissions: in stock CFD’s, brokers usually have a strong advantage over the original exchanges as they don’t charge commissions. Many brokers choose to do the same with Bitcoin and keep it commission-free. However, charging commissions on Bitcoin trading is a valid approach taken by some brokers to reduce risk, and should be considered by all brokers.
- Trading hours: Bitcoin is a special currency: it is traded 24/7 around the world. While this gives brokers a chance to engage traders and create volume during weekends, it also introduces challenges, such exposure and difficulty in scheduling technology maintenance for weekends. All brokers offering Bitcoin face an important decision: allow 24/7 trading or take an artificial approach and limit the Bitcoin offering to weekdays only?
To answer the questions above, brokers must define their risk tolerance. But risk tolerance cannot be defined in a vacuum. All brokers need to make solid decisions around liquidity and risk management technology, and then derive their risk tolerance from them. In the next section, I’ll discuss the main considerations in these areas.
LIQUIDITY AND RISK MANAGEMENT: IS YOUR TECHNOLOGY ENABLING SMART DECISIONS?
The retail FX market is still in the aftermath of the SNB shock of January 15, 2015. This infamous black swan day proved that risk management is literally a matter of life and death for a brokerage business. The cost of poor risk management ranges from extreme losses to bankruptcy. Let’s consider how risk management systems should (and should not) respond to Bitcoin.
As outlined earlier, for many brokers offering Bitcoin is a wise business decision. In an ideal world, all business decisions are easy. But in reality, it’s shocking to see how easily a single instrument can confuse old and naive risk management systems. With Bitcoin (and ever before), we’ve seen brokers resisting innovation and staying behind simply due to limitations of their risk management systems. Technology limiting business is the wrong way to run a brokerage.
The best situation for any business (not just an FX brokerage) is for technology to enable smart decision making on the business side. Most brokers today understand that risk management begins with the right technology to set policies, monitor exposure in real time and take human decisions in critical moments. For all instruments, including Bitcoin, in one place.
When we introduced Bitcoin trading, we made sure to treat it like any other instrument: our risk management solutions immediately allowed each broker to tailor a special risk management policy around Bitcoin. It then showed Bitcoin exposure side-by-side with all other instruments, and allowed brokers to take control in real time whenever needed. This seamless addition of a new instrument to the broker’s core risk policies is the key to healthy decision making.
On the liquidity side, we advise brokers to consult with experts in the Bitcoin market. As with every choice of liquidity provider, the two main considerations for choosing a Bitcoin LP are:
- Trading terms: instruments, leverage, spread, commissions, trading hours etc.
- Fund safety and counterparty risk: the sudden collapse of the major Bitcoin exchange Mt. Gox (Japan) made it clear that fund safety is an issue in the Bitcoin world, where large online exchanges are not directly regulated by government authorities. For libertarians, the fact that even Mt. Gox was not “too big to fall” shows that the early Bitcoin economy is the manifestation of “the perfect capitalism”, and I tend to agree. But theory aside, brokers should still take a pragmatic and risk-aware decisions when choosing a liquidity provider.
As discussed in this article, offering Bitcoin is a big opportunity for FX brokers and at the same time begs for solutions to new challenges: data quality, trading terms, risk management technology and choice of liquidity providers.
These challenges are closely related to each other. Brokers who want to stay ahead of the curve need to consult with a leading technology partner to address all needs- technology and business- at once.
The word “Bitcoin” has been used extensively in this article, however I encourage the readers to think outside the Bitcoin box per se. Bitcoin is just one in a whole category of cryptocurrencies that emerged and will continue to emerge in the next few years. While I try to make no judgement as to who will be “the king of cryptocurrencies” 10 years from now, I think that major cryptocurrencies will have a big impact on the global economy in years to come, and so they will remain important to all retail FX brokers.