The Future of Margin Crypto Trading

This article was written by Tom Higgins, CEO of Gold-i.

I have recently begun hungrily devouring all the knowledge I can around cryptocurrency trading as not a day goes by without it being discussed somewhere. It really seems to be the Wild West at the moment with seemingly hundreds of cypto exchanges popping up everywhere, all with the 'nirvana' of offerings.

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Now as I started my working life designing the first automated trading platform (Called APT) for LIFFE as a PA Consulting group consultant and then went on to head IT at the International Petroleum Exchange, I do know a bit about how large-scale exchanges work.

The difference between the new crypto exchanges and existing exchanges (also known as RIEs, or Recognised Investment Exchanges) is vast.

Mind The Gap!

The new exchanges don't, in fact, look like exchanges at all, but more like a retail platform with payment, CRM, and affiliate marketing bolted together. The RIEs have some knowledge of crypto trading but little about retail trading.

The second big area of confusion is between margin trading and physical trading. In the retail FX world that I live in, never the twain shall meet as they serve very different masters. But in the crypto world there is no distinction (yet) and this causes massive confusion.

Just imagine the difference between exchanging GBP for USD to go on holiday to punting in the GBP/USD market with a leverage of 1:100, and trying to use the physical exchange to punt on!

It doesn't bear thinking about, but that is just what is happening in the crypto world. So we need to develop the idea of a real margin crypto market with some leverage (probably very small due to the high volatility) with an aggregated executable price feed across multiple crypto exchanges to give the best option for price discovery and trading.

This all cries out for the introduction of a derivatives market for cryptos, such as the CFDs we have as a proxy for equities in the stock exchanges. CFDs allow people to trade on the price move without ever having the bother of owning the actual stock. Brokers will often hedge CFDs against real stocks in the market, in order to manage their risk.

Time goes by, so slowly…

I am sure that many people assume that as cryptos are so new, that they must operate at light-speed with instant settlement and no risk, but unfortunately this is not the case. Bitcoin, for example, uses the public Blockchain Blockchain Blockchain comprises a digital network of blocks with a comprehensive ledger of transactions made in a cryptocurrency such as Bitcoin or other altcoins.One of the signature features of blockchain is that it is maintained across more than one computer. The ledger can be public or private (permissioned.) In this sense, blockchain is immune to the manipulation of data making it not only open but verifiable. Because a blockchain is stored across a network of computers, it is very difficult to tamper with. The Evolution of BlockchainBlockchain was originally invented by an individual or group of people under the name of Satoshi Nakamoto in 2008. The purpose of blockchain was originally to serve as the public transaction ledger of Bitcoin, the world’s first cryptocurrency.In particular, bundles of transaction data, called “blocks”, are added to the ledger in a chronological fashion, forming a “chain.” These blocks include things like date, time, dollar amount, and (in some cases) the public addresses of the sender and the receiver.The computers responsible for upholding a blockchain network are called “nodes.” These nodes carry out the duties necessary to confirm the transactions and add them to the ledger. In exchange for their work, the nodes receive rewards in the form of crypto tokens.By storing data via a peer-to-peer network (P2P), blockchain controls for a wide range of risks that are traditionally inherent with data being held centrally.Of note, P2P blockchain networks lack centralized points of vulnerability. Consequently, hackers cannot exploit these networks via normalized means nor does the network possess a central failure point.In order to hack or alter a blockchain’s ledger, more than half of the nodes must be compromised. Looking ahead, blockchain technology is an area of extensive research across multiple industries, including financial services and payments, among others. Blockchain comprises a digital network of blocks with a comprehensive ledger of transactions made in a cryptocurrency such as Bitcoin or other altcoins.One of the signature features of blockchain is that it is maintained across more than one computer. The ledger can be public or private (permissioned.) In this sense, blockchain is immune to the manipulation of data making it not only open but verifiable. Because a blockchain is stored across a network of computers, it is very difficult to tamper with. The Evolution of BlockchainBlockchain was originally invented by an individual or group of people under the name of Satoshi Nakamoto in 2008. The purpose of blockchain was originally to serve as the public transaction ledger of Bitcoin, the world’s first cryptocurrency.In particular, bundles of transaction data, called “blocks”, are added to the ledger in a chronological fashion, forming a “chain.” These blocks include things like date, time, dollar amount, and (in some cases) the public addresses of the sender and the receiver.The computers responsible for upholding a blockchain network are called “nodes.” These nodes carry out the duties necessary to confirm the transactions and add them to the ledger. In exchange for their work, the nodes receive rewards in the form of crypto tokens.By storing data via a peer-to-peer network (P2P), blockchain controls for a wide range of risks that are traditionally inherent with data being held centrally.Of note, P2P blockchain networks lack centralized points of vulnerability. Consequently, hackers cannot exploit these networks via normalized means nor does the network possess a central failure point.In order to hack or alter a blockchain’s ledger, more than half of the nodes must be compromised. Looking ahead, blockchain technology is an area of extensive research across multiple industries, including financial services and payments, among others. Read this Term to record all transactions.

Transactions can be recorded quickly but are not validated as legitimate until a consensus of miners has run their proof of work. As the public blockchain is growing all the time and there is a maximum data rate allowable, this validation can take from 10 minutes to a couple of hours.

The question has to be asked - "What happens if validation fails, and how does the trade unwind?" The answers I have had to this vary from 'no Idea', 'it doesn't matter', to 'the exchange, acting as a broker, owns this and will stand by the trade'. This is analogous to a futures trade that is cleared by a clearing house. The bilateral traders are counterparties to the trade until it is 'novated' to the clearing house, and therefore carry counterparty risk.

It's a Mad Mad World

Full depth pricing in Bitcoin can be a scary place to be, as liquidity is so fragmented, and volatility is so high. It can be difficult to know the real price of a Bitcoin all the time. This brings in an interesting idea that the Chicago Mercantile Exchange (CME) brought to market fairly recently to solve this issue; the CME Bitcoin Real Time Index.

CME take 6 or so crypto exchange Bitcoin prices and build a reference price in real time, discarding prices that fall too far out of line. This can then be used by anyone as the current real price of Bitcoin. It is currently free to use, but that may change over time as exchanges do like to charge for data and it is a significant revenue stream for them.

Which Coin will be NEO (The One)?

Whilst most of the focus is on Bitcoin and its public blockchain, there are many other Cryptocurrencies Cryptocurrencies By using cryptography, virtual currencies, known as cryptocurrencies, are nearly counterfeit-proof digital currencies that are built on blockchain technology. Comprised of decentralized networks, blockchain technology is not overseen by a central authority.Therefore, cryptocurrencies function in a decentralized nature which theoretically makes them immune to government interference. The term, cryptocurrency derives from the origin of the encryption techniques that are employed to secure the networks which are used to authenticate blockchain technology. Cryptocurrencies can be thought of as systems that accept online payments which are denoted as “tokens.” Tokens are represented as internal ledger entries in blockchain technology while the term crypto is used to depict cryptographic methods and encryption algorithms such as public-private key pairs, various hashing functions, and an elliptical curve. Every cryptocurrency transaction that occurs is logged in a web-based ledger with blockchain technology.These then must be approved by a disparate network of individual nodes (computers that maintain a copy of the ledger). For every new block generated, the block must first be authenticated and confirmed ‘approved’ by each node, which makes forging the transactional history of cryptocurrencies nearly impossible. The World’s First CryptoBitcoin became the first blockchain-based cryptocurrency and to this day is still the most demanded cryptocurrency and the most valued. Bitcoin still contributes the majority of the overall cryptocurrency market volume, though several other cryptos have grown in popularity in recent years.Indeed, out of the wake of Bitcoin, iterations of Bitcoin became prevalent which resulted in a multitude of newly created or cloned cryptocurrencies. Contending cryptocurrencies that emerged after Bitcoin’s success is referred to as ‘altcoins’ and they refer to cryptocurrencies such as Bitcoin, Peercoin, Namecoin, Ethereum, Ripple, Stellar, and Dash. Cryptocurrencies promise a wide range of technological innovations that have yet to be structured into being. Simplified payments between two parties without the need for a middle man is one aspect while leveraging blockchain technology to minimize transaction and processing fees for banks is another. Of course, cryptocurrencies have their disadvantages too. This includes issues of tax evasion, money laundering, and other illicit online activities where anonymity is a dire ingredient in solicitous and fraudulent activities. By using cryptography, virtual currencies, known as cryptocurrencies, are nearly counterfeit-proof digital currencies that are built on blockchain technology. Comprised of decentralized networks, blockchain technology is not overseen by a central authority.Therefore, cryptocurrencies function in a decentralized nature which theoretically makes them immune to government interference. The term, cryptocurrency derives from the origin of the encryption techniques that are employed to secure the networks which are used to authenticate blockchain technology. Cryptocurrencies can be thought of as systems that accept online payments which are denoted as “tokens.” Tokens are represented as internal ledger entries in blockchain technology while the term crypto is used to depict cryptographic methods and encryption algorithms such as public-private key pairs, various hashing functions, and an elliptical curve. Every cryptocurrency transaction that occurs is logged in a web-based ledger with blockchain technology.These then must be approved by a disparate network of individual nodes (computers that maintain a copy of the ledger). For every new block generated, the block must first be authenticated and confirmed ‘approved’ by each node, which makes forging the transactional history of cryptocurrencies nearly impossible. The World’s First CryptoBitcoin became the first blockchain-based cryptocurrency and to this day is still the most demanded cryptocurrency and the most valued. Bitcoin still contributes the majority of the overall cryptocurrency market volume, though several other cryptos have grown in popularity in recent years.Indeed, out of the wake of Bitcoin, iterations of Bitcoin became prevalent which resulted in a multitude of newly created or cloned cryptocurrencies. Contending cryptocurrencies that emerged after Bitcoin’s success is referred to as ‘altcoins’ and they refer to cryptocurrencies such as Bitcoin, Peercoin, Namecoin, Ethereum, Ripple, Stellar, and Dash. Cryptocurrencies promise a wide range of technological innovations that have yet to be structured into being. Simplified payments between two parties without the need for a middle man is one aspect while leveraging blockchain technology to minimize transaction and processing fees for banks is another. Of course, cryptocurrencies have their disadvantages too. This includes issues of tax evasion, money laundering, and other illicit online activities where anonymity is a dire ingredient in solicitous and fraudulent activities. Read this Term trading happily away today, with Ethereum, Ripple and Litecoin being next in line to the throne.

Ethereum, for example, is taking a novel approach to the slow validation issue by introducing proof of stake rather than proof of work. Look here to understand this very complex idea! It aims to achieve consensus and validation much more quickly than can be achieved with proof of work, but time will tell if it is accepted.

The End Game

Ultimately all cryptocurrency trading will take place on exchanges, but will this be existing RIEs like CME that adapt to the new world or the current crypto exchanges that will have to grow up to meet the stringent demands regulators will place on them?

Due to their scale I think the RIEs have a good chance of winning, but they need to move mindset from where they are now to a more flexible, cheaper, and directly connected place. Equally, the new exchanges have no legacy systems and are quick to move so can build the necessary functions very quickly. Time will tell I guess.

Whilst we are definitely still in the hype phase, cryptocurrencies are here for good and will be part of our future, there is no doubt about that.