Volatility on Steroids – A Closer look at Bitcoin

I think it is safe to say we all love volatility. The discussion on volatility reaches a whole new level

I think it is safe to say we all love volatility. Volatility drives volume and revenue, and in many cases attracts retail participants looking to capitalize on extreme price movement. The discussion on volatility reaches a whole new level when we are talking about Bitcoin.

The rise of the cryptocurrency as an alternative traditional currency has been covered well on this website, as well as in the broader media. As the buzz surrounding the digital currency continues to grow, more and more brokers are beginning to consider offering it to customers as a trading product akin to other currency pairs or CFDs. Before doing so, brokers need first make sure they understand the risks associated with offering such a volatile product and also make sure they have proper risk mitigation strategies in place.

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Many forex traders are attracted to products based on the profit potential volatility can bring, but using the term “volatile” to describe Bitcoin may be underselling just how much Bitcoin prices actually move. By way of comparison, here are the largest daily ranges as a percentage of prior day close for some commonly traded products during 2013:

The daily close price of Bitcoin has moved over 10% from the prior day close 43 times this year. As further illustration, the 1987 Black Monday stock market crash saw the Dow fall 22.6%. Bitcoin has closed with over a 20% daily move 9 times in 2013, and that doesn’t include intraday moves.

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With this in mind, brokers considering offering Bitcoin as a trading product to customers need to plan carefully prior to launch. Simply plugging in a price feed and creating a contract without careful consideration and modeling of risks could be disastrous. The things that need to be considered are not necessarily unique to Bitcoin, but their importance is magnified because of the nature of Bitcoin prices.

Extremely important risk measurements brokers must consider

  • Margin limitations (standard 200:1 or 100:1 is likely not feasible)
  • Maximum position limits irrespective of margin
  • Minimum deposit requirements
  • Daily trading hour limitations
  • Controls on intraday trading

In addition, the broker will need to try to find a reliable liquidity source that will allow them to offload some risk. This may be the toughest task in launching a Bitcoin offering.

With all of this said, Bitcoin is an exciting product and traders will likely become increasingly interested in the prospect of trading it. For brokers that are able to properly control their own risk, Bitcoin trading may offer access to a growing customer base and strong revenue potential. The question for today, though, is whether the Bitcoin market is mature enough to make proper risk management possible without creating a product so restricted that traders will not be interested.

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