Published : 6 years ago, on 01/08/2018

Retail derivatives vs Holding Underlying Cryptocurrency – will ESMA be a game-changer?

Currently, it is hard to avoid the almost daily news on “Cryptocurrency”, “Blockchain” or “Bitcoin.”

All of these terms are regularly banded around and in many circles these terms have become (incorrectly) a byword for one and the same thing.

For every evangelist of one or all of these terms there are an equal and opposite number of harbingers of doom. Whichever way you look at it- the whole “Blockchain” topic won’t be going away anytime soon, with Blockchain news and speculation sure to dominate our lives, and its underlying technology sure to become a key part of future technology.

An inevitable by product of this new sector has been the angle that speculators and investors have sought for a money making opportunity, with the current overall volatility creating large potential opportunity of gains for participants.  The most viable way to do this is through the burgeoning market of spread betting or contracts for difference (CFDs) on Cryptocurrencies. As such, organisations that are able to support and offer these products have been channelling advertising spend to snap up clients looking to get involved in this new and exciting market.

But is it all that it is cracked up to be and is there a viable alternative?

Spread betting or CFDs

This is by far and away the most accessible way of getting involved in the space.  For the few that don’t already have a spread betting or CFD account, simply fill out some online forms, provide your identification, deposit some funds and if you pass the Know Your Customer (KYC) and suitability, you are away.  Typically, the coins you have access to are restricted to those with the most liquidity- namely the top 20 and the speed to get in and out of each trade is as simple as clicking a button. However, due to cryptocurrency volatility, margin requirements have always been high – and for European traders, that situation will only get worse when the EMSA leverage restrictions come into force on August 1st. The maximum leverage for retail clients will be 2:1, meaning an allocation of your deposit against an open position, and the reality that a move against your position will result in further deposits of margin to maintain the position and thus avoid automatic “closing out” and subsequent loss of funds. (Something that can’t be discounted with 5% moves in a day not uncommon.)

There is also the small subject of “funding” each trade, something spread betting and CFD providers impose on their clients.  As the client is only required to deposit a proportion of the actual size of the trade in their account to open it (the margin requirement) this funding charge is made for holding the position overnight and typically varies from an annualised rate of around 30% and upwards depending on which company that you use.  This daily charge against any open position is quite well hidden and can add up. (I.e. if you had a position open for £10,000 of Bitcoin, you would face a charge of upwards of £3000 per year in order to have that position open, which would then need to be offset against any gains/losses that you make.)

Delivering the Underlying Cryptocurrency

Whilst a comparatively less marketed channel, there are brokers entering the marketplace that offer clients the ability to own the actual underlying cryptocurrency purchased which immediately removes any form of funding or margin implication which can ultimately be prohibitive if using a spread betting or CFD provider.  Users can also freely buy and sell the cryptocurrency that they own and move it back to Fiat currency (e.g. sterling, euros or dollars) as and when they choose to.  The KYC and account opening process for these brokers tends to mirror that of opening a spread betting account although some may have additional proof of funds checks to further identify clients and the underlying transactions they wish to make.  In addition, some brokers enable clients to buy and sell not only the top 20 cryptocurrencies but also a number of the more esoteric currencies, known as “Alt” coins, which provides a real opportunity for those wishing to invest large or small amounts in smaller “start-up” businesses (ICOs) in the sector.

When it comes to holding the underlying coin, this is where things are slightly more detailed than the spread betting environment.  Firstly, the client will need to open a wallet that is relevant to the underlying cryptocurrency being purchased.  This is a relatively straight forward task and most popular wallets are able to house all of the top tokens/ currencies (reputable brokers will assist with this set-up for you).  However, there is not one wallet that houses all currencies/tokens and there are many tokens where another wallet will need to be set up.  Transactions to and from these wallets of your coins tend to be extremely fast and whilst also safe, it is fair to say that there is no complete guarantee of safety of your coins from attack and ultimately theft.  This can be counteracted by either moving your coins to a “cold wallet” held offline which provides a much higher degree of safety, but does mean some expenditure to get set up.  Alternatively, a client could utilise safe custody which is offered by some reputable brokers for a relatively small annual charge.  This removes the need for wallets altogether as coins will be stored on your behalf in cold storage and then be moved back onto exchange as and when the client is next looking to buy or sell.

Conclusion

For some, the convenience factor of spread betting will always offset any sort of margin or funding that is put up to enter these trades along with the speed of entry and exit.  After all, normal spread betting and CFD trading of stocks, currencies and indices attracts funding charges and margin and this hasn’t put clients off thus far.  If as expected, the crypto market evolves then you could feasibly expect to see volatility reduce. Such a move would normally see more generous leverage limits, but the regulatory change from ESMA has put pay to this – at least for now. In turn, this has the potential to drive more investors to buying and holding the underlying coin.  The initial set up may be slightly more cumbersome however costs in terms of funding and margin disappear and the sheer range of coins that you have access to in any volume gives a lot more variety to the average investor.  All of this means that there is a relatively easy access point for those that wish to diversify their portfolio or get involved (in any amount) in smaller tech businesses that they feel are going to thrive and be the next big thing. After all, the tech companies that dominate today were born out of the tech boom and imagine being invested in those in a very small amount from the very beginning!

About the author

David Thomas is a co-founder and director of GlobalBlock. He began his career at a Commercial Foreign Exchange company in 2003, which went on to become one of the UK’s largest non-bank forex providers, which was subsequently sold to private equity in 2015.  David’s belief in the future of blockchain and its underlying technology was a key factor in establishing one of the UK’s first phone brokered, deliverable cryptocurrency providers.