Crypto CFD challenges: Liquidity, counterparty risk, regulation

Providing liquidity is no easy function to achieve. It requires a combination of capital, technology, and established institutional relationships for successful delivery.

When it comes to crypto CFDs, it means bringing an emergent asset class to the world of contracts for difference products. The challenge became feasible in 2017 as the crypto ecosystem matured to the point even CME Group launched the first Bitcoin futures contract.

FinanceFeeds spoke to Natalia Zakharova, Head of Business Development at FXOpen, a global company that has regulatory licenses in Australia, in the UK, and European jurisdictions, to ascertain her view on the challenges of crypto CFD liquidity aggregation and delivery.

“If we speak about crypto CFDs, I don’t see why liquidity aggregation should be any different than forex. It might have been an issue back in 2017 when crypto CFDs were new, liquidity was thin and demand was huge. These days there is a choice of reputable LPs offering consistent pricing and execution.

“Deliverable crypto is a different matter. When crypto exchanges start being regulated and offering reliable connectivity, brokers still have to make sure that their aggregation software is able to handle cryptos and their infrastructure can ensure timely delivery. Moreover, counterparty risk remains much higher than with a regular forex LP”, said Ms. Zakharova.

Indeed, a number of established prime brokers have launched their crypto CFD offerings, including CMC Markets Connect, Advanced Markets, and B2Broker.

These companies have developed unique products, minding the spread competitiveness, minimal slippage, leverage, and most importantly, market depth with an ever-expanding crypto CFD liquidity pool as the institutional players join the party.

A solid crypto prime CFD solution that ensures the deepest liquidity pool will should aggregate cryptocurrency exchanges and brokers, non-bank liquidity providers, OTC orders of institutional clients, hedge funds, and client-broker orders.

In regard to counterparty risk mentioned by Ms. Zakharova, the irony is that Bitcoin was created with the intent of eliminating counterparty risk with its decentralized and open blockchains.

But when Bitcoin users hand their Bitcoin over to a custodian such as a cryptocurrency exchange, counterparty risk is reintroduced into the system. News that established names such as Goldman Sachs are preparing their crypto custody services are likely to inspire greater confidence in the leveling of the playing field.

Will Crypto CFDs be around for long?

While the industry quickly adapts to the digital asset class, so are the financial watchdogs across the globe, namely the top jurisdictions for CFD trading.

The UK Financial Conduct Authority has imposed a ban on crypto CFD products for retail traders. The ban announcement was issued on 6 October 2020 and retail brokers started to enforce the new restriction on 6 January 2021. The total ban will take effect on 25 March 2021.

“The FCA considers these products to be ill-suited for retail consumers due to the harm they pose. These products cannot be reliably valued by retail consumers because of the:

inherent nature of the underlying assets, which means they have no reliable basis for valuation
prevalence of market abuse and financial crime in the secondary market (eg cyber theft)
extreme volatility in cryptoasset price movements
inadequate understanding of cryptoassets by retail consumers
lack of legitimate investment need for retail consumers to invest in these products
These features mean retail consumers might suffer harm from sudden and unexpected losses if they invest in these products.”

The regulator stated that retail consumers are estimated to save around £53m from the ban on these products.

FXOpen was one of the first FX and CFD brokerages to offer crypto trading pairs, with currently more than 40 cryptocurrency markets in its offering, including Ripple (XRP) which is currently ‘fighting for its life’ amid the SEC vs Ripple lawsuit we have been covering. The SEC claims XRP is a security that was sold in coin offerings. Ripple responded that it never held an ICO. Wherever the case may take us, it is likely to establish a meaningful precedent.

FXOpen announced the closure of all crypto CFD positions for UK retail clients by January 5. Professional clients are exempt from the ban in the UK and FXOpen maintains its crypto CFD offering for customers across the globe.

In the aftermath of the UK ban on crypto CFDs, the trading industry eyes other regulators alike to get a clearer view of what is ahead.

Although the UK is now out of the European Union, ESMA may regard the FCA’s move as an example for its future policy. Australia did draw inspiration from Europe for its restrictions on CFD products coming into effect later this month.