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.
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.
Cryptocurrencies: the new gold?
By Gerald Moser, Chief Market Strategist, Barclays Private Bank
Time to add to a portfolio?
There has been a lot of talk about bitcoin, and cryptocurrencies in general, being a “digital” gold. Similar to gold, there is a finite amount, it is not backed by any sovereign and no single-entity controls its production. But for bitcoin to be considered in a portfolio and to become an investable asset, similar to gold, the asset would need to improve the risk/return profile of that portfolio. This seems a tall order.
While it is nigh on impossible to forecast an expected return for bitcoin, its volatility makes the asset almost “uninvestable” from a portfolio perspective. With spikes in volatility that are multiples of that typically experienced by risk assets such as equities or oil, many would probably throw the cryptocurrency out of any portfolio in a typical mean-variance optimisation.
And while bitcoin’s correlation measures are relatively supportive, it seems to falter when diversification is most needed, such as during sharp downturns in financial markets. Looking at weekly return correlations since 2016 shows that bitcoin is not strongly correlated with any assets (see below). It is however only second to US high yield in its correlation with equities. US Treasuries, gold and US investment grade were better diversifiers than bitcoin when it comes to equities.
Furthermore, looking at global equity corrections since 2015 (see below), it is noticeable that bitcoin has performed even worse than equities over the last three corrections. And while gold and fixed income provided some relief during those corrections, bitcoin compounded the loss that investors would have incurred from equities exposure.
The fact that cryptocurrencies also fluctuate alongside equities suggests that investment in bitcoin is more akin to a bubble phenomenon rather than a rational, long-term investment decision. The performance of the cryptocurrency has been mostly driven by retail investors joining a seemingly unsustainable rally rather than institutional money investing on a long-term basis.
Several studies around market structure have shown that emerging markets with high retail/low institutional participation are more unstable and more likely subject to financial bubbles than mature markets with institutional participation. And while more leading financial houses seem to be taking an interest in cryptocurrencies, the market’s behaviour suggests that the level of institutional involvement is still limited. Another issue is around its concentration: about 2% of bitcoin accounts control 95% of all bitcoins.
In summary, difficulty to forecast return, lack of diversification and high volatility makes it hard to consider bitcoin as a standalone asset in a diversified portfolio for long-term investors.
An inflation hedge?
Another point widely quoted in favour of cryptocurrencies is that they provide an inflation hedge. This might be a valid point, if inflation stems from fiat currency debasement. As mentioned above, a currency’s worth comes from the trust economic agents have in it. If unsustainable amounts of debt and large money creation shatter belief in sovereign-backed currencies through spiralling inflation, cryptocurrencies could be seen as an alternative.
Regardless of its price, bitcoin’s production is set on a precise schedule and cannot be changed. If oil or copper prices go up, there is an incentive to produce more. This is not the case for cryptocurrencies. In a very specific and highly hypothetical scenario of all fiat currency collapsing, this could be positive. But other real assets such as precious metals, inflation-linked bonds or real estate usually provide a hedge against inflation.
Bitcoin’s technology should theoretically make it extremely secure. As there is no intermediary, each transaction is reviewed by a large number of participants which can all certify the transaction. However, there have been frauds and thefts from exchanges. Another point to consider is the risk of “losing” bitcoins. According to the cryptocurrency data firm Chainanalysis, around 20% of the existing 18.5m bitcoins are lost or stranded in wallets, with no mean of being recovered. As there is no intermediary, there is no backup for a lost bitcoin.
From a sustainability point of view, adding cryptocurrencies to a portfolio will make it less green. Mining and exchanging them is highly energy intensive. According to estimates published by Alex de Vries, data scientist at the Dutch Central Bank, the bitcoin mining network possibly consumed as much in 2018 as the electricity consumed by a country like Switzerland. This translates to an average carbon footprint per transaction in the range of 230-360kg of CO2. In comparison, the average carbon footprint of a VISA transaction is 0.4g of CO2.
Beyond energy use, the mining process generates a large amount of electronic waste (e-waste). As mining requires a growing amount of computational power, the study estimates that mining equipment becomes obsolete every 18 months. The study suggests that the bitcoin industry generates an annual amount of e-waste similar to a country like Luxembourg.
Cryptocurrencies are here to stay
Innovation in digital assets continues rapidly and will likely drive increased participation, both from retail and institutional investors. The underlying blockchain technology behind bitcoin was meant to disrupt a few different industries. While results have not lived up to the initial hype, more sectors are investigating the use of the technology.
And with Facebook announcing a stablecoin, or a cryptocurrency pegged to a basket of different fiat currencies, central banks have accelerated the movement towards central bank digital currencies. Those could improve payment systems resilience and facilitate cross-border payments.
Energy stocks drag down FTSE 100, IG Group slides
By Shivani Kumaresan
(Reuters) – London’s FTSE 100 slipped on Thursday, weighed down by falls in energy stocks as oil prices slid after a surprise increase in U.S. crude inventories, while IG Group tumbled on plans to buy U.S. trading platform tastytrade for $1 billion.
The blue-chip FTSE 100 index lost 0.4%, while the domestically focussed mid-cap FTSE 250 index also slid 0.4%.
Energy majors BP and Royal Dutch Shell fell 3.2% and 2.5%, respectively, and were the biggest drags on the FTSE-100 index. [O/R]
“What is holding back the UK is a lack of tech stocks to capture the ‘rotation’ back into tech seen since Netflix results,” said Chris Beauchamp, chief market analyst at IG.
“Stock markets overall are much quieter today, looking so far in vain for a new catalyst for further upside.”
The FTSE 100 shed 14.3% in value last year, its worst performance since a 31% plunge in 2008 and underperforming its European peers by a wide margin, as pandemic-driven lockdowns battered the economy and led to mass layoffs.
British Prime Minister Boris Johnson said it was too early to say when the national coronavirus lockdown in England would end, as daily deaths from COVID-19 reach new highs and hospitals become increasingly stretched.
IG Group tumbled 8.5% after announcing plans to buy tastytrade, venturing into North America after a stellar year for the new breed of retail investment brokerages.
Ibstock jumped 7.3% to the top of the FTSE 250 after the company said fourth-quarter activity benefited from better-than-expected demand for new houses and repairs.
Pets at Home Group Plc rose 2.2% after reporting an 18% jump in third-quarter revenue, boosted by higher demand for its accessories and veterinary services as more people adopted pets during lockdowns.
(Reporting by Shivani Kumaresan in Bengaluru; editing by Uttaresh.V and Mark Potter)
Wall Street bounce, upbeat earnings lift European stocks
By Amal S and Sruthi Shankar
(Reuters) – European stocks rose on Wednesday after Dutch chip equipment maker ASML and Swiss luxury group Richemont gave encouraging earnings updates, while investors hoped for a large U.S. stimulus plan as Joe Biden was sworn in as president.
The pan-European STOXX 600 index closed 0.7% higher, getting an extra boost as Wall Street marked record highs.
All eyes were on Biden’s inauguration as the 46th U.S. President, with traders betting on a bigger pandemic relief plan and higher infrastructure spending under the new administration to boost the pandemic-stricken economy.
Tech stocks rallied to a two-decade peak in Europe after ASML Holding NV rose 3.0% to all-time highs on better-than-expected quarterly sales and a strong order intake for 2021.
Meanwhile, Richemont rose 2.8%, after posting a 5% increase in quarterly sales as Chinese splashed out on Cartier, its flagship jewellery brand.
Britain’s Burberry jumped 3.9% after it stuck to its full-year goals, saying higher full-price sales would boost annual margins, while Asian demand remained strong.
The pair boosted European luxury goods makers that are heavily reliant on China, with LVMH and Kering gaining between 1% and 3%.
“Any sign that retail spending is picking up in China is going to be a boost to the Western markets and those heavily exposed to it,” said Connor Campbell, financial analyst at SpreadEx.
The European Central Bank is set to meet on Thursday. While no policy changes are expected, the bank could face more questions about an increasingly challenging outlook only a month after it unleashed fresh stimulus to bolster the euro zone economy.
“With the new round of easing measures fully in place and no new forecasts to be presented tomorrow, it should be a fairly uneventful day for the euro,” ING analysts said in a note.
Italy’s FTSE MIB gained 0.9% and lenders rose 1.6% after Prime Minister Giuseppe Conte won a confidence vote in the upper house Senate and averted a government collapse.
Conte narrowly secured the vote on Tuesday, allowing him to remain in office after a junior partner quit his coalition last week in the midst of the COVID-19 pandemic.
Daimler AG jumped 4.2% after its Mercedes-Benz brand unveiled a new electric compact SUV, the EQA, as part of plans to take on rival Tesla Inc.
Germany’s Hugo Boss added 4.4% after Mike Ashley-led Frasers said it boosted its stake in the company.
(Reporting by Sruthi Shankar and Amal S in Bengaluru; Editing by Shailesh Kuber and Arun Koyyur and Kirsten Donovan)
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