In an effort to curb cryptocurrency speculation, financial regulators are limiting the amount of money that traders are allowed to borrow. New measures may help reduce price volatility, giving institutional buyers the confidence to invest in the crypto asset class. Improved price stability could also make bitcoin more viable as a day-to-day currency.
Margin trading—the practice of borrowing money to trade a financial instrument—is especially popular on cryptocurrency exchanges, where platforms like Bitmex have allowed a trader to control a bitcoin position worth $100 with just a $1 deposit. This strategy multiplies potential profits, and losses.
When margin traders place losing bets, exchanges may ask them to deposit more money or force them sell holdings to cover their losses. When the latter happens, the immediate sale of crypto holdings can cause wild price swings and result in a cascade of selloffs. For instance, in summer 2017, a flash crash on Coinbase Pro (formerly “GDAX”) caused ether to fall from $318 to just $0.10 in an instant. The price bounced back seconds later, but a small number of traders lost almost their entire positions.
Japan’s government last week signed off on proposed amendments to limit margin trading of virtual currencies. The caps will be between two and four times a trader’s capital, aligning much closer with foreign exchange trading standards. According to Japan’s Virtual Currency Exchange Association, a trade group, margin trading of crypto was a 8.4 trillion yen ($76 billion) market in December 2018.
Similarly, in Canada, regulators are considering ways to tame crypto speculation. Authorities recently proposed that crypto exchanges should not offer margin trading, at least in the “near term.” In a consultation paper, Canadian securities regulators also suggested prohibiting short selling—betting that crypto prices will fall—and “dark trading,” or transacting in private forums as opposed to public marketplaces.
Japan and Canada’s attempts to bring order to the crypto markets dovetail with similar European measures. In December, the European Securities and Markets Authority renewed its 2:1 leverage limit on cryptocurrencies.
While margin trading is a niche part of the crypto ecosystem, it can have far-reaching effects on prices. By putting guardrails on crypto trade, regulators make bitcoin less prone to dramatic fluctuations. And while that may frustrate day traders, it’s an extremely positive development for the future of crypto overall.
Although cryptocurrencies are mostly owned as an investment vehicle, their future lies in being used as actual currency, particularly in poorer countries where they can compete with unstable fiat currencies. As regulators clamp down on market manipulation, these virtual assets could become more palatable to consumers and merchants. Price stability will be welcomed by people who strive to use bitcoin for day-to-day purchases.
Dampening volatility may also make the crypto asset class less frightening to institutional investors. From investment banks to pension funds, managers have been pressed by clients about whether they’re getting involved in the virtual currency industry. Though managers have been hesitant—and in some cases, prohibited from—buying into cryptocurrencies, as digital assets are increasingly regulated like other financial instruments, they may become part of growth-oriented portfolios.
While price swings are exciting and attract speculation, the gradual increases in price and adoption will be key if bitcoin is to ever compete with traditional currencies.
What you need to know—and why
Digital Asset has a new CEO. Yuval Rooz, who previously served as CFO and COO, was named the new head of the enterprise blockchain company, replacing Blythe Masters. Founded in 2014 and supported by high-profile investors like JP Morgan and Accenture, Digital Asset is developing a distributed ledger for the Australian Securities Exchange’s post-trade processing system. The system, which raised concerns that it’s being rolled out hastily, is anticipated in early 2021, a Digital Asset spokesperson confirmed.
Takeaway: Digital Asset has suffered worrying departures in recent months, which may cast a shadow over the prospective ASX implementation. Masters, a Wall Street legend who helped devise credit-default swaps, left Digital Asset in December citing “personal reasons.” Since then, the firm has also lost the product manager for its proprietary Digital Asset Modeling Language (DAML), the head of its European division, and its CTO—the firm’s second in six months. ➡️