Cryptocurrency derivatives enjoy high leverage
Authorities beginning to address high risk instrument
LONDON: Jay Smith has little doubt the cryptocurrency market will crash.
The price of bitcoin has increased sixfold in the past year, despite a 25% plunge this month triggered by China’s crackdown on digital tokens. Not a week goes by without startups launching new ones to fund everything from dentistry to Las Vegas strip clubs. Even Paris Hilton is tweeting to her 16 million followers about her cryptocurrency investments. If that isn’t a jump-the-shark-moment, what is?
Yet Smith, the No. 1 cryptocurrency trader at online brokerage eToro, shrugs all that off as he plays the markets from his home in Basingstoke, a suburban town west of London. Every day he looks for reasons to buy more bitcoin and other digital tokens – computer programs that use cryptography to create artificial units of value.
He doesn’t have much information to size up the prospects of Blackmoon Crypto, Steem, FirstBlood and other coins that have caught his eye, but that’s cool with Smith, a high school dropout and onetime professional video-game player. His portfolio is up 295% in the past 12 months.
“I just put in an order for a Tesla, and I don’t even know how to drive,” said the 29-year-old Briton.
Smith isn’t playing with just his own cash. More than 9,000 retail investors heed his advice and copy his trades on eToro, which is licensed in Cyprus and by the UK’s Financial Conduct Authority. It’s a social trading network that enables clients to track their favourite cryptocurrency traders. In an unregulated, ultravolatile market that few investors understand, eToro injects even more risk into the mix.
The firm is one of several that use contracts for difference, or CFDs, derivatives that allow investors to speculate on the price of cryptocurrencies. Plus500 Ltd offers leverage of 30 to 1 on such bets, while XTB International Ltd, registered in Belize, touts its award as the best cryptocurrency trading provider of 2017.
Unlike futures contracts, CFDs don’t trade on exchanges and are largely illiquid. Investors can suffer big losses because they have to put up only a percentage of the value of their trades on margin. While the US largely prohibits retail investors from trading CFDs, regulators in Europe are only now beginning to address the peril they pose.
In June, the European Securities and Markets Authority, the European Union watchdog for capital markets, said it was con- cerned about the suitability of CFDs and was weighing measures to restrict their use. Combining CFDs with cryptocurrencies is reckless, said Rainer Lenz, chairman of Finance Watch, a Brussels-based public-interest organisation, who serves on an advisory group at ESMA.
“We have to put a stop to this,” said Lenz. “This is selling a synthetic instrument on top of another synthetic instrument. This is the highest form of speculation. You just can’t do that to retail investors.”
The fine print in eToro’s risk-disclosure statement warns that “If the market moves against you, you may sustain a total loss greater than the funds invested in a specific position.” But Iqbal Gandham, head of eToro’s London office, said that in practice the firm uses mandatory stop-loss orders to prevent investors from losing more than their initial deposits. He denied that mixing CFDs and cryptocurrencies is harmful to retail investors.
“You can’t lose more than you put in,” Gandham said. “And if you don’t know what you’re doing, just copy someone who does.” School Dropout
That’s where Smith comes in. An easygoing man with the air of someone dazed by his luck, Smith dropped out of school at 14. He threw himself into eSports, a competitive form of video gaming that’s huge in Asia. Soon enough Smith, who goes by the online handle Jaynemesis, was day-trading tech stocks and then bitcoin. He started buying dozens of them at $25 each (they cost $3,944 on Sept. 26).
Smith rode out the currency’s first big crash in 2013, when it lost half its value in less than three weeks. By early 2017, he’d built a portfolio of coins from Ethereum, Litecoin and other issuers. He also discovered eToro, co-founded in 2007 in Tel Aviv by brothers Yoni and Ronen Assia.
The brokerage handled stocks, currencies and other securities. In 2010, Yoni Assia became infatuated with digital tokens and provided office space to Vitalik Buterin, the brains behind Ethereum. Four years later, Assia added bitcoin trading to eToro, which is based in Cyprus.
In February, the firm expanded into other cryptocurrencies. It also launched a marketing campaign aimed at retail investors with push notifications sent to customers’ mobile phones, instructional videos on YouTube and ads in the London subway proclaiming “Crypto Needn’t Be Cryptic”.