Is Cryptocurrency Volatility A Risk To Broker Solvency?

Cryptocurrency volatility is well known. Over the 54 weeks leading up to February 24th 2019, the average daily volatility of the EUR/USD forex pair has been 0.68%. Other major fiat pairs show average daily volatility in a similar range. USD/JPY is 0.57% and USD/CHF 0.59%. In stark contrast, the average daily volatility of BTC/USD, the bitcoin to dollar pair now offered by many CFDs trading brokers, has been 4.56% over the same period. Volatility has been even higher for the BTC/EUR pair at an average daily 5.14%.

The average volatility of cryptocurrency to major fiat currency pairs is, therefore, close to ten times higher than that of major forex pairs that only include fiat currencies. That volatility is the reason why so many traders have been enticed into trading the cryptocurrency pairs that most online CFDs brokers now offer. With volatility between the major traditional FX pairs especially low over recent years, cryptos represent the opportunity for traders to catch the kind of swings that have become such a rare beast for fiat pairs.

It’s also why traders are warned of the risks involved in taking leveraged positions involving such volatile instruments. Getting caught on the wrong side of a leveraged position when a 10% swing happens over a few hours, which happened multiple times over the course of 2018, could potentially wipe out an overexposed trading account. Of course, an experienced trader, or even an inexperienced one sticking to sensible risk management, won’t allow themselves to be dangerously exposed. But in the real world it does unfortunately happen.

At least in Europe, new ESMA rules means brokers can’t allow trader accounts to drop into negative balance. So the risk of trading highly volatile cryptocurrencies is at least limited to funds held on account.

But Does Crypto Volatility Represent A Bankruptcy Risk To Brokers Themselves?

It’s not unheard of for brokers to get themselves into trouble when markets they are highly exposed to swing significantly in an unexpected direction. In January 2015, when the Swiss National Bank unexpectedly removed the EUR/CHF price peg, the value of the Swiss franc soared. Within a minute the pair went from 1:1.20 to 1:1, a swing of 20% in favour of CHF.

Traders ended up with huge negative balances and brokers were forced to cover client positions that went beyond margin requirements. FXCM, one of the biggest retail facing trading platforms in the world lost $225 million. IG announced losses approaching £30 million. Both brokers are among the best capitalised in the world and were able to absorb the losses, though they certainly hurt. FXCM’s share price plummeted 90%. Citibank also lost $150 million on the move. Other brokers were less lucky. Alpari UK went into insolvency, announcing bankruptcy within a few hours of the flash crash.

20% swings are not a common occurrence even for cryptocurrencies. But they are not uncommon either. 10%-20% swings have happened several times over the past couple of years. Not over a minute but certainly over short periods of time. So are brokers that offer cryptocurrency pairs threatened with insolvency in a way similar to the results of the EUR/CHF flash crash in 2015?

The conclusion has to be no. The leverage levels offered for positions on pairs including cryptocurrencies are much lower than is the case for forex pairs. Leverage limits retail traders can be offered generally have been significantly reduced since last year. And, finally, while crypto pairs have proven popular, their popularity is not yet on the same level as major forex pairs. So it’s very unlikely that a single broker is heavily exposed to a flash swing in crypto price.

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