TO COIN A PHRASE – IT IS TIME TO CHANGE
Mathieu Ghanem, Global Head of Sales at ADS Securities.
Across the OTC industry and in particular the world of FX trading almost every firm is focused on the changes to regulations, whether this is at the macro-level, with MiFID II coming into play, or the micro level where individual products are subject to change. But, although extremely important, I believe that over the next five years it will be technology, not regulation, which has the greatest impact.
Technology in trading is always changing as systems are improved and updated, but at the moment the financial services industry is on the cusp of potentially one of the greatest changes in its history. This will not happen overnight, but there will be gradual implementation of systems in two key areas. These are the introduction of blockchain technology and the use of artificial intelligence (AI) solutions to manage a much greater proportion of trading.
The market has been slow to adopt blockchain, and at the moment the use of the technology is mostly based around cryptocurrencies, but the systems open up many options. In recent years, regulators have made it clear that they want FX trading to be exchange based – mostly for transparency purposes. For a number of reasons, and using the current format, this would be very difficult to achieve, but blockchain, if properly implemented, could potentially resolve it. A secured cryptographic ledger system would transform the way the FX market operates. Clearing transactions through blockchain would move the market to a new model, revolutionising settlement, making it faster, while decreasing risk, without the need for a central entity making post-trade confirmation much cheaper.
This would be a dramatic change to the way that financial services are delivered. If it is a model that can be made to work, banks and or financial institutions could have a capital role as custodians and arbitrators, helping to apply the necessary regulations and framework that, at the moment, central banks, on behalf of governments, provide.
The use of smart contracts, as part of the blockchain technology, also has many advantages, including the ability to keep the identity of the parties involved secured, and at the same time provide full visibility of the contracts being executed. Smart contracts also remove the need for a number of ‘middlemen’, reducing costs and in many areas additional complications. This would allow trading solutions to be moved from a centralised to a decentralised model, significantly lowering the price per trade. An immediate benefit of this would be the democratisation of market participation which would help increase liquidity.
Algorithms are already an integral part of trading but increasingly it is the deep learning ability they offer which is starting to be linked to marketing and customer relation management (CRM), which is creating more opportunities. Traditional AI systems analyse markets and can trade on behalf of clients (or institutions), across multiple asset classes, optimising returns on investment or helping to manage risk. But, the next generation of algos will also be able to take into consideration big data stored in marketing systems which are used to acquire and engage with clients.
Sophisticated digital marketing understands what motivates clients, and in the future may be able to actually dictate what motivates them. Geographical, social, economic and historical footprints are used to create a picture of the individual. When this is combined with current market behaviour, provided by the AI trading systems, this deep learning can be used to present the right client, with the right opportunity, at the right time. But the important fact is that the approach to the client includes two aligned factors; firstly, it is a trade the investor is interested in and secondly it is based on a genuine market opportunity. Traditional systems have always strived to achieve this outcome, but cannot match the speed, breadth and efficiency of AI systems – at some point and like in other industries where AI is utilised, regulators will need to step in so no single actor or dominant force (or an uncontrollable machine!) ends up taking over. If the regulation is in place, a network of transparency, automation and optimisation could be spread out across the world.
If automation is looked at alongside the development of blockchain-based trading systems, the potential impact is huge. Crypto-technology allows for the digitalisation of assets. Everything can be coin based, along with the services which support the trading, from insurance through to arbitration. The blockchain can become a complete, transparent and cost-effective environment. In this world, by effectively owning the token without having the need to hold the asset, it would dramatically increase the speed of operation of world exchanges and could potentially contribute to new and massive economic growth.
ADS Securities was the first brokerage in the GCC (Gulf Cooperation Council) to start offering CFD Bitcoin and CFD Ethereum on its platform and is in the process of introducing other cryptocurrencies focusing on those most highly traded. But, for the firm this is just the starting point in engaging with the technology. It is currently building its third generation trading platform using blockchain technology for the backend systems. Settlement, clearing and reconciliation systems will all use blockchain, however the front end of the platform will be a development of the type of GUI which is already being used. It will provide investors with the interactivity and trading tools that they are used to when trading using the ADS Securities OREX platforms, but they will have the benefit of all trades being logged through a secure cryptographic ledger system.
The expansion of cryptocurrencies has created a very dynamic investment environment, but investors do need to be very careful when looking at buying into Bitcoin and other non-fiat currencies. Many traders are focused on the rapid increase in values, but do not look at the volatility and consider whether this is an asset which would work well in their investment portfolio.
Opening and maintaining a cryptocurrency wallet has its own issues and as the exchanges are still unregulated, investors need to be aware that there will be a co-mingling of funds. There is also a very real danger from hackers and concerns over the way that Initial Coin Offerings (ICOs) have been managed.
Another problem for traders is that, unless you are accessing the cryptocurrency as a derivative product, you can only effectively go long on the investment. Instead of setting up a cryptocurrency wallet and buying direct from a coin exchange many investors are therefore choosing to access the asset through CFDs, which gives much greater security and flexibility especially when there is a lot of volatility in the market.
As the UK and Europe continue to discuss the terms of Brexit and questions of where the euro will be cleared are regularly discussed, future conversations may be about which of the major central banks will be the first to regulate cryptocurrencies – Japan for example has taken a step. It is likely that the country which has first-mover advantage will put itself in a very strong position, but it will also be taking on a major challenge and will need to have the resources and expertise to manage this very fast moving asset class.
The financial services industry has always been very quick to adopt change, especially where it provides value and opportunity. Cryptocurrencies are already providing value and many people can see the opportunities that will arise from the technology, so we can assume that through 2018 we are going to hear a lot more about blockchain and AI.