Can settlement speed change the experience for individual traders?
TL;DR: Kollider is using the lightning network to change the experience of how traders access cryptocurrency markets
Last week’s Gamestop headlines have shown us that traders are no longer just professionals. Whether it’s shares or derivatives, it’s become more convenient than ever to access markets. But has the experience for the retail trader actually improved?
Historically, the experience for a trader has improved dramatically. Picture yourself in Amsterdam in the early 1600s. You were limited to physically travelling to the exchange to buy a limited selection of commodities or later, ‘shares’ in overseas expeditions. The experience was slow and access was limited. You’d have had a similar experience if you lived in Japan during the 1700s and wanted to buy rice futures at the first futures market, the Dōjima Rice Exchange. Today, around three hundred years later, you’re able to open up your favourite brokerage app, buy a call option on your favourite company, and do it all without getting out of bed in the morning.
What a time to be alive!
But things are still not as simple as they could be. Traders are still subject to a lack of direct access, opaque fees and unlimited liability.
Most retail traders looking to trade are at the mercy of the broker. This is because no trader is allowed direct access to the market on traditional exchanges. If you wanted to trade a futures contract on an exchange such as the CME, there would be at least three or four layers of middlemen to go through. The only way you’d get to trade is via a broker or a software vendor. Both would need a connection directly to a clearing member, who are the only parties with direct access to the exchange order book. Which means for most people, they’re trading through a third party, never directly on the exchange order book themselves.
Why is this a problem? Without direct access to the exchange, the trader only has access to the market on someone else’s terms. Take Gamestop as a recent example. For many that tried to trade Gamestop last week, they used neo-broker services such as Robinhood, which is just a brokerage with a great user interface. Robinhood, like many brokerages, had to stop their users buying further Gamestop shares because of the antiquated settlement times used by clearing members, which caused deposit requirements to raise overnight. In short, these layers between the exchange and trader results in a scenario where the broker decides, when you, the trader, are allowed to trade.
Fees are not what they seem.
Let’s say you want to short a company’s stock using a put option. You’ll have to find a broker to let you trade it. On your search you’ll come across brokerage services telling you “The future of trading is zero fees” or “zero commissions!”. But if a service is free, you’re usually the product. Brokerages are no different. Many brokerages have moved from fixed or proportional trading fees, which are transparent for the trader, to a ‘zero commission’ or ‘free trade’ model.
Brokerages that offer zero commission trading make money by selling their orders to a market maker that quotes at a price that is lower or higher than the current actual rate in order to profit from the spread. The ‘zero commission’ or ‘no fee’ claim is just a reshuffle of how traders pay fees. Retail traders are no longer given clear fees, just a market price dictated by another party, not the market. Basically, a middleman dictates the price for the trader with fees conveniently baked in for them and the trader is none the wiser.
Because traditional exchanges only check margining a few times per day, traders that access their markets via brokers can end up in situations where they owe the broker more money than they started with. This is due to accessing an exchange via a third party like a broker, who can open the trader up to unlimited liability. Picture it, your leveraged position goes in the wrong direction, and you are held responsible for ensuring your account is solvent. The broker issues you a ‘margin call’ to top up your margin, but you don’t have enough.
Markets are not open to all
Not everyone in the world has access to neo-brokers. Traditionally, if you wanted to trade a niche derivative contract, you could not go to the exchange to trade it directly. You would need to find a brokerage that offered that product over the counter first. Once you found one that offers a product you want to trade, you would need to go through the nightmare that is the sign-up and onboarding process, which can sometimes take days or weeks. When (or if) you make it through onboarding, you are now greeted with a minimum contract size that causes your eyes to water (seriously, sometimes the minimum premium you’d need to spend can be thousands). But you’ve come this far, so now you need to get your collateral, or margin on the brokerage, to open a position. You’ve had to sell your kidney to afford it, but you’ve finally got the capital required to open a position. Now you need to send your collateral via bank transfer to the service. After you’ve sent that transfer and waited a day or two for it to get there, you’re ready to trade.
/r/Wallstreetbets traders could learn a thing or two from /r/SatoshiStreetBets because trading on cryptocurrency exchanges is a much better experience than trading on traditional venues. With the invention of cryptocurrencies, the experience of how retail traders access markets has changed dramatically. For the first time, new and experienced traders alike are able to send their collateral to the exchange and trade directly on the order book without the need for middlemen. They can even trade across a range of different products down to minimum contract sizes of a dollar, or even lower, 24 hours a day, 7 days per week. Access to financial markets has become liberalised and now virtually anyone, anywhere is able to quickly access a cryptocurrency exchange and open a position, regardless of whether they have a bank account or how much wealth they have.
Limited liability and transparent fees
Aside from direct access, cryptocurrency venues help protect users with the use of limited liability and transparent fees. A cryptocurrency exchange constantly checks a user’s margin balances in real time, allowing a trader to take a leveraged position and only risk losing the funds they fund their account with, allowing new users to learn about products without fear of losing everything. Furthermore, unlike neo-brokers, crypto exchanges all have transparent fees for each trade and the price a user is shown is the fair price, not a price with a spread baked in.
The first cryptocurrency exchange venues have kick-started a revolution in trading. They’ve provided access to a new generation of traders around the world to parts of finance they’d never dream of getting access to before. Yet despite all these improvements over traditional venues, cryptocurrency exchanges are suffering from new problems, specifically surrounding settlement speed. Let’s say you want to enter a derivatives position using Bitcoin, you need to send your Bitcoin to the exchange to fund your position to act as collateral. But, by doing so you are giving the exchange ownership of your bitcoin, and you’re now exposed to counterparty risk. Or rather the risk of the exchange getting hacked, and you lose your bitcoin forever.
You could withdraw what you don’t use, but this is painful as a user needs to navigate through the withdrawal process and wait for the slow transaction times to get their funds out of the exchange. This lack of settlement speed means that traders can miss market opportunities and compounds traders to leave more funds than are needed on the exchange. So how will the traders of tomorrow access markets without these problems?
Kollider: direct, instant settlements to protect traders
This is where second layer protocols come in. Second layer protocols provide cryptocurrencies with extended functionality beyond what they were originally capable of. Bitcoin’s second layer protocol is the Lightning Network, and it can be used to allow traders to experience all the aforementioned benefits of using a cryptocurrency venue, but with much more control of their funds and speed of access that does not exist anywhere else.
We believe that with second layer protocols we can create a completely new model for how traders, new or old alike, access cryptocurrency markets.
So starting with the Lightning Network, we’re building new ways to offer traders a fundamentally new experience of how they access cryptocurrency markets. Starting with Kollider.
Kollider is a P2P cryptocurrency trading platform (not another broker, we promise) that puts traders in control of their own funds and allows them to enter or exit positions on derivative contracts directly from their own wallet of choice. We’ve built the lightning network directly into our settlement engine to enable traders to:
- Instantly fund positions and claim any profit or loss directly from their own wallet or node
- Never leave any funds with the exchange that are not being used on an open position (massively reduced risk)