Crypto

A Crypto Currency is a virtual currency that is set up using a concept called a block chain. This is a huge, decentralized underlying database that when traversed, contains every transaction ever made. The database is a collection of remote servers scattered all over the world with built in redundancy and backup. It is designed to be virtually impossible to hack due to its distributed nature and also impossible to control by any one entity, like a government.

It has gained in popularity largely due to these reasons. There are now a few businesses that accept bitcoin as payment, but not many, and it is somewhat difficult to use it as a form of payment for goods and services.

For now it is mostly considered to be an investment, similar to gold or silver, though it is not a physical commodity. Many people are reluctant to put money into the Crypto markets for this reason. All you have is a long string of numbers that allow you to access your Crypto, not anything you can actually hold or see.

But this is not the only reason Crypto investing is not more popular. Another big reason is that the options for storing your money are antiquated to say the least. And it has come a long way from what it was a few years ago. Also Crypto had a couple of collosal failures early on that gave it a terrible name. Here is a little history for starters.

We will start with Bitcoin itself. No one knows who built the initial infrastructure for Bitcoin, but they were clearly a genius. It has been credited to someone named Satoshi, from Japan. In fact a single unit of Bitcoin, the equivalent of a penny in US Dollars, is referred to as a Sat, short for Satoshi. A programmer named Jed McCaleb got interested in it and in 2010 decided Bitcoin buyers needed a repository to keep their Bitcoin, so he developed Mt Gox, an on-line bank of sorts. He sold it to a French programmer living in Japan in 2011. On June 13, 2011, Mt Gox was hacked and reported about 25,000 Bitcoins were stolen from the exchange. This was a catastrophe for the nascent industry.

Over the next 3 or 4 years Mt Gox struggled to find lost coins and fight off lawsuits. Other online banks sprouted up during this time where people could store their Bitcoin, but as you can imagine everyone was a little apprehensive about putting any appreciable amount of money into any of these places given the rocky history of Mt Gox. By 2016, creditors claimed to have lost $2.6 trillion in Mt Gox and it filed for bankruptcy.

During this time, and since then a number of seemingly reputable vendors started up, but it took awhile before investors were comfortable leaving their coins there. Of course these companies are HIGHLY incented to protect the assets at any cost. Given the history, any bad behavior or hacking could bring a company down over night.

So all that said, I will now say a few things about the technical aspects of depositing and moving money around in these accounts.

Here are a few examples. I am not exaggerating with any of these things. These examples are from the 2017 era. It was worse before this, which is why so few non-technical people bothered to actually go through with funding for any of these accounts.

Real actual currencies are called “fiat” currencies. The US Dollar, Euro, British Pound, and all others are lumped into this category. In 2017 the brokers did not accept fiat in their brokerages. Most of them did have a “crypto” called USDT that tracked the US Dollar to within a couple cents above or below. So what you had to do is open a temporary account at a holding company that would accept your fiat and only allow you to move it all into USDT. This step alone ran off a lot of prospective investors.

Once you had USDT in this account, you could buy whatever crypto with it you wanted in another account. All the brokers had reputational issues at the time so it was a real struggle to figure out which one to use just to get your initial purchase. Once you figured this out and opened an account, you could then purchase crypto. In order to get these accounts set up you had to give them a lot of information about yourself, including account numbers where the money was that you were planning on moving there. This was disconcerting given the shoddy and clunky interfaces you had to deal with to set up your accounts.

At the time, in addition to keeping your coins at an on-line brokerage, you could also keep them in a “hardware” wallet. These were things resembling jump drives but each one supported only 1 or maybe 2 at the most different types of crypto. So for example lets say you bought some Bitcoin and some Etherium, you needed one hardware wallet for each of the two types. And transferring the information (large strings of numbers and letters) was quite complicated.

There was also what is called 2-factor authentication. You had to download a Google app and run it. It gives you a 6 digit number the website asks you for. So besides your email and forcing a long complicated password, you have to type in this number. This is all fine, however most of the time you were told the number you types was wrong. Turned out if your phone wasn’t set to military time instead of Am and PM, the number you got was incorrect. There was no documentation provided so you had no way to know this.

This kind of stuff went on all the time. The interfaces were near impossible to figure out. Your only hope was to find some blog page or discussion on the internet somewhere to get answers. There was no help anywhere.

Today there are some improvements to these interfaces, but they are still nowhere near what you would find with say Fidelity or Schwab for stocks and options trading. But it is clear more and more people are getting into crypto trading which is a sign the interfaces are getting better and people are getting more technically saavy.

Foreign Exchange

The Foreign Exchange (ForEx) market is the exchange where the price differences are set for various currency pairs. The market is a trillion dollar market with huge amounts of money passing through it each day.

The Forex is broken into currency pairs. A given currency is matched against another pair, for example the GBP/USD. In this case the GBP refers to the British Pound and the USD is the US Dollar. The value of the GBP/USD is a number that moves up or down constantly, dependent on how the market feels the two compare to each other at any given moment.

This comparison is based on economic conditions in BOTH countries. So while one country might be having good economic success (we will look at the meaning of this in a minute), their currency might be falling in value against another countries currency because the other country might be having better success.

The order the two pairs show up matters. The way you see it listed on your broker is the way it will always be. So the GBP/USD will always be the GBP/USD and never the USD/GBP. Here is what the order means. The GBP/USD is how many British Pounds you can get for 1 US Dollar. So if the price is say 1.4000 it means it takes 1.4 US Dollars to get 1 British Pound. If the price were 1.000 it means you can get 1 GBP for 1 USD. And if it were 0.6543 it means you need 0.6543 USD to get 1 GBP. So if you were travelling to the UK, your dollar would go a lot farther if the GBP/USD were less than 1.0000 as opposed to greater than 1.0000.

In order to trade in the Forex, you must deposit money at a broker that is connected to the Forex market. There are a lot of these, but you must be very careful which one you choose to give your money to. Just like the crypto industry, there have been a lot of broker problems, but unlike the crypto industry, the problems were not caused by hacking but rather unscrupulous brokers that were reticent to give traders their money in the unlikely event they made decent profits. I will explain this comment later, but for now lets focus on the brokers themselves.

Many of these brokers were initially based in far flung places like Seychelles, the Netherlands Antilles, the Canary Islands, and other places where regulation was lax. But even the ones based in the US or UK have never been under the same regulation as stock or futures brokers. In fact, at one point in 2015, the Federal Trade Commission, in response to complaints that traders were losing huge amounts of money and even their homes in the Forex, came out with a new regulation limiting the amount of money traders could deposit at these places, effectively cutting it in half. But this did not in any way address the issues of broker manipulation and cheating, it only lessened the amount traders could be cheated out of.

This is not to say that everyone who lost money was cheated out of it. In fact the vast majority of Forex losses are due to inexperience and false expectations. There are hundreds of training courses available that attempt to teach traders how to trade based on following dozens of indicators and doing all sorts of plots and graphs to try to determine the way the market will go next. There are sold as great predictors but in reality they are extremely unreliable and prone to setting false expectations. Traders tend to make some small trades and make a little money then increase their trade size until they lose all their money.

Anyway this type of trading is called Technical Trading because it is based on technical indicators. You put your favorite indicators on the chart and when most of them say something is going to happen at a certain place, you make a trade in that direction for an amount you feel comfortable with. The vast majority of traders trade this way.

There is another style of trading called Fundamental trading or news trading. Here is how it works. At certain days of the month, each country releases data points that indicate how weak or strong their economy is. For example each country releases the CPI, Employment Change, GDP, and a whole host of other releases during the month. THese releases are set to come out at a certain day and time, set at least a month in advance. To prevent leaking, reporters are escorted into a “lockup”, a room with no access to the outside and no cell service. The release is given to them 20 minutes before being released to the world so they can write up analysis that will be sent out as soon as the information is made public.

Each release has 1 or more numbers associated with it. For example, the CPI number might come out as 2 numbers, CPI and Core CPI, where Core CPI is the CPI number minus auto sales, which tend to fluctuate more than other things and skew the number.

A couple weeks prior to each release, a bunch of the top economists make predictions about where the release will come out, and the currency pair adjusts itself to those expectations. As the seconds tick down to the actual release the pair gets real volatile, moving up and down sporadically. When the data is released, a couple of things can happen. If the economists were close to being right, the pair will push up and down a little but not more too far in any one direction. But if they missed by a lot, the pair will spike in one direction or the other to compensate for the missed expectation.

News traders will place orders above and below the current price milliseconds before the news is released. These are NOT LIVE ORDERS. This is important. These are pending orders that only go live if the price moves far enough to touch or pass the entry price you gave it. If there is a big spike, one of the orders goes live and often is very profitable in a second. There was a period of quite a few years when this worked like clockwork. It does require a good bit of skill to get the orders in properly and to manage them properly, and lots of traders lose in volatile markets like that, but skillful ones can do very well.

Here is why this is an issue with the brokers. We will start from the beginning, back in the 2006-2007 timeframe. The broker concept for Forex trading was fairly new at that time.

First we will look at the increments of change in currency trading. The smallest difference between 2 prices is called a “pip”. If the price is say 1.0000 at one instant, and 1.0001 at the next instant, the price went up by 1 pip. If it went from 1.0000 to 0.9990 it went down by 10 pips. Some pairs have 4 digits after the decimal point and others have 2, but the pip concept is the same. So for example if the price is 35.30 and goes up to 35.37, it went up by 7 pips. Conversely if it drops from 35.30 to 35.23, it went down by 7 pips. This concept is very important to understand.

As with any reputable broker, they make their profit off what is called the spread. Lets say the actual price for a pair is 1.0000. You can’t actually buy or sell at that price. The brokers add a few pips above (called the Ask) and below (called the Bid) the current price, called the “spread”. So lets say the spread is 8 pips, 4 above and 4 below the current price. In our example the bid would be 0.9996 and the ask is 1.0004. The spread is the difference between the Bid and the Ask. If you chose to sell the pair at that instant, you would be selling at 0.9996 and if you chose to buy, you would be buying at 1.0004. The broker is guaranteed a profit of a few pips, which is fine. That’s how they are supposed to make their money.

When you choose to buy or sell, your trade should be matched up with someone who is willing to do the opposite you are doing at that exact same price. That way the broker doesn’t care which trades wins or loses, they make their money from the commission. In an ideal works that is what happens. However the brokers back in the 2006 neighborhood couldn’t help but notice that 93% of trades came out losers. 93%!!. So then they got the idea if THEY take the other side of every trade, they will not only make the commission but also all the money the trader loses will also be theirs, and since 93% of trades are losers, that equates to a ton of money. One of the problems with this is that the broker is highly incented to see you, the trader, to lose. If you make more that the spread in profit, they actually lose money on the trade.

In a properly regulated industry the owners would go to prison for doing this, but not in the Forex industry. They were all happy with this arrangement. Initially, and for a few years, most did not look too closely at the trades and traders who were consistently winning because the brokers were making tons of money each month, so it didn’t really matter. The fact that a tiny percent of traders did well did not concern them at all. They figured the traders were just lucky and all that money would come back to them over time.

The traders who were consistently winning at that time were the news traders, and a big reason was based on something called slippage. If a trader places an order say 4 pips above the current price, and for some reason the market in an instant screams up 40 pips in a few milliseconds (as happens when a big news release was missed substantially by the economists), your order should be filled (filled means someone is willing to take a trade going against you) at the next best price another trader is willing to take it at, which could in this case be 10 or 15 pips or more above where you told the system you wanted to enter. This can seem confusing but is how it works. But back at this time the broker would take the other side of the trade so there was no slippage at all. Zero. So in the example where the price spikes 40 pips and the Bid price you got was 4 pips above the current price, your order has gone live and up by 36 pips instantly.

Lets have a look at what is called leverage and how pip movement affects the value of a live order. These accounts are set up to allow the trader to use what is called leverage, which basically means they can amplify the value of their trade and trade all the way up to just about all they have in the account on a single trade.

The basic trade quantity is called a “lot”, and a lot for most USD currency pairs is worth $10 per pip of movement. You can (and frequently should) trade small fractions of a lot unless you have tens of thousands of dollars in your account. So for example, 0.1 lots traded equates to about $1 per pip of movement.

Now lets get back to the news traders I mentioned earlier. Because the brokers were trading against their customers there was no slippage, and back at the time we frequently saw big spikes when economists missed their guesses with news releases. Some types of releases, like CPI for example, were not too hard for the economists to hit because CPI only fluctuates from maybe -0.1 to maybe 0.3% of growth. On the other hand, something like an employment trade can vary by hundreds of thousands. For example, they might estimate the US added 100,000 jobs in the last month, but in reality it might have actually been over 200,000 or only 20,000. The larger the difference between the estimate and the actual, the bigger the spike would be for the pair to adjust itself to the new reality. Spikes of 40 or 50 pips were not that uncommon.

So what these news traders would do is find a new broker just starting up, put some money there and trade very small lot sizes to be sure the price movement was what is should be, then quietly put in tens of thousands of dollars into the account, and when certain news releases were about to come out, load up a trade with 20 or 30 standard lots or more (placing one of these pending orders on either side of the price so that a spike in either direction would take one live), and hope for a big deviation.

If the big deviation did NOT happen, the price would still sometimes move far enough to take in one of the orders and sometimes not. If not, they got out for no loss. If so, they would close the order fast for worse case a few pips loss or maybe even a few pips gain.

If the big deviation did happen, and the broker took the other side of the order insuring no slippage, the trades was often instantly up 30 or 40 pips, or sometimes a lot more. If the trader was trading say 30 standard lots, which equates to $300/pip, and the spike was 40 pips, the trader is up $12,000 in about 1 second. Most frequently, the price would retrace a few pips then continue up another 10 or 15 pips from there. So the trader could easily pocket 15 or 20 grand or more in 15 to 20 seconds.

Since most traders were losing during these times, the brokers did not pay much attention to the small few who were killing them. But after a few years they started to catch on, and to come up with mitigation strategies. Each one approached it differently. Some tried to turn off trading a couple seconds before a news release until a couple seconds after. Others came out with policies that said if you trade at news times, they reserve the right to not give you your money. Others made the spreads balloon 100 pips or more for just a fraction of a second right before a news release to destroy traders. And all of these techniques were allowed since they were, and still are, largely unregulated.

There were lots of cases where brokers would tell traders they could not give them all their money and try to negotiate to give them half or less. A number of brokers simply went out of business, disappearing with all the money and resurfacing in some other far flung locale under a new name.