Venezuela has issued new rules for crypto service providers in the country, including exchange platforms and miners.

The country’s Ministry of Popular Power for Communication and Information (MIPPCI) published an official gazette last week that included the “Constituent Decree on the Integral System of Crypto Assets.” The publication in effect activated a new regulatory framework that means businesses working with crypto assets will now have to register with Sunacrip, the country’s superintendency of crypto-related activities.

Sunacrip will now establish the registration requirements and processes, and accordingly inform affected businesses, the gazette states. Those who will not register face a penalty equivalent to 100–300 petros, the country’s national cryptocurrency.

As a result of the decree, the regulator has now become the highest crypto authority in Venezuela, with powers ranging from day-to-day oversight to administrative-level execution of plans and programs.

The decree lists a total of 63 articles, covering definitions of crypto terms, Sunacrip’s remit, businesses’ registration and audit requirements, penalties for non-compliance or criminal behavior, and more.

Sunacrip will henceforth carry out the inspection and auditing of crypto companies and can revoke licenses if they are found to be non-compliant or a danger to the public. Crypto firms found non-compliant with the new rules face imprisonment of one to three years and a penalty equivalent to 50–100 petros. Mining rigs can also be seized with the agency retaining the equipment.

The government has indicated previously that it may limit the number of crypto exchanges that are allowed to operate in the country.

Venezuela is notably one of the only nations to have launched a national cryptocurrency, and U.S. President Donald Trump ordered sanctions against the petro in March 2018, soon after it launched.

Nicolas Maduro, the nation’s president, has since made a number of efforts aimed to force the adoption of the oil-backed petro, both at home and abroad.

Back in December, Maduro said that the nation would move to sidestep the U.S. dollar and use petros for oil sales starting this year, soon after adding plans to appeal to OPEC for the token to become the “digital currency for oil.”

The country has also reportedly begun converting pension and salaries into petro from its fiat currency, the sovereign bolivar. Venezuela started selling petro to citizens last October via a government portal. Further, banks have been ordered to use the token, as have some businesses.

Editor’s note: Some statements have been translated from Spanish.

President Maduro image via Shutterstock 

The U.S. Securities and Exchange Commission (SEC) is seeking a tool to provide a Big Data view across major blockchains.

In a solicitation notice published Thursday, the regulator said it is looking for both small and large businesses who can provide data for the “most widely used” blockchain ledgers based on transaction volume, in order to “monitor risk and improve compliance” related to cryptocurrencies.

The SEC said it requires the data in an “easily reviewable” format, along with an overview of how the information is extracted and converted to ensure “there is no loss in data completeness and accuracy due to the data transformation tools and processes applied.” Notably, the agency is seeking to identify transaction details among “the universe of available information.”

Interested vendors should respond to the SEC by Feb. 14, according to the announcement.

The news comes soon after the SEC said that digital assets or cryptocurrencies will be one of its examination priorities this year, including “concerns related to custody and safekeeping of investor assets, valuation, omitted or misleading disclosures regarding the complexities of the products and technology, and the risks of dramatic price volatility.”

Last October, it set up the Strategic Hub for Innovation and Financial Technology (FinHub) to enable fintech startups, including those launching initial coin offerings (ICOs), to navigate the legal implications of their products.

The commission has also said it soon plans to release “plain English” guidance on when and how cryptocurrencies may be classified as securities to help developers determine on their own for any potential token offering.

Another top U.S. regulator, the Commodity Futures Trading Commission (CFTC), said it was looking to learn more about ethereum in December, ranging from its technology to how it’s used, in order to ensure compliance of derivatives markets based on the cryptocurrency.

U.S. SEC image via Shutterstock 

One of the most important rules for trading financial markets is cutting losses quickly and letting winners run.

Generally, you want to let your trades that are in the green run as long as the market is willing to provide. 

Conversely, you should cut your losses and exit the position to preserve your capital when you immediately identify that a trade is going/staying south. In other words, the trade is not going to come through and you’d be better off cutting your losses and reducing your risk exposure. 

The idea is to provide those trades that are in profit with room to develop without self-sabotaging your own position. Doing so while conditions are favorable is key, rather than closing on a trade prematurely and losing out on potential gains.

Sounds simple right? Well, it’s not always so easy.

That losing feeling

This fundamental rule set for trading winners and losers is widely known, but it is often forgotten by both novice and professional retail investors alike, as emotions tend to take charge.

“Sure” you say, “I can manage that and keep my emotions in check,” but the reality is that no one is that robotic in nature, and nobody knows 100 percent of the time the correct direction that the price will take. 

As human beings, we are prone to “loss aversion” – a tendency to ignore or avoid losses. Hence, we tend to let our losers run, in order to avoid taking a loss.

Identifying when a trade is heading south is the difference between stubborn financial ruin and modest success (with the latter obviously being the preferred option). 

However, research suggests that despite knowing the obvious and most logical course of action to take, people will sometimes deviate from that path and experiment. Yet, experimenting with your money or your trades is a one-way ticket to “Rect City” when making investments.

Instead, work on a series of rules/guidelines that you follow – and stick to them. By vetting any inconsistencies that don’t align with the mantra of “cut your losses,” you can severely limit your risk and exposure to the market.

Fighting instinct

In essence, successful traders possess a very particular type of personality and mental psychology that allows them to look at a piece of information without snap judgement.

The instinct to know when to cut or exit a trade comes from experience and the ability to cultivate value from your stringent trading rules is what separates the novice from the professional.

Confirmation bias also presents a problem, wherein you attempt to be “right” as opposed to remaining objective and on course with following the aforementioned rules.

The toxicity of emotions in trading cannot be overstated, so cut those losses and let your winners ride a little while longer, especially if you see no reason to end the trade then and there.

So what to do?

Here are some rules that could help you master the art of letting winners run and cutting losers:

Trading is the opposite of investing: Both trading and investing involve seeking profit, but they pursue that goal in different ways. Investing essentially involves betting on an idea that is likely to lead the economic growth, say 10 years from now. So, hope is an inherent part of investing.

Hope, however, has no place in trading, as it usually involves leverage. As a result, holding onto loss-making positions on the hope that it would eventually recover lost ground only yields deeper mark-to-market losses (ask a futures trader).

Remember you are a trader: When in a loss, most traders go from being speculators to long-term investors in no time, citing sound long-term fundamentals. That kind of a sudden role switch often leads to trading disasters, as speculative bets usually involve high leverage. So, eventually, a big drawdown forces a trader to accept their folly and move out of markets. 

Revenge trading is a big no: Revenge trading is that irrational desire to win back losses in the shortest possible time and usually from the same market that you lost money in. That again leads to traders taking quick profits and letting losers run, leading to even deeper drawdowns. The best thing to do after a big loss is to sit on the sidelines for a few days.

Avoid win-rate fixation: Most traders, especially beginners, are always looking for a high win rate in the ratio of wins and losses. From our childhood, we are rewarded for being right, so having a high win rate is more satisfying. That obsession with having a high win rate, however, is what drives traders to take quick profits.

If we take quick losses and allow the winners to run, our win rate might be between 50 to 60 percent. However, we would be making more money on our good trades compared to what we would lose on bad trades.

Remember, the captain of Titanic was only wrong once. It is the size of the mistake that matters and not the number.

Disclosure: The author holds no cryptocurrency at the time of writing.

Stock chart image via Shutterstock

Every quarter, CoinDesk Research surfaces the key data, trends, and events with its State of Blockchains reports. As our research efforts evolve and expand, we hope to provide amplification to perspectives within the crypto community. We reached out to analysts, builders, and lawyers to understand the industry from their unique vantage point.

Let’s dive in:

Tom Shaughnessy ()

51percent Crypto Research LLC (Senior Analyst)

4Q for crypto was a waiting room to see the doctor for a lot of projects, and a lot of projects couldn’t afford to see the doctor. We’ve seen a massive reality check for private companies (Bitmain and ConsenSys cut the majority of their workforces) and for projects (ETC Dev cut teams, Steemit had major layoffs). While reality is trimming the fat, the developer community is stronger than ever in our opinion as resources shift from would-be projects to those who are executing. Ethereum’s Constantinople upgrade in January offers developer updates as a roadway to Serenity, we’ve seen MakerDAO grow and is now locking up 2%+ of all ethereum as decentralized finance grows and Bitcoin’s Lightning network has seen impressive growth. Net, reality set in, but so did developers.

Kevin Kelly ()

Delphi Digital (Co-Founder)

Q4 saw a lot of bloodshed across risk assets, with public crypto prices being no exception. We may not be out of the woods yet, but we are starting to see a number of signs a bottom for BTC may be on the horizon (our analysis points to Q1 2019) if historical cycles are any guide. Sentiment has certainly shifted from pure euphoria to skepticism, which is no surprise given how much the market got ahead of itself a year ago. This year will likely mark a turning point where teams building real products with real use cases and consumers will attract both talent and capital, driving great dispersion among returns.

Ria Bhutoria ()

Circle Internet Financial (Lead Analyst, Circle Research)

Interest in crypto has shifted from ICOs and retail mania to solving real pain points for consumers and institutions in a way that should drive sustainable adoption and help the industry mature. Pain points we expect will be addressed include improving the user experience, encouraging institutional adoption, further integrating stablecoins into applications that require a price-stable asset, and finding ways for projects to compliantly raise money through vehicles like security token offerings.

Alex Kruger ()

Aike Capital (Founder)

Cryptocurencies are mostly in the doldrums, with realized volatility down to September levels. The two main bullish catalysts, BAKKT’s launch and Ethereum’s block rewards reduction, were both delayed. Facing a certain SEC rejection, the CBOE withdrew the Van Eck bitcoin ETF application. Temporarily. Meanwhile, the bitcoin community is excited with GRIN, LN continues to expand, the Veil app revitalized Augur, Maker’s Dai keeps growing, TRON is jumping on the back of its BitTorrent token, and the bitcoin market is back into accumulation mode. My base case scenario for the months ahead is a continued trading range. I see considerable odds of new lows. Incremental retail demand has disappeared, institutional interest continues to wane, and miners and exchanges always need to sell.

Hayden Otto ()

CoinSpice (Executive Editor)

Q4 2018 saw the final capitulation of most ICOs and blockchain projects that gave us nothing but hot air. Blockchain, like all new technology, must be accessible and have undeniable utility. When people realize that our greatest opportunity, then and now, is as a P2P electronic cash system, the whole space will be a lot better off. Projects which understand this will emerge at the end the current bear market as champions; unscathed and a top pick for investors as the new bull market begins.

Cole Kennelly ()

On-The-Chain Newsletter (Founder / Consultant)

While 2018 wasn’t kind to the price of cryptoassets, it was still a great year. 2018 was an exceptional year for building and learning. Lightning Network (LN) and MakerDAO were among the top developments in 2018. This past year, LN went from virtually 0 to 5000 nodes. In Q4 alone, LN capacity nearly tripled. As for MakerDAO, Dai remained stable as ETH declined more than 90%. Furthermore, Q4 saw a 65% increase from Q3 in the number of collateralized debt positions (CDPs) created with Maker. Looking forward, I am especially excited for WBTC to serve as collateral for Dai. What a time to be alive.

Christopher Bendiksen ()

CoinShares (Head of Research)

Q4 proved yet again that yes, miners will go offline if unprofitable… and no this does not cause “death spirals”. In that sense this was the most exciting quarter in years from a Bitcoin mining perspective. For the first time ever, the technological development of mining gear had matured to the point where the industry could observe meaningful, successive difficulty decreases on the back of large price contractions. As miners saw their cashflows turn negative, large amounts of unprofitable hardware was shut down and removed from the market. Furthermore, the system worked exactly as intended with difficulty coming down almost 40% and setting a new profitability equilibrium to reflect the reduced hashrate. Looking ahead towards the next price cycle and reward halving I am extremely excited for those miner entrepreneurs whose economic calculations were correct, and look forward to the improvements the disruption will bring to the industry.

Zack Voell ()

Messari (Analyst)

Q4 saw the price of bitcoin and other digital assets take new investors full circle from “hilariously rich” to predictably “rekt”. But by any other measure, this quarter was one of the industry’s best, specifically for scaling and privacy. The quantity and quality of privacy options grew enormously with the continued development and record-breaking use of other Bitcoin solutions like Samurai’s Stonewall feature and CoinJoin use via Wasabi Wallet and the launch of both Grin and Beam just around the corner. Scaling solutions for Bitcoin (and other assets) also bounded forward with Blockstream’s Liquid sidechain and the steady clip of infrastructural build out that Lightning developers maintain. In short, Q4 positioned 2019 to be the industry’s most successfully private, scaled year to date.

Steven Zheng ()

The Block (Head of Research)

In Q4 we saw the bear market finally take its toll on the industry’s rank and file. A blend of poor treasury management and exuberant spending during the bull run ended with firms desperately looking for ways to cut costs. And, as we’ve seen, the most attractive cost-cutting option appeared to be widespread layoffs. Crypto businesses ultimately realized that they were spending too much time thinking about cryptoeconomics rather than business economics and were rightfully penalized. My prediction for the new year is more layoffs, followed by an intense refocus on building products that actually matter for end users.

Nic Carter ()

Castle Island Ventures (Partner)

Q4 saw sentiment found a new low as enthusiasm for public blockchains continued to abate. Despite this, some trends continued to manifest: block usage on Bitcoin and Ethereum continued its recovery as the major chains saw fresh utilization; LocalBitcoin volumes ticked up, especially in crisis-struck countries; and more mature market infrastructure plays were funded and announced. Subjectively, venture funding finally felt the chill from the downturn in public markets, but it remains robust overall. In the next quarter, I expect a few larger ICO projects to make a stand against regulators while most others melt away and give back what funds they can.

Bernhard Mueller ()

ConsenSys (Product and Security Engineer)

This quarter we’ll see a continued focus on enabling mainstream adoption as major obstacles discovered in the past two years are being cleared. Stablecoins will solve volatility, while scaling solutions and refined user interfaces will gradually make trustless e-commerce on the Internet a reality. Useless coins will continue to die off as investors have become more skeptical about the value propositions of blockchain projects. I expect investments to flow into platforms that innovate and consistently deliver real-world use-cases.

Vin Armani ()

CoinText (Chief Technology Officer)

The last quarter of 2018 was a turning point for Bitcoin and the wider cryptocurrency market. The Bitcoin Cash “Hash War,” which resulted in the creation of the Bitcoin Satoshi Vision (BSV) network fork, left many questioning their understanding of the interconnected nature of the ecosystem. Major Bitcoin miners battled in November, moving hash power off of the BTC network and onto BCH while selling large sums of many different coins to keep the war raging. The resulting price action was a shock to many, who thought that conflict on one chain wouldn’t spill over onto theirs. In the coming years, as consolidation continues in the mining industry, investors and entrepreneurs alike will be wise to gauge the sentiment not only of the market as a whole, but of the key individuals who can turn their personal conflicts into market-wide turmoil. In 2019, I expect to see impressive growth of the entrepreneurial portion of the community, thanks to an ever growing set of tools built specifically to empower new breeds of Bitcoin businesses.

Santiago Siri ()

Democracy Earth (Coder)

In the ecosystem of decentralized applications, use cases that get traction can be found in the metrics that are intrinsic to each project. In the case of Maker DAO, the sustained growth of created CDPs (Collateralized Debt Positions) throughout 2018 shows a real interest in decentralized credit. Other projects like Aragon, DAOStack and Democracy Earth benchmark the economic activity around DAOs (Decentralized Autonomous Organizations). These metrics rather than the analogy of measuring Daily Active Users —as if blockchains served the same purpose of web based networks— are far more relevant to understand what’s actually relevant in the dapp ecosystem.

Jonathan Hales ()

BitBacker.io (Creator)

Q4 closed out the year on a dour note, with prices around the lows of the year. However, the continued censorship and deplatformings on social media platforms and payment processors have created an incredible opportunity. Blockchain and free speech focused platforms such as BitBacker.io will lead a wave of crypto adoption. While we won’t see a return of the speculative frenzy of 2017, there will be a large increase in usage accompanied by a modest price recovery.

Elon Moist ()

Honeyminer (Advisor)

Q4 2018 was quietly one of the most interesting times to be in Bitcoin. As the price dropped, so did its importance in the conversation. We started to see more philosophical questions on Bitcoin emerge. Discussions regarding POW vs POS, Big Blocks vs Small Blocks, On-chain vs Off-chain Governance became mainstream… The average crypto user will be more comfortable with hardforks & network upgrades as we can assume all forks that can exist, will exist. Bitcoin will be defined as the sum of all forks. I believe the most exciting future developments are in Bitcoin-As-A-Computer. As more developers enter the space and actively build applications that store, manage, and run data on-chain, we will see exponential progress in what I believe is the first true “World Computer”. The implications of this are incredibly far reaching. Regardless of what happens in the near term, this is one of the most exciting times to be building in the space. I look forward to a Bitcoin future.

Andrew Hinkes ()

Athena Blockchain (General Counsel / Co-Founder)

The SEC continued its informal “guidance through enforcement,” started with the July 2017 DAO report, and emphasized through its settlement orders with Tokenlot, Paragon, Airfox and others, and its summary comments issued shortly thereafter outlining a “path to compliance” for issuers of non-complaint products, that the law as it exists will be applied to securities, regardless of their form of issuance. Director Hinman’s comments about securities being “sufficiently decentralized” have seemingly been orphaned. We now see multiple approaches taken to token offerings internationally, and see US states experimenting with different approaches- although the domestic state-by-state experimentation is laudable, it has been of limited impact so far. Regulators clearly want federally non-compliant ICOs to remain offshore and away from US investors. Expect more litigation and enforcement against exchanges of cryptoassets, ICO issuers, promoters, and persons acting without required licensure as broker dealers and syndicators of ICOs in the coming years as the SEC mines the data obtained in response to its subpoena campaign of early 2018 to identify defendants. These efforts may be impaired, however, by the ongoing government shut down. As ICOs wound down, domestic fundraisers began to look to compliant tokenized securities. Early versions of these assets resemble ICOs wrapped in securities compliance, providing instruments with restricted liquidity and uncertain legal terms and rights to buyers.

Jason Seibert ()

Seibert-Law (Attorney)

Q4 2018, also known as the great crypto-winter, saw an interesting shift in narrative and dialogue. While some in the industry continue to rail against regulatory interference, others applaud the possibility of regulatory acceptance with the introduction of the token-taxonomy act (and others). Experts continue to argue over the legality of certain types of offerings and ICO’s have all but stopped completely. Many hope that the passage of legislation carving out exceptions for ICO’s will bring a return to the highly speculative industry. Until then, the STO is the new shiny toy, but without adequate or available liquidity in the form of ready exchanges, the success of STO’s remains to be seen.

Nelson Rosario ()

Smolinski Rosario Law PC (Principal)

For whatever reason, the crypto-community treated the end of Q4 2018 as an event to celebrate. As if the so-called CryptoWinter had passed and nothing but green pastures lay ahead. In terms of the legal and regulatory landscape the reality seems to be quite different. Regulators began asserting themselves in earnest in 2018, and there is no reason to think they will pull back in 2019. Similarly, many of the parties that were burned by failed ICOs have only recently begun filing lawsuits and we can expect many more lawsuits in 2019. The CryptoWinter may have just begun.

We want to hear your perspective too! Do you have thoughts on the crypto industry? Do you want to add to the conversation? Do you want to help shape the direction the ecosystem moves in? If the answer is yes to all three of those, please fill out our survey. We will be releasing this in the coming weeks with tons of insights provided by…none other than YOU!

https://www.surveymonkey.com/r/LQJQMR7

Michael J. Casey is the chairman of CoinDesk’s advisory board and a senior advisor for blockchain research at MIT’s Digital Currency Initiative.

The following article originally appeared in CoinDesk Weekly, a custom-curated newsletter delivered every Sunday exclusively to our subscribers.

___________

Don’t look now, but there’s an elephant in the room. Scratch that. It’s an entire herd of elephants.

While Crypto Twitter bickers and fights, leaving competing coin projects and blockchain startups to defend each others’ counter-allegations of centralizing misdeeds, the real centralizing power-mongers of our digital economy have been pillaging our data and reshaping humanity into an instrument of their domination.

That’s the alarming, bold conclusion of “The Age of Surveillance Capitalism: The Fight for a Human Future at the New Frontier of Power,” the recently released mega-tome by Harvard Business School professor Shoshana Zuboff.

My prediction: this book, which eviscerates the “applied utopianism” and “technological inevitablism” of data-gobbling Silicon Valley titans such as Google and Facebook, will become a defining text of our age. Read it. It is of vital importance.

I especially think it’s critical reading for the crypto community, where people will feel both vindicated and challenged by Zuboff’s thesis.

If blockchain technology is to play an integral role in the evolution of the digital global economy and be a force for good, rather than a vehicle of computerized subjugation, its advocates will have to contend with the angry backlash against digital technologies that this book will help fuel.

How, truly, is blockchain any better than GAFA (Google, Amazon, Facebook, Apple)? How do we ensure that it doesn’t fall for the same pattern of what Zuboff calls “behavioral surplus extraction?” A general public that’s increasingly anxious about their invaded privacy and lost personal agency deserves such questions answered.

Not left, not right

It’s hard to pigeonhole this writer. Zuboff’s instincts are liberal, and she takes a very hard view of raw market power. But her defiant support of the right to individual free will – framed in her elegant phrasing as the right to “sanctuary” and to “the future tense” – dovetails nicely with the views of many pro-privacy advocates in the blockchain community.

The lines between left and right have been blurred for some time. While Zuboff’s no fan of unfettered market capitalism and doesn’t think much of Friedrich Hayek, the Austrian economist who’s a darling of many bitcoin fans, there’s much that lines up here with the crypto world’s cypherpunk vision of freedom.

To be sure, the solutions are different. A blockchain solution for breaking down surveillance capitalism would naturally be a technological one, embracing the power of math and cryptography to design a new digital topography of trust that disempowers the centralized middleman and creates human agency within a decentralized system.

Zuboff, by contrast, is suspicious of the absolutism of math-based solutions, and focuses instead on the levers of government. And, since she’s very concerned with the complicity of Western governments in encouraging the current model, she first insists on restoring real democracy to change the system from outside the digital realm.

Her most important contribution to our reckoning with this problem is to craft a language with which to describe what has happened to society in the past two decades. Zuboff’s task is to get us beyond the pre-existing frames of reference that constrain our ability to define the unprecedented – as when people at the start of the last century described cars as “horseless carriages.”

Introducing new words and concepts such as “surveillance capitalism,” “instrumentarianism,” “Big Other” and, my favorite, “surveillance-as-a-service,” or SvAAS, she gives people a taxonomy for describing the previously indescribable.

That, in itself, will have powerful ramifications, as it will enable the counterattack from citizens, businesses and governments feeling dislocated by the social dysfunction that shows up in our politics, economic divisions and crumbling bonds of trust.

“If democracy is to be replenished,” Zuboff writes, “it is up to us to rekindle the sense of outrage and loss over what has been taken from us.”

A topic we can’t ignore

I personally found many of Zuboff’s anti-technology positions too extreme. Whereas she sees the concept of “hive minds” as dehumanizing, reducing individuals to automatons, I think it’s possible to envisage an information technology-enriched world in which truly autonomous, free-thinking humans more easily come together and collaboratively innovate. The open-source inventiveness of global blockchain development communities speaks directly to this.

But where people like Zuboff matter is that, right or wrong, their words stir discourse and debate. Like it or not, this is going to be a talking point for all of us.

So, if blockchain technology is to be relevant, if its advocates are to rise above the false but, sadly, prevailing mainstream view of them as scam artists and lambo-loving day traders, they will need to insert themselves into the debate.

Some will rightly see an opportunity here for pro-privacy developers. Those building zero-knowledge-proof systems and other privacy-protection layers can talk to a vision of decentralized protocols that both empower individuals to control their own data and prevent the public ledger from becoming a new behavior extraction tool. That’s one potential answer to surveillance capitalism.

But it’s also important that crypto-savvy businessmen, lawyers, policymakers, academics and journalists are part of this conversation.

How can we ensure that the right regulations, standards, and best-practice norms are installed such that the technology develops on a much healthier trajectory than that with which the current Internet economy has evolved?

Let’s keep our eyes on that ball.

Surveillance camera image via Shutterstock.

Eric Gravengaard is the co-founder of several digital currency businesses including Athena Bitcoin and Red Leaf Advisors.

———

I have spent much of my career in financial services working for Chicago’s proprietary trading firms which act as market makers on the derivatives exchanges. These firms are responsible for providing prices to the derivatives exchanges (CBOT, CME, CBOE) for options contracts, futures, etc. and are an important part of an orderly marketplace.

In this post, I will discuss both the function and role of a market maker, the rules that govern market makers in the United States at major exchanges, and how that should guide exchange rules for crypto assets including ICOs and STOs.

Making a market orderly

The goal of any exchange is to create an orderly market for assets, whether they be stocks, futures, options or anything else that can be traded.

Orderly is defined as having a balance between buyers and sellers that deal in an equitable manner at prices that are roughly equal to fair value. One way exchanges create orderly markets is by selecting or permitting market makers who have both an obligation to provide quotations and in return receive special access.

In general, market makers are obligated to provide a quotation, prices to buy or sell an asset, at all times when the market is open. Exchanges can then guarantee to customers that they can trade at a reasonable price at all times. Markets without market makers can be functional and orderly, but there are no guarantees that a customer will always be able to trade a reasonable amount for a reasonable price, unless someone is obligated to provide such a quotation.

To make a market, a trader must have a sense of what the fair value is for an asset. For example, if Stock AAA last traded at 10.00 and was relatively liquid I might make a market 9.95/10.05 — I would be willing to buy a share of AAA for 9.95, or sell a share of AAA for 10.05. In the fast-paced world of listed stock trading, that market is far too wide, but perhaps not if AAA only trades once or twice a day.

There is nothing to say that a customer must trade with the market maker; they could send a limit-order to buy 100 shares of AAA for 10.01.

In that case, the market maker is in competition with other market participants to trade the difference is that market maker may have an obligation to send prices at all times, where the lone trader does not have such obligations.

Obligations?

I’ve used the word obligation several times to describe the duty of a market maker. Each exchange may have different rules for market makers and participants.

At the CBOE, Rule 8.7 (Obligations of Market-Makers) describes the many obligations of participants in their market making program including 8.7(b)(iv):

“To price options contracts fairly by, among other things, bidding and/or offering in accordance with the bid/ask differential requirements determined by the Exchange on a class by class basis.” And Rule 8.7(d)(ii)(B) states that “A Market Maker will be required to maintain continuous electronic quotes […] in 60% of the […] options series of the Market-Maker’s appointed classes…”

Those are just some of the obligations that the CBOE places on participants in their market making program, the entire rule delves more deeply into the nuances of the hybrid floor/electronic model and the specifics of the products that are traded on the options exchange, but the general model is that market makers help the exchange to create a fair and orderly market.

The market for token

Recently, I and some of the companies I am associated with have been approached by token issuers, token technology providers, and token exchanges to make markets for tokens. In general, we could probably provide a quotation and contribute to an orderly marketplace for these tokens.

There are many reasons why we might not be able to create an orderly marketplace, but that is probably best left for another article. In most of these offers, we are to be compensated for operating as a market-maker by either the exchange or the token issuer. And in this case, I am speaking of both tokens that were issued explicitly as securities in an STO and also utility tokens that were sold in an ICO. We have never said yes to these offers.

Why can’t we say yes to making a market and being paid for providing such a service? Our response generally comes down to two problems.

The first is ethics, it is a conflict of interest to be paid by the issuer of a security or other asset and also be responsible for making a fair quotation that respects a true balance between supply and demand. Could a quotation be skewed by a profit motive other than dealing around fair value? That is not a position we wish be in or an ethical dilemma we need to invite upon ourselves.

The second reason we have not entered into pay-for-market-making arrangements is that it is explicitly against the rules that govern the securities industry. FINRA, the Financial Industry Regulatory Authority, a self-regulatory organization that many/most broker-dealers are members of, specifically prohibits this behavior in Rule 5250 (reprinted below):

FINRA Rule 5250

(a) No member or person associated with a member shall accept any payment or other consideration, directly or indirectly, from an issuer of a security, or any affiliate or promoter thereof, for publishing a quotation, acting as market maker in a security, or submitting an application in connection therewith.

(b) The provisions of paragraph (a) shall not preclude a member from accepting:

(1) payment for bona fide services, including, but not limited to, investment banking services (including underwriting compensation and fees);

(2) reimbursement of any payment for registration imposed by the SEC or state regulatory authorities and for listing of an issue of securities imposed by a self-regulatory organization; and

(3) any payment expressly provided for under the rules of a national securities exchange that are effective after being filed with, or filed with and approved by, the SEC pursuant to the requirements of the Exchange Act.

(c) For purposes of this Rule, the following terms shall have the stated meanings:

(1) “affiliate” shall have the same definition as used in Rule 5121;

(2) “promoter” means any person who founded or organized the business or enterprise of an issuer, is a director or employee of an issuer, acts or has acted as a consultant, advisor, accountant or attorney to an issuer, is the beneficial owner of any of an issuer’s securities that are considered “restricted securities” under Securities Act Rule 144, or is the beneficial owner of five percent (5%) or more of the public float of any class of an issuer’s securities, and any other person with a similar interest in promoting the entry of quotations or market making in an issuer’s securities; and

(3) “quotation” shall mean any bid or offer at a specified price with respect to a security, or any indication of interest by a member in receiving bids or offers from others for a security, or an indication by a member that it wishes to advertise its general interest in buying or selling a particular security.

This is very clear guidance that broker-dealers, associates and affiliates of broker-dealers, or generally any registered persons should not be compensated by “promoters” of securities, whether tokenized or not. We take this rule very seriously and we believe the rest of the STO/ICO market should as well. I fully understand that many firms, be they hedge funds or individuals, are not members of FINRA and do not have to comply with this rule, however, the rule exists for good reason and helps to create a fair and orderly market.

Have ICOs paid for market making in the past? Yes. I have heard from many people that such deals have been struck in the wild days of 2017 and 2018. I think that needs to stop immediately. How can the public trust prices if some of the market participants are being compensated for trading? Are there undisclosed bonuses being paid if the price stays above a certain level?

I originally titled this post “Market Making as a Service” because that was the title of an email I received recently by someone in the STO market, who was suggesting that my firm start offering a service to token issuers and that he could arrange for such contracts. Many of the early crypto traders did not come from traditional financial services backgrounds, and I recognize that the Chicago market-making community is but a small piece of the entire financial services world.

However, it is time that the crypto-world began to adopt some of the best practices of the traditional public securities exchanges, and that includes basic rules of ethics, fair dealing, and orderly markets. And that starts with ending the practice of issuers or promoters paying for market making.

Why can’t anybody act as a market maker?

So why can’t a customer or hedge fund or generally savvy trader act as a market maker?

This again gets to the rules of the exchange. Remember, exchanges want to have orderly markets with fair prices. So they regulate who can and cannot act as a market maker. Most US exchanges have rules that are similar to CBOE Rule 6.8, which is titled “Prohibition Against Customers Functioning as Market-Makers” and I think makes it pretty clear that on their exchange not just anyone can enter two-sided quotations:

CBOE Rule 6.8

Prohibition Against Customers Functioning as Market-Makers

(a) TPH organizations may neither enter nor permit the entry of priority customer orders into the Hybrid System if (1) the orders are limit orders for the account or accounts of the same beneficial owner(s) and (2) the limit orders are entered in such a manner that the beneficial owner(s) effectively is operating as a market maker by holding itself out as willing to buy and sell such securities on a regular or continuous basis.

(b) In determining whether a beneficial owner effectively is operating as a market maker, the Exchange will consider, among other things, the simultaneous or near simultaneous entry of limit orders to buy and sell the same security and the entry of multiple limit orders at different prices in the same security.

Envelope image via Shutterstock.