Crypto Prop Trading Firms: How They're Changing the Investment Landscape

Proprietary trading firms are increasingly entering the cryptocurrency space, using their expertise to profit from opportunities in crypto. They’ve adapted their trading platforms, infrastructure, and technology to accommodate the unique requirements of crypto trading. The high volatility and price fluctuations in this market help create greater opportunities for crypto prop trading firms to generate high returns.

Here, we explore the world of crypto prop trading firms, how they work, their challenges and advantages, and what the future of proprietary trading in the cryptocurrency market looks like.

What Are Crypto Prop Trading Firms?

Prop trading is short for proprietary trading, where a financial firm engages in trading activities to make money for itself, rather than for external clients. The firm provides traders with capital and a trading account. These affiliated traders then use their skills and experience to make trades and generate a profit, part of which is shared with the firm. This type of trading model is appearing more and more in the crypto space, where prop firms are using their expertise to profit from the digital asset market.

The key characteristics of a crypto prop trading firm are:

• It has no external clients and uses its own capital to trade cryptocurrencies for a profit.

• Professional crypto traders use the firm’s capital to profit from price discrepancies and fluctuations within the crypto market.

• These firms provide crypto traders with various tools, infrastructure, training, mentorship, and strategies to help improve their skills.

• They also provide traders with access to substantial capital for trading.
  To join such a firm, a trader will need to undergo an evaluation period and demonstrate their ability to generate profits in the crypto market.

• The profits generated through this process are then shared between the prop trading firm and the traders themselves.

• Most crypto prop trading firms have rules that affiliated traders must adhere to, such as a maximum daily loss limit, an end-of-day drawdown limit, and a limit on the maximum number of open trades.

• Failure to follow these rules could lead to warnings and eventual profile suspension.
  

Some factors that traders should consider when choosing a crypto prop trading firm include the profit-sharing ratio, membership fees, tools and infrastructure, withdrawal rules, and educational resources such as courses and mentorship opportunities. 

Which Prop Firms Support Crypto Trading?

Due to the risks associated with cryptocurrencies and their speculative nature, only a few prop trading firms currently support crypto trading. Some of the most popular ones amongst individual traders include:

• FTMO Proprietary Trading Firm: Has revolutionised the crypto trading market with its challenging two-stage assessment and 90-10 revenue sharing model.

• HowToTrade: Provides the affiliated crypto traders with world-class resources, including education materials, analysis, 24/7 support, video tutorials, and more.

• City Traders Imperium: Provides traders with a 70-30 revenue-sharing model, alongside a wide variety of tradable assets (including various cryptocurrencies) and great flexibility.

• Fidelcrest: This prop trading firm is known for its rigorous security layers and risk management protocols, as well as its rapid withdrawal mechanisms designed for maximum efficiency.

• Crypto Fund Trader: Specialising in crypto futures, this firm offers an 80-20 revenue-sharing model, tailored educational content, and highly sophisticated risk management tools.

• Lux Trading Firm: They offer a powerful and versatile trading platform with automated trading capabilities, technical analysis tools, and access to more than 500 cryptocurrencies. 
  

The Evolution of Cryptocurrency Trading

After the launch of Bitcoin in 2009, crypto trading began as a niche market driven primarily by retail investors who were drawn to the idea of decentralised digital currencies. During the early 2010s, the crypto market experienced huge volatility, investor speculation, and the resultant price fluctuations. 

This was followed by the emergence of regulatory frameworks, which helped attract institutional investors to the crypto market. To cater to the institutional demand, specialised cryptocurrency hedge funds and investment funds began to emerge, allowing financial institutions to gain exposure to crypto through safe, professionally managed portfolios. 

The Role of Institutional Investors

This coincided with (and aided) the emergence of crypto prop trading firms, which began deploying their own capital to make trades and generate profits in the crypto space. These prop trading firms, along with state-of-the-art crypto trading platforms, made digital assets available to investors and traders around the world, further expanding the market. 

Over time, the entry of institutional investors like banks, insurance companies, and pension funds helped turn crypto into a legitimate asset class. For institutional investors, cryptocurrencies began to serve as a potential source of uncorrelated returns as well as a hedge against the fluctuations of traditional financial markets.

Some factors contributing to the rise of crypto prop trading firms are:

•  Lower barriers to entry, thanks to cutting-edge tools and infrastructure.

• Increased regulatory oversight in the crypto space, leading to greater clarity.

• Global market accessibility and the resultant expansion of crypto trading.

As trading technology continues to advance and regulations become more well-established, the influence of institutional players (including crypto prop trading firms) is likely to increase, helping shape the future of crypto markets.

The Function of Crypto Prop Trading Firms

Some of the key functions that a proprietary trading firm performs in the crypto market are:
 
Market Making: Crypto prop trading firms provide liquidity to the market by using high-frequency trading and automated algorithms to constantly buy and sell cryptocurrencies, to profit from the bid-ask spread. This makes the market more efficient and helps reduce volatility.

Arbitrage: Crypto prop trading firms exploit minor price differences for the same asset on different crypto exchanges to buy low, sell high, and make a profit. This helps keep the prices aligned on different exchanges, enhancing the efficiency of the crypto market in general.

Quantitative Trading: By making use of data-driven algorithms and statistical models to identify opportunities and execute high-frequency trades, crypto prop trading firms minimise market inefficiencies and contribute to the overall stability of the crypto market. 

In short, crypto prop trading firms perform several vital functions within the crypto market by exploiting arbitrage opportunities to increase market efficiencies, providing liquidity, and using their robust market analysis capabilities to manage risk, thus helping steer the market in the right direction. 

Advantages and Challenges

Now that you know about the evolution and functions of crypto prop trading firms, it’s time to learn about some of their major advantages as well as the challenges they frequently face. 

Advantages

• Specialisation: Each trader at a prop trading firm has specialised knowledge in a different area of the crypto market, allowing the firm to make use of this diverse and in-depth expertise to make profitable trades. 

• Advanced Technology: The best crypto prop trading firms provide their affiliated traders with cutting-edge trading tools, analytics software, and risk-management tools, vastly improving their competitive edge.  

• Capital: Crypto traders can access significantly larger amounts of capital by working with a prop trading firm, allowing them to take larger positions and earn higher profits with each successful trade.  

• Training: Crypto traders working with a prop trading firm will receive comprehensive training, support, educational resources, and (occasionally) mentorship opportunities, helping them rapidly improve their skills. 

• Shared Risk: By providing the capital for trading, crypto prop trading firms also take on a part of the risk. This allows traders to take larger positions without risking all of their own money. 

• Compensation: Prop trading firms can incentivise traders to make better, more profitable trades by offering attractive profit splits, meaning that the trader will only get paid if they generate a profit for the firm. 

• Regulatory Flexibility: Since crypto markets haven’t yet become as heavily regulated as other financial markets, crypto prop trading firms still enjoy a significant amount of regulatory flexibility that can allow them to be more adaptable and innovative in their trading strategies. 

Challenges

• Volatility: When compared to some of the other more established asset types, the crypto space can be relatively volatile and unregulated. This can increase the risk of potential losses caused by sudden and significant price swings. The relatively unregulated nature of crypto can add to the problem by creating further uncertainty and compliance complexities, which would affect stability and make risk management even more difficult. 

• Security: Being highly dependent on technology and digital tools, crypto prop trading firms must face certain security challenges. These include system outages, the risk of a potential data breach, hacking, and capital mismanagement. Hence, the firm must invest in a robust and secure IT infrastructure that can protect against cyberattacks. This is essential for the safekeeping of sensitive data, such as proprietary trading strategies and the personal and financial details of the firm’s affiliated traders. 

• Liquidity: Liquidity risk is an unavoidable reality of the cryptocurrency market. The volatility and price fluctuations in the crypto space can make it difficult for a prop trading firm to exit a position promptly (and at a favourable price). Moreover, the relatively new and untested crypto exchanges are susceptible to system outages, which could prevent a prop trading firm from accessing its account or selling its holdings at a given time. 

Impact on the Investment Landscape

Crypto prop trading firms play a key role in streamlining and optimising the operations of the crypto market, while also having an impact on the broader financial and investment ecosystem. They improve price efficiency, affect market liquidity, and often spearhead innovation in the realms of trading technologies, strategies, and risk-management tools.
 
The rapid and high-frequency trading strategies employed by these firms can impact market volatility and contribute to short-term price fluctuations in the crypto space. However, their innovations in risk management and efficient trading practices have also contributed to the stability of crypto markets. 

Market fragmentation, potential disruptions, and systemic risks are some of the challenges posed by proprietary trading firms. Regulators must find a way to deal with these risks before the market as a whole can benefit from the advantages offered by these companies. 

Here are some of the important ways in which crypto prop trading firms impact the wider market and the investment landscape:

• The largest crypto prop trading firms are highly interconnected with major market participants like hedge funds, banks, crypto exchanges, and institutional investors of all stripes. 

• This interconnectedness ensures that any change or disruption within a major prop trading firm will reverberate throughout the wider crypto market, as well as the financial ecosystem as a whole. 

• By buying and selling large amounts of crypto assets, prop trading firms also raise the level of liquidity in the market, making it easier for other investors to start trading in the crypto space. 

• Lastly, the rise of crypto prop trading firms has added to the competition in the crypto space, which will over time result in lower fees, better execution, and higher returns for investors.

   

So, while these firms have had an overall positive impact on the market, regulators must stay vigilant in trying to minimise their potential drawbacks. 

Regulation and Compliance

The regulatory environment for crypto prop trading firms is still nascent and evolving, both in the UK and across the EU. The Financial Conduct Authority (FCA) has yet to issue any specific regulations for these firms beyond the usual anti-money laundering (AML) related requirements. However, various potential regulatory measures are under consideration and may be implemented in the near future. These include:

• Imposing capital requirements on crypto prop trading firms

• Requiring them to acquire licensing or authorisation from the FCA

• Establishing clear criteria for obtaining and maintaining such a licence

• Making it mandatory to implement strong risk management systems

• Setting limits on position sizes and leverage to reduce systemic risks

• Enforcing regular reporting and transparency in trading activities

• Requiring regular audits of cybersecurity measures implemented by the firm

• Mandating the appointment of a compliance officer to ensure observance

Most crypto prop trading firms will benefit from further regulatory oversight, as it would provide them with some much-needed clarity and certainty about the environment in which they’re operating. This would lead to greater stability in the crypto market as a whole. However, the firms will have to bear the costs associated with compliance, which might be seen as a burden by some. 

The Future of Crypto Prop Trading

The crypto market is still in the (relatively) early stages of its development, but growing interest from institutional investors and increasing regulatory clarity could help expedite the development and growth of crypto prop trading firms. These firms are expected to play a key role in:

• Facilitating the integration of crypto assets with traditional finance

• Providing market-making and liquidity services to the crypto market

• Encouraging the development of innovative trading strategies 

Despite their great potential, however, crypto prop trading firms still face many challenges such as regulatory uncertainty and high volatility. They also deal with the difficulties of attracting (and retaining) key talent to a relatively new sector. These problems will have to be addressed and resolved before crypto prop trading can reach its full potential. 

Summary

Crypto prop trading firms are playing a critical role in facilitating the integration of cryptocurrency assets within traditional finance. By using specialised knowledge and advanced technology to navigate the volatile and dynamic crypto market, these firms are spearheading a transformative shift in the modern financial landscape. 

Find out how BSO’s cutting-edge crypto solutions for institutional investors can help you take advantage of this shift and enhance your company’s crypto trading strategy. Alternatively, get in touch with our experts to learn more.