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One of the most common things I’ve heard people say about prop is that it’s the new binary options.
Binary options is a phrase that seems to elicit a knee jerk response from many people in the industry and wider world. The tendency is to act as though the product is inherently evil.
To me this is kind of like looking at Bernie Madoff or Michael Milken and reaching the conclusion that investing in stocks is a bad idea. The product is not the problem, people who commit fraud using them are.
Most binary conmen emerged in about 2010 and were probably at a peak in the mid to late 2010s. The product had already existed in the retail space for over a decade before that without many problems.
And indeed today, with most of the bad people removed from the industry, there are still a lot of big players who do binary options. Did you hear about any problems? Not so much. You can still offer them in the US and Japan, with the former now shilling hard for a new form of them – event contracts.
The point is that you could take basically any instrument – crypto, CFDs, or binaries – and use them to run a boiler room fraud.
However, this is actually an area where I think props are less susceptible to fraud, compared to those other products. The basic logic of most of these scams is…
1) Someone does high pressure victim to deposit as much money as possible
2) Shows victim fake returns on scam platform
3) Victim keeps depositing
4) Scam people cut them off and steal the cash once they have nothing left to deposit
With prop there is no deposit and you are capped at how much you pay for a challenge. The most expensive challenge tends to be about $1,000.
Now imagine you are trying to get someone to continuously buy that challenge over and over again. This would be pretty difficult. You can’t claim, like the boiler room guys, that they are ‘doing great’ because the only reason you’d have to buy a new challenge is if you failed the previous one.
Then you have to factor in how many purchases you’d have to make in order to get the equivalent of a ‘whale’ as a depositor. If they were buying a $1,000 challenge then it’s 100x to get the equivalent of a $100k deposit. Good luck.
This to me actually points to one of the broader weaknesses of prop as well. A (legit) CFD broker can take a huge deposit. A prop is capped out at how much it can charge for a challenge.
The deposit factor is important for another reason as well. When you take a deposit it means holding client funds, segregated accounts and so on.
Originally binaries were not subject to regulations in most jurisdictions but it doesn’t take much to make the connection between someone depositing money and trading a derivative of a financial product and saying it should be subject to financial regulations.
Prop trading is different and, although I would not rule out regulators doing something, it will be interesting to see how they try to do that. The reason for this is obvious – no client funds are held and no ‘real’ securities are traded because everything takes place on a demo account.
At the same time, there is no doubt that the fact that the product is unregulated lends itself to ‘scam bro’ type people. We’ve already seen this kind of thing happen where people open props then shut them and run off with a bunch of cash.
I would say two points in response to that. Firstly, crypto has been around for almost two decades now and it seems like every day you read about some random heist, pump and dump, or pig butcher scheme. And yet big players seem to have no problem with crypto.
Secondly, I would not mistake incompetence for being a fraud. Many prop founders are similar to guys who set up brokers 10 to 15 years ago. They are people who come from technology or e-commerce (or both), not financial services.
As a result, many of them are essentially learning on the job. They understand marketing and selling but know a lot less about the operations of running a broker-type business. It doesn’t help that a lot of the stuff they are trying to do has not really been done before.
From my own experience so far, I would say there are many more of the latter group than the former. For example, there are several props that I am aware of who are investing heavily in dealing. It is hard to see why you would bother doing this unless your intention was to run things properly.
The final area where there is arguably some level of comparability between props and binaries is hedging. Binaries are difficult or even impossible to hedge, depending on the time frame they’re trading in.
As we’ve looked at on a few occasions, prop flow is arguably in the same boat. However, I think if we move to a point where props set up a-book flow for people that pass challenges, that point is negated.
But this is also besides the point. The people who ran binary scams weren’t ‘bad’ because they weren’t managing risk correctly (lol). They were bad because they were literally just criminals stealing people’s money.
The same is true of prop. Trading challenges are not inherently bad. People who scam you are.