eToro shifts away from high risk CFDs

Yoni Assia Photo: eToro PR

In order to list on Wall Street, the Israeli social network trading platform has been jettisoning problematic but profitable products and hiring former regulators.

On the website of Israel-Cypriot trading platform eToro is a warning that says, "CFDs are complex instruments and come with a high risk of losing money rapidly due to leverage. 67% of retail investor accounts lose money when trading CFDs with this provider. You should consider whether you understand how CFDs work, and whether you can afford to take the high risk of losing your money.

As a trading platform registered in Cyprus, eToro is required to publish this warning. It is related to the financial instrument through which the company grew and served as the main basis for its revenue until about five or six years ago: CFDs (contract for differences) - a financial contract that pays the differences in the settlement price between the open and closing trades.

The leverage decreased, the value rose

eToro is expected to complete its Wall Street listing in the third quarter of 2021. In March, the company agreed a merger with special purpose acquisition company (SPAC) led by Betsy Cohen, which gives eToro a company valuation of $10.4 billion. Wall Street SPAC specialist Cohen also led a SPAC, which last week completed a merger with Israeli payments solutions company Payoneer.

Sources close to the matter have told "Globes" that in order for eToro to reach its current valuation, it has been forced to significantly reduce its leverage in its accounts and today the proportion of its overall leveraged assets of its customers is just 5%, or $400 million. The rest is invested in other instruments such as stocks, exchange traded funds (ETFs) and crypto-currencies. Since the launch of its social network last decade, the company's revenue has grown five-fold by adding genuine trading options in digital currencies and parts of stocks that do not involve CFDs, similar to its rival Robin Hood.

One of the reasons that Israel's former Supervisor of Banks Hedva Ber and former Israel Securities Authority chairman Shmuel Hauser were brought into the company was to find ways of decentralizing the company's financial instruments and raising the company's profile for other regulators worldwide. eToro is preparing to increase activities with the regulators in the UK, EU, and the US as well as to take out trading licenses in Singapore and Abu Dhabi.

A dangerous tool for customers and companies

CFDs are a financial product that allows the trader to buy shares indirectly - in other words not directly from the stock exchange or the trading platforms of banks or financial institutions but through a broker who buys the shares in their name and attributes the share to the customer without transferring it to them. Every movement in the share is reflected in the capital that the customer invested in the account of the broker, so that the share's rise brings profit and its fall brings losses.

For the customer, the advantage is the option of buying parts of shares, to leverage the investment in the share or short trade it. As well as shares, it is also possible to buy CFDs on currencies, commodities, ETFs and crypto-currencies. But the reason for many losses by retail customers purchasing CFDs, as they are described on the company's website, is inherent in the fact that they allow leverage which increases exposure to major losses. eToro is not the only platform that offers this. Another Israeli company Plus500 and the UK's Trading 212 also offer a similar service.

The leverage that allows the customer to increase the amount that they earn, but at the same time also the amount that they lose. For CFD traders, the higher the leverage, so the risk rises tens of times. This is an instrument that generates revenue and is very profitable but regulators worldwide also consider it to be a dangerous financial instrument. US residents are still not permitted to trade in them and in Australia the authorities have warned that trading in CFDs is even more dangerous than gambling in a casino or betting on horseracing. And this is not only for private investors but also the level of risk contained in eToro itself is high.

For a company like eToro, managing CFD trading carries relatively low expenditure: the company is not always required to buy the shares and commodities that its customers buy and can function as a low risk broker by 'rolling' the risk onto external bodies. But this dependence also has its risks. CFDs are an instrument that are unacceptable in many countries including Israel and this exposes eToro's income to risk subject to sudden fluctuations in the prices of commodities or currencies, and in the past this has influenced CFD trading on the Russian ruble and Swiss franc.

Trading accessibility for the young

eToro is not the usual trading platform that offers CFDs and trading in crypto-currencies. Its success is an outcome, first and foremost, from its trading accessibility to young punters through the addition of a social network and ratings by opinion leaders and influencers in the investment sector. A new investor who joins the platform can learn to invest by following the investments of others. But there is a fly in the ointment. The influencers who are rated in an index of the biggest earners might be those who conduct the highest leverage and imitating them could lead to even bigger losses. In order to prevent this, eToro states the level of risk carried by influencers in their rankings.

Another major criticism of the company in this aspect of things relates to the profits produced by the influencers from the number of their followers. Accumulating more followers earns them higher fees, and this allows them to take greater risks and increase their leverage - something that a regular investor cannot allow themselves to do.

To the credit of eToro, it should be said that the company has succeeded in lowering the fear barrier through a system that simulates 'dry run' investment, so that a new investor can practice for a while before plunging into real investments.

eToro has successfully ridden the comparison to Robin Hood and the wave of investments by retail investors but Robin Hood declares that it does not allow trading in CFDs, which are not acceptable in the US market. "With Robin Hood, the customers themselves own the shares and Robin Hood does not engage in CFDs, which is a type of forex activity," Robin Hood's website says. "We are not a market makers but brokers." In the past few days Robin Hood has filed a prospectus for an IPO but has not yet published any expected date or valuation.

eToro currently has 20 million registered users worldwide including millions in 43 states in the US. States like Delaware, Minnesota, New York, Nevada and Tennessee allow their residents to register on eToro but not to trade. Smaller states like Hawaii and territories like the Virgin Islands prohibit their residents from becoming eToro's customers. In the rest of the US states, residents are allowed to trade on eToro but cannot trade in CFDs. They even receive benefits and discounts on fees not available to residents of other countries. As part of eToro's growth strategy, the company is interested in expanding permitted operations and launching platforms for trading in stocks for free. This will increase the competition between eToro and Robin Hood (which only operates in the US) in the niche of share trading and digital currencies.

"Few invest in complex products"

eToro said, "eToro was founded in 2007 by CEO Yoni Assia, Ronen Assia and David Ring, with a vision to open up global markets and allow every person to invest in the capital market in a simple and transparent way. eToro launched its social investment network in 2011 in order to help its customers connect with each other and follow leading investors, as well as to allow financial education using the platform. Today, eToro is one of the world's leading fintech companies in investments in share trading without fees and in crypto-currencies. eToro operates according to the strictest standards with financial licenses from the world's leading regulatory authorities including in the US, Europe, UK, Australia and more."

"e-Toro has experienced major growth in recent years as part of a global trend of a broader participation by retail investors in the capital market. As part of the global expansion of the company, several senior consultants have joined eToro including Christopher Giancarlo (former CFTC chairman), Shmuel Hauser, Salomon Sredni (former Tradestation CEO - one of the biggest brokers in the US) and Hedva Ber, who has since joined eToro as VP and global COO."

"The company recently published financial results for the first quarter of 2021 and that its customers hold about $8.4 billion in assets on the platform. Over 95% of the assets held are in shares, digital currency and cash and only a few of the customers today invest in complex financial products."

Published by Globes, Israel business news - en.globes.co.il - on July 8, 2021

© Copyright of Globes Publisher Itonut (1983) Ltd. 2021

Yoni Assia Photo: eToro PR
Yoni Assia Photo: eToro PR
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