Investing your savings is a key part of building wealth and should not be overlooked by anyone managing their own personal finances. Although the sentiment behind capital preservation is universal, unfortunately, access to investable markets is not.
The rise of alternative investment markets, consumer-fintech solutions, and blockchain technology has empowered millions of investors in emerging markets. However, the persistent inequity and inequality of financial markets shows that global financial markets still have a long way to go before being considered efficient and effective by Western standards. Distinguishing between the problems of investment market inequity and inequality is imperative for businesses that aim to address the rising demand for global market efficiency. It is important to consider; how inequity shapes investor behavior in emerging markets, the implications of equal markets, and what pain-points emerging solutions attempt to solve.
Investmentable Market Inequality and Inequity
Unequal access to investable markets is – and has been – the status quo for most markets. Investors in developed countries have access to significantly more securities than investors from emerging markets. An investor in Eastern Europe, not being able to trade shares of Apple Inc. is an example of investment market inequality, which is unequal access to the same set of (investment) opportunities.
It should come as no surprise; globally, markets may have different participants, cross different cultures, and offer different scopes of exposure. Likewise, varying banking systems, regulatory frameworks, and political and socio-economic factors also contribute to inequity. In this context, inequity is the lack of the tools or avenues required to reach the same investment objectives.
These differences inherently lend themselves to different investment climates and practices, creating challenges for participants.
Conversely, it is some of those factors that also make select markets attractive as diversifying components to investors hailing from developed jurisdictions. For example, assets governed by the laws of Islamic Banking offer investors a different scope of systemic risk.1 Unfortunately, most differences still result in the ineffectiveness of emerging securities markets, evident in the prevalence of auction markets versus dealership (quote-driven) markets.2
Whether these differences make emerging markets attractive to western investors is a secondary concern. Emerging markets can be both efficient and ineffective at the same time. They can adequately reflect all available information, but fail to reach investors’ exposure, return, or risk goals. Developed-world stock markets are but a beacon of hope in the distance, close enough to be seen, but still unattainable for most developing world would-be investors.
Malicious Actors in Equitable Solutions
Ultimately, investors in emerging markets that are unsatisfied with local solutions must bridge the inequity gap, and look for ways to invest in developed markets. If an individual is legally able to invest in foreign stock then they will inevitably have to deal with middlemen, commissions, high initial capital requirements, and potentially dubious fees and tax implications. Equity comes at a high price. This used to be the case for retail investing in western markets as well, and advances in fintech- fueled by consumer demand – were able to eliminate the inequity gap between retail and professional investors.
In the search for less taxing means of accessing foreign markets, investors from emerging markets turn to imperfect, and sometimes borderline-fraudulent, solutions.
Forex brokers, which gained popularity in the mid-2000s, target individuals with high risk tolerances from developed nations but, in emerging economies, go after the financially responsible. The promise of leveraged exposure to foreign currencies, offering a diverse market exposure, is a good sell for someone that is normally only able to invest in their local currency and in low-yield money market securities.
In the 2010s, Contracts For Difference (CFDs) became popular with retail investors seeking exposure to commodity and stock markets. At inception, CFDs were intended to be used by professionals – as most derivative instruments are – as a type of equity swap that was easy to leverage. CFD brokers, acrimoniously called “CFD shops” in reference to bucket shops of the 1900s, offer investors the opportunity to earn a return proportional to the differences in settlement between open and closing trade prices for an asset. In other words, CFD investors gain exposure to the price differences of an underlying market but without ownership. An investor can buy a CFD of Apple’s stock, and if the stock appreciates 1%, the investor earns a 1% return upon terminating the contract.
While these solutions may offer investors the exposure that they desire, they seldom help investors reach like-economic outcomes. For starters, these investments are not transferable, incur high fees, and are often brokered by parties with conflicts of interest with their clients. Many brokers resort to manipulating their own order book, quotes, or trading frictions, in order to put the client at a disadvantage resulting in the forfeiture of their balance. While there are exceptions and valid success stories in Forex and CFD trading, it is – without a doubt – no replacement for traditional investing.3
The Rise of Equal Markets
Cryptocurrency also deserves an honorable mention, as an asset class that by design lends itself to equality. Not only did the rise of cryptocurrency make personal finance attractive for novice investors, but it also empowered those that would not otherwise have access to investable markets. It also introduced the concept of fractionality, whereby investors needn’t own an entire unit of a cryptocurrency, they could invest in a fractional amount – something that was extremely uncommon in stock market investing 10 years ago but has since become a staple of the consumer-fintech world.
Cryptocurrency markets allow for equal opportunity. Although some exchanges are centralized and uphold their own strict participation policies, many services provide investors with the means of buying virtual assets anonymously.4 While many now recount the early adoption phases of Bitcoin and Ethereum among academics, computer scientists, and budding entrepreneurs of the Silicon Valley, it’s important not to forget the influence of widespread adoption across emerging markets in places like Russia, China, India, and Vietnam. This widespread adoption also served as a testament to the power of decentralised and permissionless markets and paved the way to the nascent sector of Decentralized Finance (DeFi).
DeFi products are built on the same blockchain technology that runs cryptocurrencies like Bitcoin and Ethereum but aim to provide additional value – often in the form of some utility. Ethereum, for example, serves as a boilerplate for other cryptocurrency protocols by leveraging the transparency of a decentralized ledger and the variability of smart contracts. Some protocols like Cardano and Solana, facilitate fixed-income-like returns, offering a novel and equal solution for investors.
Other protocols, like UMA, Synthetix, and Morpher, are capable of virtualizing real-world markets. At Morpher, where I work, we have developed a protocol that allows users to use cryptocurrency to stake the price-action of global stocks, indices, commodities, and any assets where we are able to access a real-time quote – transforming data into investable markets. 5
While cryptocurrency markets can provide investors with equal and equitable returns, there are still limitations that prevent them from being considered just. Limited regulatory oversight, unfortunately, contributes to an abundance of bad actors and scams. The varying degrees of protocol structure, scalability, and function also make it difficult for investors to compare and benchmark different products. Exchange rate risk is nothing new for investors and traders in traditional markets, but it is endemically higher in cryptocurrency. Not all solutions are necessarily right for the general consumer investor crowd. It can be hard to know exactly what to look out for in a sector where every project claims to be revolutionary and tries to reinvent the proverbial wheel.
Justice is Impossible
A just market combines equal access to opportunity and long-term equity for all participants. It is the role of financial regulators to ensure that there is justice in financial markets, with respect to their own citizens. At the same time, it is the objective of the financial services sector to ensure equitable solutions for relevant participants, where relevancy is a factor of demand and profitability. The relationship between equality and equity is a primer in the discussion of decentralized financial markets, and a slippery slope. Global, equal, and equitable market access would ultimately require self-governance, a redesign of existing capital markets, and would have no place for policy-making. 6
Thankfully, inequity incentivizes innovation. The future for investors from emerging markets depends on the demand for more equitable solutions that are able to compete with – and against – equality. Until then, investors from emerging markets need to proceed cautiously, and perhaps re-evaluate whether the same investment objectives can be met through alternative market exposures.
Disclosure: I am the Vice President of Operations at Morpher, and hold positions in select virtual assets including, but not limited to Morpher Token ($MPH), Ethereum ($ETH), Bitcoin ($BTC), and Cardano ($ADA). Likewise, I hold positions in select emerging market assets, none of which are listed in this article.
The financial information is provided for general informational and educational purposes only and is not a substitute for professional advice.
1 Mahmoud A. El-Gamal, “Islamic Finance: Law, Economics, and Practice”
2 Moez Bennouri, HEC Montreal, “Auction versus Dealership Markets”
3 Having worked in the retail investing sector since 2017, I have had the opportunity to see first-hand the inner workings of platform investment products. I have always conducted myself ethically and tried to encourage ethical practices amongst my peers as well. Since the implementation of MiFID II and new policies imposed by ESMA, the FX and CFD sector has become safer in Europe. Regardless, it is imperative that all individuals engaged in CFD trading do their own research, and have a concrete understanding of their own risk tolerances.
4 The blockchain is only pseudo-anonymous. All transactions are recorded on a public ledger, and although it is possible to obfuscate a user’s identity, it is very difficult to remain 100% anonymous when it comes to converting digital assets to fiat currency. In short, you’re only as anonymous as your fiat on/off-ramp.
5 I have a professional relationship with Morpher, which I try to prominently disclose whenever advocating for our products. Morpher facilitates staking cryptocurrency against the price-action of real-world securities, entirely through smart contracts. For many emerging market investors, this is a great solution for gaining like-exposure to western markets. Nevertheless, it’s important to remain mindful of Ethereum transaction fees. Find out more about Morpher on our site, or trade directly on Ethereum using the Morpher Dex.
6 Finance and Inequality, by Martin Čihák and Ratna Sahay; IMF Staff Discussion Note No. 20/01; January 2020