The foreign exchange industry once had its own glorious era, with the new economic brokers flourishing everywhere. Even those with a little experience could make their first bucket of gold in this industry. So, what led the foreign exchange industry to become today's sunset industry?
Exploring the Essence of the Forex Industry Through the Forex Industry Chain
Once upon a time, it was very simple to set up a forex brokerage. With a set of MetaTrader trading software and a back-end CRM system, you could start attracting customers. In fact, genuine MetaTrader software wasn't even necessary, as cracked/pirated MT4/5 trading systems were widely available. However, over time, such market chaos led to the word "forex" being associated with fraud. Many investors now fear when they hear the term "forex."
The root cause of this phenomenon lies in the lack of effective market regulation and the characteristics of forex margin trading as "over-the-counter trading," which led many unscrupulous individuals to use the concept of forex to scam people. Compared to stocks and futures, it is relatively easy to commit fraud in the forex industry due to its opacity. In recent years, the rise of the crypto field has shifted the focus of some scammers to cryptocurrencies. However, the bad reputation of the forex industry remains hard to restore.
The market chaos has added a new link to the industry chain: the rise of regulatory inquiry media has made many users consider regulatory licenses an important factor when choosing brokers. As a result, many unregulated brokers have been eliminated, and platform builders can no longer profit from selling fake MT4/5 software. But the industry chain keeps circling. When builders can’t profit from selling fake MT software, the license providers, due to changes in industry rules, make a fortune. A single non-member registration of the U.S. NFA once sold for $20,000, with a profit margin up to 100-200 dollars.
Is Starting a Forex Platform a Sure Way to Make Money?
As market makers, ordinary investors believe that opening a forex brokerage should be a guaranteed profitable business. But the reality is quite different.
Forex brokers have three ways to make money: 1. Commissions 2. Spreads 3. Client Losses. The first two are easily understood by everyone, but the issue lies with the third: "client losses." Different platform operation models lead to this phenomenon. Veterans in the industry are very familiar with the A-Book and B-Book models, but newcomers might not understand the difference.
A-Book and B-Book Operational Models of Forex Brokers
In the A-Book model, the platform provider sends users' orders to the market to match them with other users' orders. This is the most traditional and reasonable model. The B-Book model is different: the platform provider absorbs users' orders themselves, acting as the counterparty to the users' trades. This means that if users make money, the platform loses; conversely, if users lose money, the platform gains. It sounds unreasonable for the platform to be both the dealer and the player, having a direct conflict of interest with the users.
However, the B-Book (market maker model) has its merits too. When regular users' order liquidity is insufficient in the market, large and powerful brokers, using a market maker model, can provide sufficient liquidity, ensuring that users' orders are executed at better prices.
A robust and healthy operating platform should reasonably combine A-Book and B-Book models, providing liquidity while ensuring a certain profit. But as mentioned earlier, if a platform primarily operates under the B-Book model, it profits from users' losses. Compared to commissions and spreads, client losses are an extremely tempting pie. Therefore, numerous new platforms keep emerging, not for the paltry commissions and spreads, but because client losses entice them.
Driven by enormous profits, many unqualified owners open platforms without proper ethics. When users make small gains, the platform allows withdrawals; but when a client earns a substantial amount, and the platform must bear the loss, excuses like non-withdrawal, invalid orders, spike hunting, or sudden increases in margin requirements come up. In the worst cases, platforms shut down and run away when they can't cover the compensation.
The Prisoner's Dilemma of Forex Brokers
A healthy operating platform should reasonably combine A-Book and B-Book models. If a broker can stick to this method, they may earn less but can survive longer. So why do so many platforms still go bankrupt?
It involves the issue of commissions and spreads. For B-Book brokers primarily focused on exploiting clients, commissions and spreads are peanuts. But for A-Book brokers intending to stay in the market long-term, commissions and spreads are the only revenue. If commissions and spreads are set too high, neither agents nor direct customers will buy in; set too low, the platform may not be profitable, forcing it to operate under the B-Book model and increasing the risk of cash flow issues.
This is the classic prisoner's dilemma for forex brokers. To operate healthily, they must make money from commissions and spreads. But due to the drastically low spreads and commission conditions offered by B-Book brokers, sometimes even lower than liquidity providers’ quotes, A-Book brokers have no competitive edge in spreads and commissions. This leads to a strange phenomenon in the forex industry where bad money drives out good.
Are B-Book Platforms Inevitably Unsafe?
Does a high-spread platform mean it's relatively safe, and a low-spread platform mean it's not trustworthy? In mainland China, all platform operations are actually non-compliant, and investors are not legally protected. Whether the trading is safe depends entirely on the platform owner's integrity and overall strength. A strong broker, even with 90% of orders handled under the B-Book model, can still profit considering the more than 70% loss probability among most investors. Moreover, an A-Book broker, if the owner becomes greedy, can still take users' funds.
Many brokers that look glamorous and invest heavily in media placement once made their first bucket of gold through capital games or unethical means before washing up and offering normal trading services. Using ill-gotten gains, they've bought big licenses, changed names, and appointed foreign directors to make a flashy entrance.
Forex Brokers Also Have it Tough
"Forex brokers also have it tough" might sound like a joke to many, but it really is the case. In today's forex market, it is becoming increasingly challenging to apply for MetaTrader software, and the monthly fees are skyrocketing. Even if a platform wants to change trading software, it is almost impossible due to MetaTrader's monopoly and its derived ecosystem to find a substitute in a short time.
Even if the MetaTrader software issue is resolved, applying for a license is another headache. "No license = unsafe platform" has become almost common sense. As a result, brokerage owners spend millions to buy a "financial license" that provides no trading security for investors just to fill the façade. Although not every license costs millions, an embellished 1-3 million dollar "license" can also pass muster.
After overcoming the software and license hurdles, the next major challenge for platform owners is the media. "Pay, and we won't badmouth you. Don't pay, and even if you have a license, we'll cook up a few customer complaints to show you the consequences of not paying." Such statements are heard numerous times in the industry. Due to the industry's special nature, the media's opinion can sometimes determine the life and death of a platform. As a result, part of the marketing budget must be reserved for media management. Even if the media has no effect, you still have to pay. Buying peace of mind isn't shameful.
When brokerage owners believe everything is arranged and ready to go, a group of people appears on the scene, causing brokers countless headaches—order-hitting teams. Due to lack of experience or weak risk control, some small brokers even outsource risk control to external companies. This leads to constant attacks by order-hitting teams. Whether to process withdrawals or not becomes a dilemma. If you process withdrawals, you can't stomach it, not wanting to bear unnecessary losses. If you don't, get ready to be on the media's complaint list, as the media is eager for negative material. Thus, a closed industry loop is formed: order-hitting teams target new platforms, new platforms refuse withdrawals, order-hitting teams complain to the media, and the media blackmails the platform for money. Platform operators are helpless. Not a good sign when a new brand faces non-withdrawal complaints before it even starts operating.
Who is Actually Making Money in This Market?
After discussing the difficulties faced by enterprises, let's talk about the predicament facing ordinary traders. Many brokers operating under the B-Book model don't want their traders to make money, hoping instead that they lose as much as possible. In such an environment, traders' confidence dwindles until they eventually bail out, leading to fewer people engaging in forex trading.
So who is actually making money in this industry? As the dealers, platforms definitely make money. Agents are another main component of the market. They profit by drawing people to trade and earning commissions. Unless agents also trade themselves, they are like part-time sales for the platform. Platforms offer agents extremely high conditions, sometimes even willing to offer above-market conditions despite clear losses. The reason becomes obvious after understanding the B-Book brokers' operations: they profit from client losses while letting agents earn commissions and spreads. Some even share customer losses with agents, a practice known as “eating positions.”
Those who sell courses on trading also make money. Compared to agents and platforms who profit from client losses, charging for knowledge appears more ethical. However, the actual effect of the courses remains unrelated to the sellers. After all, if someone could consistently make money, why would they share their secrets? Wouldn't they prefer to make money quietly?
Then there are those selling EAs, licenses, and software, each taking a piece of the pie from different parts of the industry chain. But in the end, it's the ordinary traders who are the cornerstone of maintaining the industry. If the market is continuously and maliciously damaged, the industry’s decline is inevitable. Ultimately, the growth rate of new traders can't keep up with the speed of scams.
