Proprietary Trading in Crypto Explained: Definition, Advantages, and How to Establish One

In the modern financial landscape, the term “Proprietary Trading” (often shortened to “Prop Trading”) refers to financial institutions trading with their own money, rather than client funds.

This approach has transitioned from a niche activity reserved for Wall Street’s elite to a global phenomenon accessible to both individual traders and ambitious FinTech entrepreneurs.

However, as the industry matures, the distinction between a hobbyist endeavor and a professional financial service has become increasingly sharp.

For those looking to establish a proprietary trading firm or for traders seeking to understand the mechanics of the platforms they use, understanding the legal, historical, and operational framework is essential.

Unlike hedge funds, which raise capital from outside investors, proprietary trading firms use their own money for trading.

This sets proprietary trading apart from traditional investing, as it involves the firm’s own capital being deployed for active trading and risk-taking, rather than managing investments on behalf of clients. At LegalBison, we specialize in navigating the complex regulatory waters that govern this industry.

This article provides a comprehensive deep dive into traditional proprietary trading and its’ crypto counterpart, the regulatory requirements for providers, and the pathways to obtaining the necessary licenses.

What is Proprietary Trading?

At its core, proprietary trading occurs when a financial institution or a specialized firm trades stocks, bonds, currencies, commodities, or cryptocurrencies with its own capital rather than using clients’ money.

Proprietary traders utilize the firm’s capital to engage in trading activity involving various financial instruments, such as stocks, bonds, currencies, commodities, and derivatives, aiming to generate profits for the firm.

Unlike a brokerage, which earns commissions by facilitating trades for others, a proprietary trading firm earns profits directly from the market’s price movements.

Proprietary trading allows a financial institution to realize 100% of the returns earned from an investment, making it one of the most profitable operations of a commercial or investment bank.

The Two Perspectives of Prop Trading

To fully grasp the industry, one must look at it through two distinct lenses: prop traders operate on proprietary trading desks, which are generally separated or ‘roped off’ from client-focused trading desks to ensure autonomy and protect client interests.

Proprietary trading desks function as profit centers within financial institutions, such as investment banks and brokerage firms, and are often involved in market-making activities.

The main jobs at prop trading firms are traders, with roles often divided into discretionary and quantitative traders.

On another topic: Perpetual Futures (Perps) Explained and How to Start One

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The Trading Service Provider (The “Prop Firm”)

From a business owner’s perspective, a prop trading firm is a financial institution that pools resources such as capital, technology infrastructure, and data access to provide traders with the tools they need to generate profits.

The firm assumes the market risk, provides the technological infrastructure (trading platforms, data feeds, and execution tools), and in exchange, takes a percentage of the profits generated by the traders.

Proprietary trading firms typically allocate capital to traders under defined risk management rules and focus primarily on internal risk controls and capital efficiency rather than asset gathering or client reporting.

Modern “funded account” models often involve an evaluation phase where traders pay a fee to prove their skills before being granted access to the firm’s capital.

The User (The “Prop Trader”)

For the individual trader, proprietary trading represents an opportunity to trade significant capital without risking their own life savings. It is a performance-based career. The trader benefits from the firm’s institutional-grade tools and leverage, which are typically more advanced than those available to retail traders.

While proprietary traders have access to sophisticated in-house trading platforms and technology, retail traders often lack such resources and may rely on more basic setups.

Some traders may still engage in manual trading, using basic equipment like a monitor for market observation and making decisions without heavy reliance on automated systems.

Traders in proprietary firms are generally compensated through performance-based arrangements, often receiving profit splits ranging from 70% to 90% of the earnings they generate, while the firm absorbs the downside risk beyond the initial evaluation fee.

Also read: The Best Smart Contract Platforms of Today and How to Launch Yours

The History and Evolution of Prop Trading

Proprietary trading has undergone a radical transformation over the last century. Historically, large banks operated proprietary trading desks, using their own balance sheet to take significant capital risk in pursuit of profits.

Proprietary trading can be carried out under several organizational and operational models, including independent trading firms and regulated banks, and this exposes firms to potential large financial losses as they use their own money for speculative investments.

The Era of Investment Banks

Historically, prop trading was the domain of major investment banks like Goldman Sachs, J.P. Morgan, and Morgan Stanley.

These banks had “prop desks” where internal traders used the bank’s massive reserves to speculate on markets.

Proprietary trading allowed these banks to stockpile an inventory of securities, which could be sold or transferred at a future date for profit or liquidity purposes.

This era peaked in the early 2000s but faced a massive reckoning during the 2008 financial crisis.

The Volcker Rule and the Shift to Independent Firms

Following the 2008 crash, the Dodd-Frank Act in the United States introduced the Volcker Rule, which effectively prohibited commercial banks from engaging in proprietary trading.

The Volcker Rule restricts banks from engaging in proprietary trading to limit speculative investments that do not directly benefit their depositors.

It was introduced to regulate how proprietary traders can operate and to avoid conflicts of interest between the firm and its clients.

While financial institutions engage in proprietary trading to maximize profits using their own funds, regulations like the Volcker Rule have shifted these activities to independent, “boutique” proprietary trading firms. Skilled bank traders left to start these independent firms.

The FinTech Revolution and Retail Integration

With the rise of high-frequency trading (HFT) and the digitalization of assets, prop trading entered its current phase. The “Remote Prop Firm” model emerged, allowing anyone with an internet connection to undergo an evaluation.

Today, the industry is a cornerstone of the FinTech world, blending software-as-a-service (SaaS) with sophisticated financial risk management.

Firms in proprietary trading typically provide advanced technology infrastructure and high-speed trading platforms to their traders, ensuring a reliable and efficient trading environment.

Additionally, market access is necessary for traders to enter and exit the market to take favorable positions.

Related: Difference Between Spots vs Prop vs Perps

Trading Desks and Operations

Proprietary trading firms, often referred to as prop trading firms, operate specialized trading desks that deploy the firm’s own money to buy and sell a wide array of financial instruments.

These can include stocks, bonds, currencies, commodities, and derivatives, with the primary objective of generating direct profits for the firm rather than earning commissions from client trades.

Proprietary traders, who are entrusted with managing the firm’s capital, utilize a diverse set of trading strategies such as market making, global macro trading, volatility arbitrage, merger arbitrage, and index arbitrage to capitalize on opportunities across global financial markets.

Within financial institutions, proprietary trading desks are typically structured to function independently from other trading operations, ensuring that their activities remain focused on maximizing returns from the firm’s own capital.

This operational autonomy allows prop trading desks to prioritize internal risk management and capital efficiency, rather than client reporting or asset gathering, which are central to hedge funds and traditional investment banks.

Following the 2008 financial crisis and the introduction of regulations like the Volcker Rule in the United States, banks that accept customer deposits have faced significant restrictions on proprietary trading.

However, independent proprietary trading firms; those that do not handle client funds, are generally exempt from these prohibitions, allowing them to continue engaging in speculative investments using their own account.

The day-to-day operations of a prop trading firm rely heavily on advanced technology infrastructure. Proprietary traders access financial markets through sophisticated trading platforms, leveraging both manual trading and algorithmic trading techniques depending on the firm’s strategy and risk appetite.

Leading prop trading firms such as Jane Street, Tower Research Capital, and DRW Trading are renowned for their cutting-edge technology, robust data access, and comprehensive risk management systems. These firms play a vital role in providing liquidity to financial markets, buying and selling securities, and ensuring efficient price discovery.

Risk management is at the core of proprietary trading operations. Firms allocate their own capital to traders under strict guidelines, including position limits, maximum drawdowns, and predefined loss thresholds. This disciplined approach helps maintain the integrity of the firm’s balance sheet and protects against excessive losses.

Also read: Best Jurisdictions for Launching Your Perpetual Futures Platform

Compensation for proprietary traders is typically performance-based, with traders sharing a portion of the profits they generate according to contractual terms. Unlike hedge funds, which manage external investor funds, prop trading firms exclusively trade with their own capital, aligning the interests of the firm and its traders.

The benefits of proprietary trading are significant. Firms and traders enjoy the potential for higher returns, greater flexibility in developing and executing trading strategies, and direct access to global financial markets.

Proprietary traders benefit from state-of-the-art technology infrastructure, including real-time data feeds, advanced analytics, and risk management tools, enabling them to test and refine their strategies in a dynamic environment.

However, prop trading also carries substantial risks, including exposure to market volatility, liquidity constraints, and operational challenges. As a result, successful proprietary trading firms invest heavily in risk management practices and technology to safeguard their capital and sustain long-term profitability.

In summary, proprietary trading desks and operations are a cornerstone of the financial industry, driving liquidity, managing risk, and generating profits for trading firms.

By understanding the structure and function of these desks, both investors and financial institutions can better navigate the complexities of proprietary trading and make informed decisions in an increasingly competitive marketplace.

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Advantages of Proprietary Trading

Proprietary trading offers a unique set of benefits that differ depending on whether you are the provider or the trader.

For the provider (firm), proprietary trading allows financial institutions to realize 100% of the gains generated from their investments, rather than just a small percentage of the gains through fees and commissions earned from client trading.

This means that all gains from successful investments are fully retained by the firm, which can lead to higher quarterly and annual profits compared to trading on behalf of clients.

For the Provider (The Firm):

• High Profit Potential: Unlike brokers who rely on volume and small commissions, prop firms can achieve exponential returns by backing successful traders;
• Inventory Profits: Firms can buy and sell securities to benefit from the bid-ask spread and market-making activities, providing liquidity in specific securities. Proprietary trading also allows firms to stockpile an inventory of securities for future use, which can be sold at a later date for profit or liquidity purposes;
• Data Utilization: Large firms can leverage their own trading data to refine algorithms and automated strategies.

For the User (The Trader):

• Access to Capital: Traders can manage accounts worth hundreds of thousands of dollars that they would otherwise never have access to;
• Risk Mitigation: The trader’s personal financial liability is typically limited to their evaluation or “challenge” fee;
• Professional Tools: Access to low-latency execution, advanced charting, and institutional-level liquidity, as well as superior data access and pooled resources. These advantages give proprietary trading firms an edge over the average investor in terms of market information and sophisticated modeling.

The Regulatory Landscape: Why Licensing is Mandatory

As proprietary trading has moved into the retail space, regulators globally have increased their scrutiny.

While some firms initially operated in a “gray area” by claiming they were only providing educational services or “demo” accounts, the consensus among global regulators (such as the ESMA in Europe or the FSC in various jurisdictions) is moving toward stricter oversight.

If a firm handles “funded” accounts that reflect real market prices, or if they engage in activities that resemble investment services, they generally fall under the scope of financial licensing. Specifically:

• Crypto Prop Firms: Require Virtual Asset Service Provider (VASP) or MiCA-compliant licenses.
• Forex and CFD Prop Firms: Require Investment Dealer or Securities Dealer licenses.

Operating without a license exposes a firm to heavy fines, “cease and desist” orders, and the inability to partner with reputable payment processors and liquidity providers.

Related reading: What are the Differences Between VASP, CASP, and DASP?

How to Obtain a License: Key Jurisdictions

Choosing the right jurisdiction is the most critical decision for a proprietary trading entrepreneur.

To set up a proprietary trading desk, you need to register your firm as a company or Limited Liability Company (LLC), and the firm’s investments and trading activities will be reflected in its financial statements.

Below, we examine four primary regulatory frameworks that LegalBison frequently assists clients with.

A. Estonia: The MiCA Standard for Crypto Prop Trading

Estonia has long been a leader in digital finance. With the implementation of the Markets in Crypto-Assets (MiCA) regulation across the EU, Estonia offers a highly reputable pathway for crypto prop trading.

• What it allows: A MiCA-compliant license in Estonia allows a firm to offer crypto-asset services across the entire European Union through “passporting.” This includes exchange services and, crucially for prop firms, the management of crypto-assets.
• Requirements: Firms must maintain a physical office in Estonia and employ local staff, including a dedicated Anti-Money Laundering (AML) officer and members of the board with proven financial expertise.
• Compliance: Strict adherence to “Travel Rule” protocols, robust cybersecurity audits, and significant capital adequacy requirements.
• Time to Set-up: The process typically takes between 6 to 9 months, depending on the readiness of the internal documentation and the background checks of the owners.

Canada: The MSB Route for Virtual Assets and FX

For firms targeting the North American market, registering as a Money Services Business (MSB) with FINTRAC in Canada is a strategic move, particularly for those dealing in foreign exchange and virtual currencies.

• What it allows: It permits the firm to engage in foreign exchange dealing and “dealing in virtual currencies.” This is often used by prop firms as a foundational layer for their compliance stack.
• Requirements: You must appoint a Compliance Officer, develop a comprehensive written AML/ATF (Anti-Terrorist Financing) policy, and undergo regular compliance reviews. A Canadian registered legal entity is required.
• Compliance: Continuous reporting of large-value transactions and suspicious activities to FINTRAC.
• Time to Set-up: Canada is relatively efficient, with registration often completed within 1 to 3 months, though opening a corresponding corporate bank account can take longer.

Mauritius: The Investment Dealer License

Mauritius Investment Dealer License is a premier “mid-shore” jurisdiction that offers a sophisticated regulatory environment through the Financial Services Commission (FSC). It is highly favored by Forex and CFD proprietary trading firms.

• What it allows: The Investment Dealer License (Full Service Dealer) allows a firm to act as an intermediary in the execution of securities transactions and to trade on its own account (the definition of prop trading).
• Requirements: A minimum unimpaired capital requirement must be deposited in a Mauritius bank. The firm must have “substance” on the island, meaning a physical office and at least two resident directors of high standing.
• Compliance: Quarterly financial filing, annual audits, and a robust internal risk management framework.
• Time to Set-up: The licensing process generally takes 4 to 6 months.

Seychelles: The Securities Dealer License

Seychelles Securities Dealer License is one of the most popular choice for international trading platforms due to its flexible yet protective regulatory framework under the Financial Services Authority (FSA).

• What it allows: The Securities Dealer License allows a company to trade in securities (including Forex, shares, and derivatives) either as a principal (proprietary) or as an agent. It is the go-to license for many of the world’s largest prop firms.
• Requirements: A domestic company must be formed. The firm must employ at least one individual who is a licensed “Securities Dealer Representative” and have a physical office in Seychelles with proper record-keeping.
• Compliance: Requirements include professional indemnity insurance, regular auditing, and strict “Fit and Proper” requirements for all beneficial owners.
• Time to Set-up: The timeframe for obtaining a Seychelles Securities Dealer License is typically 3 to 5 months.

Dive in-depth: Best Countries to Establish a Crypto Proprietary Trading Company

Secure Your Crypto License in Favorable Jurisdictions

General Requirements for All Prop Trading Licenses

While each jurisdiction has its nuances, certain “Golden Rules” of compliance apply across the board for any aspiring proprietary trading provider:

1. Capital Adequacy: You must prove you have enough liquid capital to cover market risks and operational costs. This capital must usually be “unimpaired,” meaning it cannot be borrowed.
2. Fit and Proper Test: Regulators will perform deep background checks on directors and shareholders, looking for clean criminal records and a history of professional competence in finance.
3. AML/KYC Procedures: Prop firms must have rigorous systems to verify the identity of their traders (Know Your Customer) and ensure that the funds used (such as evaluation fees) are not the proceeds of crime.
4. Technological Infrastructure: You must demonstrate that your trading platform is secure, can handle high volumes, and has “stop-gap” measures to prevent runaway algorithmic losses. Knowledge and infrastructure for algorithmic trading are essential for effective risk management and operational efficiency.
5. Risk Management: Implementing robust risk management is crucial for identifying, assessing, and mitigating risks in proprietary trading.
6. Record Keeping: You should maintain detailed records of trading strategies, decisions, and performance metrics.
7. Experienced Team: Hiring experienced traders, analysts, and developers is important for the success of a proprietary trading desk.
8. Continuous Learning: Continuous learning and improvement are essential to adapt to market changes and enhance trading strategies.

The Future of Proprietary Trading

The industry is moving toward a “Flight to Quality.” Traders are becoming more sophisticated and are actively seeking out licensed firms over unregulated ones to ensure their payouts are secure. Simultaneously, payment providers and technology vendors are increasingly refusing to work with unlicensed entities.

Proprietary traders use various strategies such as merger arbitrage, index arbitrage, global macro trading, and volatility arbitrage to maximize returns.

Most traders at top proprietary trading firms have a background in quantitative fields, though exceptions exist.

In the coming years, we expect to see more jurisdictions introducing specific “Prop Trading” sub-categories within their investment laws, further legitimizing the industry.

How LegalBison Can Assist

Launching or maintaining a proprietary trading firm is a high-stakes endeavor that requires more than just a good trading strategy as it requires a rock-solid legal foundation.

LegalBison stands at the intersection of law and FinTech. As legal experts specialized in the industry, we provide a turnkey solution for entrepreneurs and established companies looking to navigate the proprietary trading space.

Our services include:

• Jurisdictional Crypto Consulting: Helping you choose the right country based on your target market and budget.
• Company Formation: Setting up the necessary legal entities in jurisdictions like Estonia, Canada, Mauritius, or Seychelles.
• Licensing Applications: Handling the entire application process with financial regulators, including the drafting of business plans and operational manuals.
• Compliance & AML Support: Creating the internal frameworks required to stay on the right side of the law.
• Banking & Payments: Assisting with the opening of corporate accounts and integration with payment gateways.

Proprietary trading offers a world of opportunity for those who approach it with professionalism and regulatory foresight.

Whether you are aiming to build the next global funded-account powerhouse or seeking to institutionalize your private trading desk, LegalBison is your partner in achieving full compliance and operational excellence.

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FAQ

What is the difference between “Proprietary Trading” and a “Hedge Fund”?

The core difference is the source of capital. Proprietary trading firms trade their own money and keep 100% of the profits (and risks). Hedge funds pool capital from outside investors (like pension funds or high-net-worth individuals) and charge management and performance fees to trade that money. Because prop firms don’t manage other people’s money, they generally face fewer regulations regarding investor protection compared to hedge funds.

Why are many retail prop firms stopping services for US clients?

This is due to a combination of regulatory pressure and technology licensing. The US CFTC and SEC have taken aggressive actions against firms offering CFDs (Contracts for Difference) to US residents, as these are largely illegal in the US. Consequently, technology providers like MetaQuotes (MetaTrader) have terminated licenses for firms that accept US clients to avoid being complicit in regulatory violations.

What is the “Volcker Rule” and how does it affect prop trading?

The Volcker Rule is a US regulation (part of the Dodd-Frank Act) that bans commercial banks from engaging in proprietary trading. It was designed to stop banks from making speculative bets with depositor money. This rule caused a massive shift in the industry, forcing big banks to shut down their prop desks and leading to an exodus of talent into independent prop firms and hedge funds.

How do “evaluation” prop firms actually make money?

While they claim to make money from the profits of their successful traders, many retail prop firms generate the bulk of their revenue from the “evaluation fees” paid by traders who fail the challenge. Since the pass rate for these challenges is notoriously low, the subscription and reset fees create a substantial income stream, even if no real trading capital is ever deployed.

What is “latency arbitrage” and why does location matter?

Latency arbitrage is a high-frequency trading strategy where a firm exploits tiny time delays in price updates between different exchanges. To do this, the firm must be faster than everyone else. This requires “co-location,” where the firm’s servers are physically located in the same data center as the exchange’s servers to minimize the time it takes for data to travel (latency).