FTX Irritates Exchanges By Pushing For Crypto Derivatives

FTX Irritates Exchanges By Pushing For Crypto Derivatives



Cryptocurrency exchange FTX is seeking the green light from regulators to allow individual investors to use derivatives to place leveraged bets on bitcoin, a move opposed by rivals.

Traditional exchanges and financial industry groups say FTX’s proposal could endanger market stability. Their concerns relate to a key part of the plan, under which investors could deal directly with FTX instead of going through a courtier. This approach represents a departure from the way derivatives markets have operated for decades.

“The FTX model significantly increased market risk,” Terrence Duffy, chief executive of CME Group, said at a May hearing on Capitol Hill. The Chicago-based exchange company offers a competing bitcoin derivative product.



FTX, led by 30-year-old billionaire Sam Bankman-Fried, says its proposal will bring 21st century technology to US markets, adding that it has safeguards to limit risk.

Consumer advocates fear FTX’s proposal could put volatile derivatives into the hands of unsophisticated investors as the crypto suffers a severe downturn. FTX says it is committed to protecting investors.

“We will be implementing a more comprehensive set of client protections, disclosures and suitability controls than currently exist in the futures industry,” Bankman-Fried said in an interview. “If anything, we’re going to go a little overboard on this.”

After months of lobbying from both sides, the Commodity Futures Trading Commission is reviewing the proposal and may make a decision later this year.

Obtaining CFTC approval would help FTX fulfill its ambition to enter the US market. To date, the Bahamas-based company’s main business has been its massive crypto derivatives offshore. This market is off-limits to Americans due to regulatory restrictions.

The effort to win approval is a test for Bankman-Fried, a newcomer to lobbying in Washington. After his proposal provoked opposition from vested interests, the California native ditched his trademark FTX t-shirt and shorts for a suit and tie to defend the plan in front of the celebs.

Derivatives are financial tools that allow people to attempt to make money based on price fluctuations in various markets, in this case, crypto. Traders can use them either to hedge against losses or to place speculative bets.

Last month, San Francisco-based Coinbase Global launched bitcoin futures, a type of derivative, for individual investors. CME introduced bitcoin futures in 2017.

To trade bitcoin futures at Coinbase or CME, one must log in to a broker. The broker’s job is to collect the cash collateral that investors deposit to enter into derivatives transactions, known as margin. If the bet issues an investor goes wrong, the courtier a margin call. The investor usually has one day to deposit more money.

These courtiers date back to the origins of futures contracts in the grain markets of Chicago in the 19th century. Today, their ranks apply to Wall Street banks as well as specialty firms such as Advantage Futures and RJ O’Brien & Associates LLC. They are subject to various CFTC regulations, including minimum capital requirements and obligations to avoid customer risk in futures trading.

Under FTX’s plan, users could post margin directly to FTX, with no brokers involved. The exchange monitored the markets 24 hours a day, seven days a week, settling users’ profits and losses every 30 seconds. If a user did not meet the margin requirement due to a losing bet, FTX would start closing their trades. A large enough market could warrant a process called a reverse charge move, in which FTX withdraws the user’s collateral. Potentially, this means that an FTX client could wake up in the morning and find that the exchange had liquidated the account overnight.

Dennis Kelleher, head of advocacy group Better Markets, said FTX’s plan is risky for investors, especially its self-liquidation feature. While investors can lose their money in existing futures markets, the current system gives them more time to meet margin calls, and brokers can lend customers money to help them through tough times. In contrast, FTX would move at high speed and automatically take money from investors if a trade goes wrong, Kelleher said.

“The automation is effective on a trigger to liquidate retail investor accounts 24/7/365, which is impossible for a retail investor to monitor,” he said.

FTX says it would send alerts to investors when a potential margin call is approaching and then begin closing their trades in phases, giving them time to react. FTX also claims that its US exchange would not be as quick to liquidate its clients’ portfolios as many crypto exchanges overseas.

By not requiring courtiers, FTX would gain more control over its customers’ experience, right down to its website and app interface. Potentially, FTX might also be able to offer lower margin requirements than competing bitcoin futures exchanges. Lower margin requirements gave users more leverage over their trades, magnifying their gains and losses – a key part of the appeal of crypto derivatives.

FTX argues that its approach is ultimately safer for the markets because it does not involve courtiers extending credit to customers. This sometimes drives markets higher: in March 2020, for example, Dutch bank ABN Amro reported a $200 million loss after a large client failed to meet a margin call during the resource-fueled by the coronavirus.

Still, incumbent exchanges such as Atlanta-based CME and Intercontinental Exchange say FTX’s plan would inject risk into the financial system. Removing courtiers would erase a layer of protection that helps prevent defaults from spreading through markets, stock traders told the CFTC in comment letters criticizing the proposal.

FTX counters that its plan has safeguards to contain systemic risk, including a $250 million guarantee fund to cover losses during an extreme market event.

Write to Alexander Osipovich at alexander.osipovich@wsj.com

This article was published by The Wall Street Journal, part of the Dow Jones

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