Jun 3, 2022 - Economy

Crypto platform FTX has a different model for futures trading; not everyone likes it

Illustration of a pitchfork spearing a digital coin with pieces falling away

Illustration: Sarah Grillo/Axios

One crypto trading platform wants to allow its U.S. retail customers to make levered trades on future bitcoin and ether prices, proposing a different way of running an old market that is drawing ire from Wall Street firms with skin in the game.

What's happening: FTX, a global crypto exchange, has been seeking permission from U.S. regulators to execute its model of risk management for the clearing of margined trades in the futures derivatives market.

  • The crux of the debate over this model centers on the use of middlemen, or intermediaries, who play a central role in these transactions.
  • FTX's model doesn't use intermediaries.
  • FTX takes on the role of clearing house for its customers in addition to operating its exchange, which is something of a seismic shift from the way things work now.
  • FTX's model is centralized, in that FTX is handling all of it.

How futures work: For a farmer, they are all about price risk management. The farmer today can plant corn and sell a contract to deliver it on a certain date, for a certain price, sometime in the future.

  • That contract and many others like it for physical things like grain, oil and gold — or whatever else is deemed a commodity (read: bitcoin) — are called futures.
  • Single stock, index and interest rate futures exist and are regulated by the Commodity Futures Trading Commission (CFTC) jointly with the Securities and Exchange Commission.

The intermediaries, futures commission merchants (FCMs), absorb counterparty risk in these contracts, among other things.

  • They accept the orders, collect margin from the parties involved, and see to the delivery of the asset or cash at the agreed upon date.
  • They also check to make sure their customers have sufficient capital or assets (margin requirements) to mitigate the credit-risk exposure in the trade.
  • In effect, that system is decentralized.

Details: FTX's model automates — and bypasses — the role of those FCMs, but only for crypto futures traded on its exchange.

  • The company already uses this risk management system and has been doing so for more than three years outside of the U.S. It contends that it has held up in spite of the wild swings in crypto prices.

Between the lines: In the existing U.S. model, FCMs (the intermediaries) reach out to customers when they approach credit limits, which are precipitated by movement in the underlying contracts. These are called margin calls.

  • FTX, acting as the sole risk manager for their customers, conducts margin checks automatically — every few seconds.
  • In the situation where an FTX customer's margin on deposit falls below the maintenance margin level, FTX will simply liquidate that customer's position on a 24 hours a day/seven days a week basis.

FTX also proposes posting $250 million for its default fund in the event of some adverse market event, which it says is substantially more than it has ever had to draw over the last three years, combined.

The Farmers

There is a narrative swirling that pits FTX US against farmers.

  • That seems kinda odd, because FTX's specific proposal does not touch agricultural products.

Incumbents (really not farmers), fear that if FTX's proposed application is approved, its risk management model could become the new standard not just for digital assets futures trading — but for the entire complex at large.

Catch up quick: The CFTC is reviewing FTX's application submitted recently and in late May held a roundtable discussion.

  • Included in the discussions were executives of the CME Group, the marketplace for derivatives, and New York Stock Exchange owner Intercontinental Exchange.
  • BlackRock, Citadel, Goldman Sachs and JPMorgan were also in attendance.
  • Some financial industry leaders rang the alarm on the potential dangers of FTX's model.

Commentary from Nelson Neale, president of CHS Hedging, a futures brokerage subsidiary of a farmers co-operative, struck a nerve — arguing that the model underlying the proposal would quickly spread to other asset classes.

  • Here's Neale's comment in full.
  • CHS Hedging is an FCM.

Apples and oranges, bitcoin and corn: Sam Bankman-Fried (aka SBF), who heads FTX, makes some concessions in a 50-tweet Twitter thread, acknowledging that the company's risk model has worked for digitally settled assets but "would require more work to be appropriate for goods whose settlement is primarily in physical warehouses."

  • Obviously, delivering bitcoin by a certain date is very different than a truckload of corn.
  • Again, FTX US's proposal does not intend to deal in ag futures at the moment. But incumbents fear the slippery slope.

What others are saying: "The stuff FTX is doing is the future. It is inevitable. But that doesn't mean it has no risks and doesn't mean that the old system has no value," Dave Nadig, financial futurist at VettaFi tells Axios.

  • What can be simultaneously true, says Nadig, "The new kids are running hot and fast, and the old guard is defending a monopoly."
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