“How FTX plans to reshape the US futures market with crypto tech” is the story running elsewhere on Financial Times webspace. It explains how Sam Bankman-Fried’s Central Bank of IP wants to “strip out the brokers that for the past 40 years have acted as intermediaries between customers and the exchanges where deals are done.”
SBF formally pitched his idea of automated risk management to US regulators in March. His proposal involves using the 24-hour trading of leveraged crypto futures as a proof of concept to gain the confidence of the US Commodity Futures Trading Commission.
Anyone familiar with CFDs and spread betting will by now be wondering what all the fuss is about. Accounts with upfront margin and algorithmic liquidation have been part of the scenery in European markets, and globally for forex, for almost as long as the means have existed.
The problem here is America. The CTFC still needs to get comfortable with the concept of leveraged borrowers managing their own risk, which isn’t incontestably compatible with the Commodity Exchange Act.
FTX has been lobbying the CTFC for a rule change after last year buying LedgerX, a US futures and options exchange that under current rules has to ask for customer collateral in full (or close to full). FTX wants to offer them leverage, but it doesn’t want to be reliant on futures commission merchants (FCMs), which are the market’s repo men.
FCMs have remained because they’re quite useful. Placing a gatekeeper between the exchange and the customer helps pool collateral, and is meant to ensure that clearing houses will have enough to cover any default. Gatekeeping also provides a degree of human discretion to the big decisions, such as when Citigroup was given free pass in March 2020 after missing a margin call.
FTX wants to bypass all that. “Dramatic improvements in technological infrastructure over the past twenty years” mean customers should be given direct access to exchange and clearing services, then be taken out of losing positions by a disinterested algorithm. Real time margin monitoring would shut down accounts in 10 per cent increments, with FTX laying off its risky positions where possible to “liquidity providers” and backstopping against catastrophe with its own $250mn cash fund.
SBF cites FTX’s own trading history (August 2020 to date) as evidence that such a risk management system works, and that it’s better to boil the frog with regular small liquidations than occasional big ones. Regulators who were calling for god-view futures market monitoring in the wake of the GFC are invited to see on FTX’s dashboards a microcosm version of how it might have looked.
Blockchain gets mentioned in passing because its fans believe distributed ledgers are good at instant, frictionless capital transfers. SBF has talked about how smart contracts etc are a “really beautiful experience” when applied to risk management but really, any talk of protocol improvement is incidental at best. Hurdles are all regulatory, not technical. Under the hood, FTX is just as centralised as the average tradfi trading shop; its application letter to the CFTC doesn’t mention blockchain at all.
All that’s left then is the argument over whether risk management by algorithm is positive or negative for market stability. But is FTX really the right company to be leading it? After all, SBF didn’t get rich by making crypto less volatile, he got rich by making fiat easier to lose.
Crypto lobbyists have seized on the London Metal Exchange’s nickel omnishambles in March as an example of the problems caused by human intervention — while critics have argued that LME’s autocratic style might be a symptom of Hong Kong-Chinese ownership rather than structural failings. It’s not difficult meanwhile to find examples of when algos failed spectacularly to offset risk, such as in 2015 when Switzerland scrapped its currency ceiling and crashed much of the retail CFD industry.
Regulators and tradfi firms have so far been wary of the crypto lobby’s charm offensive. As Alphaville noted at the time, a CFTC’s round table in May included a rather exasperated contribution from Chris Edmonds, ICE’s chief development officer, after Coinfund managing partner Chris Perkins used the infallibility of the big shops as an argument in support of FTX’s proposal. (Perkins was in charge of Citi’s clearing unit in March 2020 when its margin call was waived.)
A cynical take is that US tradfi has been resisting innovation to protect its profit centres. The more rational take is that futures pricing has real-world consequences for global industry and agriculture, so doesn’t deserve the same risk tolerances as applied to dogecoin. And crypto liquidations appear to be a profit centre in their own right. Moreover, FTX is lobbying to influence its preferred pick for industry regulator, should the US government ever follow through on proposals to put crypto trading within a legislative structure.
Blockchain is, and always will be, mostly irrelevant to the wider argument. FTX wants the legitimacy of regulated markets while using the same centralised systems it has developed in crypto to boil the frog and harvest the dead.
What FTX has to do is to now convince participants that its preferred mechanisms of modernisation won’t just encourage retail-driven gambling, manipulative volatility and arbitrary financialisation. What’s needed most is a clear presentation of the potential upsides, because right now the evidence from its core market isn’t great.
