After becoming the first exchange to have a stadium named after it, FTX is moving to innovate traditional stock trading. The latest clue happened earlier on May 2nd when FTX CEO Sam Bankman-Fried bought a 7.6% stake in Robinhood (HOOD), or 56.2 million shares worth $482 million at the time of the SEC filing.
At the same time, FTX has been on the hunt to acquire derivatives trading startups. The top candidates have been Apex Clearing, Webull and Public.com, according to insider sources speaking to Barron’s. Moreover, Goldman Sachs (GS) is warming up to the idea of combining FTX’s crypto-know-how with the bank’s status as a futures commission merchant (FCM).
Previously, on March 10, FTX.US, headed by Brett Harrison, requested a modification of its derivatives clearing organization (DCO) license from the Commodity Futures Trading Commission (CFTC). This is the core innovation of FTX’s entry into the traditional derivatives arena.
What Does FTX Bring to the Derivatives Table?
As margin traders know, crypto exchanges require collateral to engage in derivatives trading. FTX.US proposed that non-intermediary custody of clients’ margins be expanded to TradFi too. Meaning that the exchange would hold the funds directly from retail customers and liquidate their positions around the clock (24-7-365).
In his statement to Congress, Sam Bankman-Fried described the new model as a superior risk-mitigation system.
“…a 24/7 risk engine that is unlike the traditional system where there needs to be separate risk models for overnight, weekends and holidays where hours can go by with no ability to mitigate risk to the system.”
Specifically, the FTX automated derivatives trading system would:
- Check clients’ margin call positions every 30 seconds.
- If/when margins go too low, automated liquidation would commence in 10% increments.
- In liquidation wipeouts, clients’ margin call positions would be controlled by backstop liquidity providers, specifically tasked for that role.
- FTX itself would fortify the new derivatives trading system with a $250 million guarantee fund.
In short, by continually monitoring clients’ positions, the market at large would be more stable. After all, FTX has been running this model for crypto assets for years. To illustrate further, when Bill Hwang, a convicted South Korean hedge fund manager, took 5x-6x leveraged positions on Chinese tech-growth stocks, he lost $80 billion worth of bets.
This affected the stability of the world’s largest financial institutions, including Credit Suisse, having lost $5.5 billion, and Wall Street firms drained by $10 billion. With FTX’s proposed 24/7 position monitoring every 30 seconds, it is unlikely that such a destabilizing scenario would have unfolded.
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What Do Market Makers Think of FTX’s Innovation?
On May 25, CFTC held a roundtable focused on FTX’s proposal, gathering all the big players to provide their input: CME, Goldman Sachs, Citadel Securities, BlackRock, JPMorgan, Coinbase, CoinFund, and of course, FTX. Altogether, 31 industry professionals were present.
First of all, due to its automated nature, there would no longer be a need for futures commission merchants (FCMs).
In the current model, FCMs’ role is to gather margins and ensure clients have sufficient funds to cover their positions. Additionally, they add funds to clearinghouses, as settlement checkpoints between futures sellers and buyers.
By injecting a crypto-based model, FCMs would not only be redundant but it would make derivatives trading cheaper and faster too. However, one of the bigger concerns was that the auto-liquidation scheme would have a different impact on crypto trading vs. more critical commodities such as energy or foods.
Robert Creamer of Geneva Trading asked the FTX CEO in which scenarios would his system cause more trouble than it’s worth. Sam simply said that it is not yet a universal system.
“I don’t want to say those are unsolvable problems, but those are problems that would require further work and further thought.”
Likewise, even before the CFTC roundtable, on May 11, FIA (Futures Industry Association) warned that auto-liquidations could spark market instability if they happen prematurely.
“During market turbulence, immediately liquidating a large participant during cascading markets can . . . add to market volatility and may cause further defaults,”
If CFTC ends up approving the FTX model, we are looking at a new era of one-stop platforms for both cryptos and futures markets. Of course, for CFTC this is a major concern due to monopolization potential. Nonetheless, Joe Cisewski of Pantera Capital noted that only 6-8 clearinghouses dominate the US market, so the field is already in need of dilution.
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After Terra’s collapse, algorithms got a bad rap. Do you think this would influence CFTC in evaluating FTX’s model? Let us know in the comments below.
About the author
Tim Fries is the cofounder of The Tokenist. He has a B. Sc. in Mechanical Engineering from the University of Michigan, and an MBA from the University of Chicago Booth School of Business. Tim served as a Senior Associate on the investment team at RW Baird’s US Private Equity division, and is also the co-founder of Protective Technologies Capital, an investment firm specializing in sensing, protection and control solutions.