A crypto trading platform wants to allow its U.S. retail clients to trade leveraged future bitcoin and ether prices, offering a different way to run an ancient market that is angering Wall Street firms with skin in the game.

What is happening: FTX, a global crypto exchange, has sought permission from US regulators to run its risk management model for clearing margin trades in the futures derivatives market.

  • The crux of the debate around this model revolves around the use of intermediaries, or intermediaries, who play a central role in these transactions.
  • The FTX model does not use intermediaries.
  • FTX takes on the role of a clearinghouse for its clients in addition to operating its exchange, which is somewhat of a seismic change from the way things currently operate.
  • The model of FTX is centralizedas far as FTX handles all of that.

How futures contracts work: For a farmer, it is price risk management. Today’s farmer can plant corn and sell a contract to deliver it on a certain date, for a certain price, in the future.

  • This contract and many others like it for physical things like grain, oil, and gold – or anything considered a commodity (read: bitcoin) – are called futures contracts.
  • Stock, index and interest rate futures exist and are regulated by the Commodity Futures Trading Commission (CFTC) in conjunction with the Securities and Exchange Commission.

Intermediate, futures commission agents (FCMs) absorb, among other things, the counterparty risk in these contracts.

  • They accept orders, collect margin from the parties involved and ensure delivery of the asset or money on the agreed date.
  • They also verify that their clients have sufficient capital or assets (margin requirements) to mitigate credit risk exposure in trading.
  • In fact, this system is decentralized.

Details: FTX’s model automates – and circumvents – the role of these FCMs, but only for crypto futures traded on its exchange.

  • The company already uses this risk management system and has done so for more than three years outside the United States. She claims she has held up despite the wild swings in crypto prices.

Between the lines: In the existing US model, FCMs (the intermediaries) contact customers when they approach credit limits, which are precipitated by the movement of the underlying contracts. These are called margin calls.

  • FTX, acting as the sole risk manager for its clients, performs margin checks automatically – every few seconds.
  • In the event that an FTX client’s margin on deposit falls below the maintenance margin level, FTX will simply liquidate that client’s position 24/7.

FTX also offers posting $250 million for its default fund in the event of an adverse market event, which it says is significantly more than it has ever had to draw in the past three years, combined.

Farmers

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

  • This seems a bit odd, as FTX’s specific proposal does not touch agricultural products.

The holders (really not the farmers), fear that if FTX’s proposed application is approved, its risk management model could become the new normal not just for digital asset futures trading, but for the entire complex as a whole.

Catch up fast: The CFTC is reviewing the recently submitted FTX application and held a roundtable at the end of May.

  • Discussions included executives from CME Group, the derivatives market, and the owner of the New York Stock Exchange, Intercontinental Exchange.
  • BlackRock, Citadel, Goldman Sachs and JPMorgan were also present.
  • Some financial industry executives have sounded the alarm about the potential dangers of FTX’s model.

Commentary by Nelson Neale, chairman of CHS Hedging, a futures brokerage subsidiary of a farmers’ cooperative, struck a nerve – arguing that the model underlying the proposal would quickly spread to other asset classes.

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

Apples and oranges, bitcoin and corn: Sam Bankman-Fried (aka SBF), who runs FTX, makes some concessions in a 50-tweet Twitter threadacknowledging that the firm’s risk model has worked for digitally settled assets but “would require more work to be appropriate for commodities whose settlement occurs primarily in physical warehouses”.

  • Obviously, delivering bitcoins on a certain date is very different from a truck full of corn.
  • Again, the FTX US proposal does not intend to deal in agricultural futures contracts at this time. But the holders fear the slippery slope.

what others say“What FTX is doing is the future. It’s inevitable. But that doesn’t mean there are no risks and the old system has no value,” said to Axios Dave Nadig, Financial Futurist at VettaFi.

  • Which may be true at the same time, says Nadig, “The new kids run fast and well, and the old guard defends a monopoly.”

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