BETA
This is a BETA experience. You may opt-out by clicking here

More From Forbes

Edit Story

The FTX US Proposal That Shook Congress And The Crypto Derivatives World

Following

May 2, 2022 4:41pm ET: Story updated.

Last month, the Commodity Futures Trading Commission (CFTC) sought public comment on a request from FTX US to modify its derivatives clearing organization (DCO) license to offer a new kind of crypto margin trading to U.S. retail customers. FTX US is requesting the ability to use a new kind of ‘non-intermediated’ model of crypto derivatives trading, meaning there is no intermediary used to hold customer’s funds.

As crypto exchanges typically take collateral from the customer directly, the FTX US model would directly custody the margin from retail customers and liquidate positions held by the exchange on a 24-7-365 basis. Under the FTX US model, the customer’s positions will be reviewed for potential margin calls every 30 seconds. Sam Bankman-Fried, the CEO of FTX, recently described this model to Congress as, “...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.”

The CFTC appears to be taking its time in deliberating over the proposed model and confirming these promised benefits with the extension of a public review process that ends next Wednesday, May 11th. From a recent hearing where the FTX US proposal came up, Congress is expecting the CFTC to move cautiously on crypto derivatives market regulation as well. Below is a timeline of the events regarding the FTX US proposal followed by an interview with Brett Harrison, the President of FTX US.

Timeline

January 4, 2022 - Rostin Behnam is sworn in as Chairman of the CFTC. Behnam testifies in Congress on March 31st how he has committed months behind-the-scenes with FTX US on their proposal regarding the clearing of margin trades for crypto derivatives.

March 10, 2022 - The CFTC formally announces that Derivative Clearing Organizations (DCOs) are asking the CFTC whether they can offer the clearing of margined products directly to participants without using a FCM intermediary. The CFTC also announces the reviewing a formal request from FTX US Derivatives (FTX) to amend its registration to modify its existing non-intermediated model that currently clears futures and options contracts on a fully collateralized basis to clearing margin products for retail participants while continuing with a non-intermediated model. The CFTC requests public comment on FTX that is set to be due in 30 days.

March 24, 2022 - The CFTC announces that it is extending the request for public comment on FTX to 60 days, moving the due date to May 11. Comments can be provided through a link from the CFTC and a link with materials that can be reviewed from FTX US is available here.

March 31, 2022 - The House Agriculture Committee holds a hearing called ‘State of the CFTC’ where Chairman Rostin Behnam of the CFTC is a witness. Chairman David Scott (D-GA) of the Committee opens the hearing with a statement about his ‘love and affection’ for the world’s greatest financial system as well as his background as a graduate of the Wharton School of Business. Scott mentions all of this to convey to those watching the hearing can “...understand the concern that I have with this cryptocurrency situation,” stated Scott.

In questioning Benham, Scott notes, “...there is a proposal pending at the CFTC by a cryptocurrency exchange that is seeking approval to operate a new and untested exchange ... and I'm very concerned about this ... very much concerned about this proposal and the broad implications it poses.”

Scott further announces that he is organizing a hearing in the House Agriculture Committee on Tuesday, May 17 about the FTX US proposal. Scott noted the hearing will include traditional clearinghouses for derivatives such as the Chicago Mercantile Exchange (CME) and the Intercontinental Exchange (ICE) on how they feel about this new method of margin clearing, and that he had invited the CEOs from both organizations to testify.

What To Expect

May 11, 2022 - This date is the deadline to respond to CFTC about the FTX US proposal. According to the site where stakeholders can provide comments on the proposal, there are an astounding 931 responses posted as of May 2.

May 17, 2022 - The date that Scott has promised a hearing with the CEOs of the Commodity Mercantile Exchange (CME) and the Intercontinental Exchange (ICE) to listen to the traditional clearinghouses provide their views on the non-intermediated model of cryptocurrency derivatives margin clearing by FTX US.

May 25, 2022 - The CFTC announces a roundtable of CFTC staff that will meet with stakeholders such as DCOs, FCMs, FCM customers, end-users, academics, proprietary traders, public interest groups, and others to discuss the impacts generally of using non-intermediated models with derivatives clearing.

Interview with Brett Harrison, President of FTX US

Jason Brett: Can you tell us about the significance of the CFTC’s decision to review your application to amend the DCA registration that would allow for a new kind of clearing process for derivatives between FTX US and your customers?

Brett Harrison: The story and the significance hasn't really been picked up, but I think it is an important topic of for the crypto industry. I think the significance really can't be overstated. In crypto, 97% or more of that derivatives volume happens offshore or outside the United States. And that is because for crypto native companies to be able to offer derivatives in the U.S., they must obtain the appropriate CFTC licenses to be able to offer crypto derivatives products, but those licenses can be difficult and take a long time to obtain. FTX US obtained the licenses through the acquisition of Ledger X, but Ledger X’s license designation required full collateralization of products. So, the point of our application is to amend the DCO designation to be able to remove the need for fully collateralized crypto from the requirements to allow people to post margin and to take leverage on positions. And by doing this, FTX US will be able to really compete as a derivatives exchange in the U.S.

Brett: Why do you need to modify the license from the CFTC? How are cryptocurrency derivatives different?

Harrison: The way in which FTX conducts derivatives trading with customers is novel in three different dimensions. One is what we describe as a ‘direct to retail’ or ‘direct to customer’ margin model. The way that every crypto exchange in the U.S. or globally works is that customers onboard with the exchange and they directly post collateral with the exchange. When all the collateral is posted directly to the exchange, it also allows that crypto exchange to fully measure the risk in the system. Today, it is basically impossible to know the full risk that is in the Commodities Mercantile Exchange (CME) clearinghouse because the CME relies on the diligence that the Futures Commission Merchant (FCM) has already done on behalf of their customers. For example, the creditworthiness of the customers is based on how much the FCM is likely to be able to receive in the case of a margin call. That's not the case with FTX US - all the collateral is posted directly from the customer to the DCO ahead of time.

Number two, CME and ICE have a daily margining system where the institutions compute the initial margin requirements for the next 24 hours, which is once per day, five days a week, during normal trading hours. The FTX US derivatives margin model is proposing to compute that risk every 30 seconds, 24 hours a day, seven days a week. This is real-time risk calculation and margining. And the strong belief that we hold here is that this will result in a much safer system for financial markets because instead of worrying you are on a position on 3pm on a Friday and some catastrophic global event happens on Saturday, you suddenly must wait 24, 48, or 72 hours before margins are going to be reassessed, which ultimately results in large dislocations and people being liquidated. Instead, we can liquidate people’s positions piece by piece in a continuous fashion. We can flush risk from the system, again in a continuous fashion. And this is ultimately a safer, more effective way to be able to manage risk. And this is empirically been proven by the fact that we've been able to operate this model with many billion dollars per day in the overseas derivatives market with FTX, where we've encountered large price movements with assets such as Bitcoin BTC and Ether ETH .

The third dimension is the margin model itself. A new market model has not been approved in a very long time. And in general, it takes a very long time for new margin models to be approved by regulators. So, having a new margin model approved for us through this exchange would be a significant event. Not to mention FTX US would be the first crypto-native company to be able to offer margin products in the U.S. With CME, you are not able to post Bitcoin for collateral. You must post cash and so there is a capital efficiency problem if you want to trade Bitcoin versus Bitcoin futures. Our aim is to be able to integrate the spot and the derivatives platform together under one roof.

Brett: Is it your opinion that your way is a healthier way for financial markets in general to operate?

Harrison: The short answer is FTX US is a safer system. A bigger concern is for people who keep waking up at 4am to find that 10% of their position got liquidated. It is the farmer who bought a corn future and suddenly because of three days’ worth of price movements, wakes up by Monday to find that the price of cows has suddenly moved 10% in a very discontinuous fashion. And their entire position gets liquidated at once. And the farmer does not have enough time to post more collateral and must basically re-enter the position, as opposed to being liquidated in small batches. In a real-time fashion, this gives individuals the opportunity to come back and post collateral. So, FTX US thinks that this is a healthier way of operating markets in general and not just for crypto derivative markets. I think that the 24/7 nature of crypto markets results in a much less discontinuous type of events that you see under normal circumstances where large news can come out overnight for securities or derivatives in such a way that people can't express their opinion and enable price discovery and either put on or take off risk in an efficient fashion.

Brett: Are you hopeful that the 97% of crypto derivatives trading that currently occurs offshore is a benefit to our country?

Harrison: For the majority or plurality of the volume trades in the U.S., think about equity index futures or bond futures. So much of that volume occurs in the U.S. and the strong belief behind this is the U.S. has some of the best regulated markets in the world. Investors have the confidence to be able to trade in large quantities at low latencies in a market where they know that there is proper regulation and oversight. So by and large, it is better and healthier for the global crypto markets and derivative markets in general for that volume to be trading in the U.S. under the oversight of the U.S. federal regulators. And right now, because of ambiguity or difficulty obtaining certain licenses, or just historically in how U.S. regulators approach new products, much of that volume is happening offshore, and it would be better for the health of the entire ecosystem for a lot of that volume to move onshore into the U.S. market. It does not make sense that only 2% to 3% of the total crypto futures volume is trading in the U.S. That's what we want to change and so at FTX US we've been taking an approach by saying we want to be regulated. We want to walk into the front door of the regulatory system and get licensed by the existing framework and not wait for something new to happen in the future. We want to be licensed now with whatever current paths exists and be able to bring as much of that trading on U.S. shores as possible.

Brett: Can you tell me a little bit about yourself for the readers to get to know you?

Harrison: Sure. So, I joined FTX US in May of 2021 before we first engaged with Ledger X about considering acquiring them. My journey to FTX came through Sam Bankman-Fried. He and I worked together for four years at Jane Street Capital (Jane Street) when he was a trader, and I was an engineering manager. I spent the better part of eight years of my career at Jane Street. My exposure to crypto started when I was exchange trading when they were forming their crypto arbitrage desk.

And so, I went on my separate way for a while and Sam went off to start Alameda Research and later FTX. Knowing that there was such a large hole in the crypto market in the United States and Sam being from the U.S., he really wanted to engage in the U.S. market and started FTX US as a separate company to engage in the licensed and regulated path in the U.S. to be able to eventually offer services like futures and options to U.S. customers. And Sam wanted to bring someone in who could help lead those efforts and sort of pull together a proper business here and that's where he first engaged with me and recruited me to come be the President of what is now FTX US.

Brett: Right, thank you so much for your time.

Follow me on Twitter or LinkedInCheck out my website