How FTX intends to use crypto technology to transform the US futures market
The largest foray by a crypto group into traditional banking to yet is being attempted by FTX, which aims to upend the vast US derivatives market.
Sam Bankman-Fried created the three-year-old exchange, which is requesting permission from the US Commodity Futures Trading Commission to offer consumers bitcoin futures, contracts that let users wager on the value of the most widely traded digital asset in the world. If the organisation is successful, it might alter the workings of a market that is utilised by everyone from hedge funds betting on oil prices to farmers locking in prices for maize.
The proposed procedure would eliminate the brokers who, for the previous 40 years, served as a middleman between clients and the exchanges where transactions are made. The exchange would automatically monitor the market, 24 hours a day, seven days a week, and debit client accounts in accordance with market conditions rather than brokers asking consumers to provide more funds, known as margin, when trades go sour.
Although primarily unregulated offshore crypto marketplaces like Binance and FTX already use this procedure, the US market requires government clearance. The United States trades a significant portion of the 29 billion contracts that were transacted on the global futures market last year, so if FTX’s plans are accepted, they might have far-reaching repercussions.
Margin calls versus automatic liquidations
Leverage lies at the core of both the current system and FTX’s proposal. Typically, futures traders only deposit a small portion of the total value of their position, which enlarges both potential gains and losses. “Margin” refers to the chips that market players lay out on the table. In leveraged trading, margin is essential since it guarantees that the party on the opposite side of the trade can be made whole if the bet goes south.
Cryptofinance
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The way that margin is handled in the FTX concept compares favourably to the current system. In accordance with the present system, a broker may issue a “margin call,” or request that a trader provide additional funds to support the transaction, when a wager becomes excessively underwater. If the trader meets the margin requirement, their transaction is kept open; if not, the broker starts unwinding their holdings and reclaiming the margin that was used to execute the deal.
The margin requirements for products like bitcoin futures are adjusted frequently on cryptocurrency exchanges like FTX and Binance. Trading occurs without the need of a broker, directly between traders and the exchange.
If a user’s margin drops below a set threshold, crypto platforms automatically start unwinding positions. Users will often be notified if their accounts are in danger, but given the volatility of digital assets, these types of forced liquidation events have the potential to quickly wipe out traders.
Unlike cryptocurrency, which is always trading, most conventional futures, including those that track commodities, expire on Fridays and Saturdays. However, while the majority trade efficiently 24/7 during business hours, several smaller market participants have expressed concern that the FTX proposal may cause them to lose everything during non-business hours. In contrast, a margin call offers some wiggle room to meet funding obligations.
The “flash crash” of cryptocurrency in May 2021
Automatic liquidations are already widely used in the cryptocurrency sector, where $1.3tn in bitcoin futures were traded just last month. During times of market turmoil, traders can be completely eliminated very rapidly, and additional leverage accelerates the rate at which a user is forcibly liquidated.
The case study that follows is based on a “flash crash” that caught many leveraged bitcoin traders off guard approximately a year ago. The trader in this example used Binance to open a 100-times leveraged position by investing $2,500 on a trade with a theoretical value of $250,000. They need to put in ever more money when the market begins to decline in order to avoid being liquidated even while the prices quickly recover.
The temporary decline, which occurred in May 2021, resulted in significant losses for many retail traders. However, due to automatic liquidations, market participants often only stand to lose the amount they staked on the trade rather than incurring debt.
The argument
Since the CFTC started a consultation in March, the FTX idea has sparked a heated discussion in the US.
Those who support the FTX idea think it will lead to the market’s next evolution since markets will inevitably evolve as technology does for the rest of society. Proponents claim that it encourages competition, democratises futures trading, and—most importantly—protects smaller investors from accruing debts they cannot afford, which have occasionally had catastrophic results.
People who believe the old system offers a necessary “breathing space” for crucial decisions to be made and time to obtain additional funds are on the opposing side of the argument. For instance, a farmer wouldn’t have to be concerned about unforeseen market changes closing positions he had established to protect himself from changes in the price of crops. Customers wouldn’t be required to contribute more money than is necessary only to ensure their piece of mind. Exchanges and brokers, the central mediators of the system, would be able to utilise discretion to resolve possible problems during tumultuous times.
The CFTC is taking its time because it is investigating each link in the chain to determine how it will operate and what effects it will have. A choice might not be made this year. It’s possible that both models will be accepted. However, if more investors look at bitcoin futures, there might be more proposals.
