Bahamas-based crypto exchange FTX is pressing the Commodities and Futures Trading Commission to grant a license to offer bitcoin derivatives to retail investors as opposed to traditional exchanges.
Chicago Mercantile Exchange CEO Terrence Duffy believed the move would create “market risk” during a hearing on Capitol Hill in May.
CME offers a bitcoin derivative product that is designed to compete with FTX. Exchanges such as the CME and Intercontinental Exchange cite the need for consumer protection for products in which retail investors may suffer major losses, with the potential for leveraged positions taken in the broader economy.
Both exchanges have petitioned the CFTC in writing regarding their concerns regarding a specific aspect of the FTX offer. Specifically, automation games.
the heart of the matter
FTX first introduced a plan in April to use algorithms instead of brokers to ensure investors get the assets they buy and sellers get the money they owe. This would remove the need for the plumbing previously used to clear trades, leaving brokers unemployed should the automated strategy be adopted more widely. FTX CEO Sam Bankman-Fried believes this is a way to modernize US markets, while incorporating stronger risk mitigation.
Bankman-Fried said in an interview that the exchange is committed to comprehensive customer protection. If anything, the company’s new security, disclosure and suitability checks exceed those of existing futures products, he added. A futures contract is a type of derivative product that allows investors to bet on the future price of a stock, or in the case of FTX, cryptocurrency prices.
But the officials are courting controversy saying that brokers play an important role in margin calls. Wall Street banks and specialist firms play the role of brokers in today’s exchanges which is a lucrative business. They are accountable to the CFTC and must warn investors about risky derivatives products.
Speed of automatic liquidation cause for concern
In leveraged trades, investors supply capital and borrow funds from platforms such as FTX to invest in bitcoin. When the price of bitcoin rises, profits increase, thereby benefiting the investor. Suppose the price of bitcoin declines to the point where the investor’s initial capital, called margin, becomes insufficient to cover his bitcoin purchases. In that case, the broker advises the investor that he needs to deposit more cash within a day or so. This is called a margin call. If the investor does not put in more cash, FTX liquidates his position and takes his money.
Dennis Kelleher of Better Markets says the liquidation feature is risky for investors. Currently, if an investor fails to meet the margin call, the broker can give them more time or lend them money. FTX’s system, on the other hand, is designed to liquidate an investor’s position as soon as the margin becomes insufficient, making it difficult for a retail investor to understand his position.
FTX argues that the system will notify investors in advance of their impending liquidation and will close out their positions in phases, giving them sufficient time to react. The company also has $250 million to cover losses during the extended market downturn.