Crypto Billionaire's Derivative Plan Raises Hackles

At a posh financial-industry gathering known for swaying palm trees and late-night yacht parties, this year's main attraction was a face-off between a crypto billionaire and a futures-exchange kingpin.

There was Sam Bankman-Fried, whose FTX platform has rapidly become a dominant venue for investing in virtual coins, going toe-to-toe with Terry Duffy, the longtime chief executive officer of CME Group Inc. at the event in Florida. Among the topics broached in their intense conversation was an FTX proposal to execute every aspect of customers' crypto derivatives trades on its own -- thus bypassing other exchanges, banks and financial intermediaries. 

If FTX's bid is approved by regulators, many in traditional finance fear the model could be applied to other assets, threatening Wall Street's stranglehold over lucrative aspects of market plumbing. The centerpiece of FTX's plan is using algorithms rather than brokers to help clear trades, a crucial process for settling transactions that ensures sellers get their funds and buyers get the assets they've purchased. 

“It's the first real constructive disruption to traditional market structure that we've seen in awhile,” said David Weisberger, who earlier in his career built trading systems for Morgan Stanley and Two Sigma and now runs crypto company CoinRoutes. “All change creates tension.” 

Opponents say FTX's plan would undermine investor protections, could cost brokers their jobs by cutting them out of trades and risks disrupting markets that are functioning well. But a bigger concern is that the proposal, which is being reviewed by the Commodity Futures Trading Commission, could give FTX a toehold to expand into vast markets for everything from oil to gold to currencies. 

When asked about the plan during a Tuesday Bloomberg Television interview, Mr Bankman-Fried said that FTX is focused on retail crypto transactions for now. Though he added that “there are really interesting applications to a pretty wide variety of asset classes.” 

CME, New York Stock Exchange parent Intercontinental Exchange Inc., Cboe Global Markets Inc. and Wall Street banks that clear trades on those platforms could all be impacted if FTX does indeed grow beyond crypto. Last year, CME posted $3.8 billion in revenue from trading and clearing futures, while ICE made $2.4 billion, according to data compiled by Bloomberg.  

The high stakes were on display in March when Mr Duffy, 63, and Mr Bankman-Fried, 30, met at The Boca Raton resort, according to more than half a dozen people who witnessed the conversation that lasted more than an hour or were briefed on it. Onlookers attending the Futures Industry Association conference watched the exchange abuzz. 

Messers Duffy and Bankman-Fried both declined to comment on their conversation, as did CME, ICE and Cboe on FTX's plan. The CFTC, which also declined to comment, hasn't specified a date when it will decide on the proposal.

What makes FTX's pitch so different is that customers would open accounts directly with the platform and its computers would monitor their trades made using margin, which involves putting up collateral. The automated system, as opposed to brokers, would then assess whether investments have lost value and if more funds must be deposited. Should positions fall below a certain level, the algorithms would even liquidate them.

FTX already clears some trades directly, but the proposal would for the first time allow it to do so for crypto futures bought on margin by retail investors. The firm would put up $250 million of its own capital to backstop losses if buyers or sellers can't fulfill their obligations. That contrasts with the model used by CME, which requires that its member brokers kick money into a communal fund to cover defaults. 

“It's a sea change in how the futures industry has worked up to now,” said Julian Hammar, a partner at law firm FisherBroyles who previously worked at the CFTC. 

FTX's bid has its own supporters on Wall Street including Nasdaq Inc. Executive Vice President Tal Cohen, who called it “a great step forward” in a recent interview. Anthony Scaramucci, the founder of SkyBridge Capital, said the plan to cut out middlemen would benefit investors by reducing costs and making the market more efficient.

Even as the CFTC deliberates, the industry is taking the fight to Capitol Hill. When the agency's chairman, Rostin Behnam, testified March 31 before the House Agriculture Committee, he was grilled over FTX's plan. 

ICE and CME have long been major contributors to lawmakers from both parties on the panel, which oversees the CFTC. David Scott, a Georgia Democrat who chairs the committee, warned the proposal “could very well make our derivatives regulatory system riskier and our customer protections weaker.” 

Behnam told lawmakers his agency is proceeding cautiously, but would fairly consider FTX's plan. He compared it to the transition to electronic trading 30 years ago -- an idea that was initially met with resistance.

FTX executives argue that their proposal is intended to offer an alternative way of trading, not to bypass intermediaries entirely. The CFTC will also get to weigh in on whether it could be applied beyond crypto, they said. 

“It's just a natural human behavior to respond a certain way when something seems new or novel,” said Mark Wetjen, a former CFTC commissioner who's now head of policy and regulatory strategy for FTX's US arm.