Sam Bankman-Fried went to Washington this week to press his case for modernising US financial services and ran into a problem. Some of the nation’s farmers are worried that billionaire chief executive of the FTX cryptocurrency exchange could cost them sleep.
Their bedtime concerns were aired at an all-day open meeting of the Commodity Futures Trading Commission, which is considering a proposal by FTX to bring the automated risk management systems it uses in 24/7 crypto trade to the leveraged futures markets where participants take positions on everything from the direction of stocks to the price of corn.
So seriously is the FTX plan being taken by the US derivatives regulator that all five CFTC commissioners attended the gathering, listening to more than six hours of discussions that pitted Bankman-Fried against an array of interested parties — ranging from farm groups to such financial-services heavyweights as JPMorgan Chase, Goldman Sachs and the CME Group.
The results suggest the road ahead for the FTX plan could be bumpy. Bankman-Fried’s ideas have clearly captured the imagination of traders who dart in and out of the markets in search of returns. But key industry participants say they remain perplexed by the mechanics of his system — and the farmers made it clear that they would like to keep their distance.
Leveraged futures contracts appeal to both swashbuckling investors and agricultural hedgers because they enable them to take large positions while putting up a fraction of the value of a trade, called margin. In today’s markets, brokers, known as futures commission merchants, collect margin and make sure customers have enough of it to support their positions.
The novelty of FTX’s plan is that it would use computer algorithms to replace the human intermediaries. Under its system, margin levels would be calculated every 30 seconds of every day and customers would be responsible for maintaining enough of it in their FTX accounts to support their positions.
Failure to do so would trigger the start of an automated liquidation — no matter the time. In more dire scenarios, FTX says further support could come from such sources as “backstop liquidity providers” who would agree in advance to take on positions as well as a $250mn guarantee fund paid for by FTX.
This kind of automated system appeals to derivatives players who dream of moving around their collateral as quickly as they put on positions. They see a measure of security in around-the-clock trading, enabling them to react in real time to the latest disaster or opportunity. To them, the 24/7 nature of the crypto trade is glimpse into the future of financial services.
Farmer groups, which pack a considerable political punch in Washington, wondered how their members could sleep in such a world. Although FTX currently only deals with cryptocurrency contracts, CFTC approval of its proposal could clear the way for it to deal in other kinds of futures, potentially bringing it into the agricultural realm.
Nelson Neale, president of CHS Hedging, the futures brokerage arm of a leading US farmer co-operative, said at the CFTC meeting that an overnight automated liquidation posed a bigger threat to farmers who turn to the futures markets to hedge their risks than to traders who use such contracts for “speculation”.
“With an auto-liquidation scheme, a crypto trader goes to bed at 11pm and wakes up at 7am and, all of a sudden, he’s been knocked out of his position, or liquidated — a bad day certainly, but perhaps not as bad if we consider the same scenario for the American farmer,” he said.
“He goes to bed with a corn position to hedge his physical inventory at 11pm, wakes up at 7am, or probably a bit earlier, and he has no position. All of a sudden, the value of his inventory goes down considerably . . . He may have loan obligations he may no longer be able to commit to.”
In the face of the agricultural industry complaints, Bankman-Fried gave ground. While maintaining his position that automated liquidations could prevent bad situations from growing worse, he said the FTX approach was better suited to “digitally settled” contracts — such as those for crypto — than to trades where physical collateral such as wheat or corn is used.
His rhetorical retreat pointed to a possible way forward for the CFTC as it considers the FTX proposal. The derivatives regulator obviously sees something of value in the plan, having put it out for public comment and then spent an entire day listening to market participants talk about it.
If the CFTC really wants to let FTX experiment in the leveraged futures markets, it might limit its activities to the 24/7 crypto trade, at least for a set period. That way its supporters could find out whether FTX’s system is really the next big thing — and the nation’s farmers could get their rest.
