Automated margin calls are another thing blockchain doesn’t need to fix

“How FTX plans to reshape the US futures market with crypto technology” is the story running elsewhere on the Financial Times webspace. It explains how Sam Bankman-Fried’s Central Bank of IP wants to “remove the brokers who for the past 40 years have acted as intermediaries between customers and the exchanges where deals are made.”

SBF formally presented the idea of ​​automated risk management to US regulators in March. His proposal involves using 24-hour trading of leveraged crypto futures as a proof of concept to gain the confidence of the US Commodity Futures Trading Commission.

Anyone familiar with CFDs and spread betting will now be wondering what all the fuss is about. Advance margin accounts and algorithmic settlement have been part of the scene in European markets, and globally for forex, for almost as long as the funds have existed.

The problem here is America. The CTFC still needs to get comfortable with the concept of leveraged borrowers managing their own risk, which is not indisputably consistent with the Commodity Exchange Act.

FTX has lobbied the CTFC for a rule change after they last year bought LedgerX, an American futures and options exchange that under current rules must request full (or close to full) customer security. FTX wants to offer them leverage, but they don’t want to be dependent on futures commission merchants (FCMs), who are the market’s repo men.

FCMs have remained because they are quite useful. Placing a gatekeeper between the exchange and the customer helps to collect collateral, and is intended to ensure that clearing houses have enough to cover any defaults. Gatekeeping also adds a degree of human discretion to the big decisions, such as when Citigroup got a free pass in March 2020 after missing a margin call.

FTX wants to bypass all that. “Dramatic improvements in technological infrastructure over the last twenty years” means that clients should be given direct access to exchange and clearing services, only to be taken out of losing positions by a disinterested algorithm. Real-time margin monitoring will close accounts in 10 percent increments, with FTX offloading its risky positions where possible to “liquidity providers” and buffering against disaster with its own $250 million cash fund.

SBF cites FTX’s own trading history (August 2020 to date) as evidence that such a risk management system works, and that it is better to boil the frog with regular small liquidations than occasional large ones. Regulators who called for futures market surveillance in the wake of the GFC are invited to look at FTX’s dashboards for a microcosm of what it might have looked like.

Blockchain is mentioned in passing because fans believe distributed ledgers are good for instant, frictionless capital transfers. SBF has talked about how smart contracts etc. are a “truly beautiful experience” when applied to risk management, but really any talk of protocol improvement is incidental at best. Obstacles are all regulatory, not technical. Under the hood, FTX is as centralized as the average trading store; the application letter to the CFTC does not mention blockchain at all.

All that remains then is the argument about whether risk management using algorithms is positive or negative for market stability. But is FTX really the right company to lead it? After all, SBF didn’t get rich by making crypto less volatile, he got rich by making fiat easier to lose.

Crypto lobbyists have seized on the London Metal Exchange’s nickel omnishambles in March as an example of the problems caused by human intervention – while critics have argued that the LME’s autocratic style may be a symptom of Hong Kong Chinese ownership rather than structural flaws. It is not hard, meanwhile, to find examples of algos failing spectacularly to compensate for risk, such as in 2015 when Switzerland scrapped its currency cap and crashed large parts of the CFD industry.

Regulators and tradfi firms have so far been wary of the crypto lobby’s charm offensive. As Alphaville noted at the time, a CFTC roundtable in May included a rather irritated contribution from Chris Edmonds, ICE’s head of development, after Coinfund’s managing partner Chris Perkins used the infallibility of the big stores as an argument in support of FTX’s proposal. (Perkins was responsible for Citi’s clearing unit in March 2020 when the margin call was waived.)

A cynical view is that American industry has resisted innovation to protect its profit centers. The more rational solution is that futures pricing has real consequences for global industry and agriculture, so does not deserve the same risk tolerances applied to dogecoin. And crypto liquidations appear to be a profit center in and of themselves. Moreover, FTX is lobbying to influence its preferred choice of industry regulator, should the US government ever follow through on proposals to put crypto trading within a legislative structure.

Blockchain is, and always will be, largely irrelevant to the broader argument. FTX wants the legitimacy of regulated markets while using the same centralized systems it has developed in crypto to boil the frog and harvest the dead.

What FTX needs to do is now convince its participants that its preferred modernization mechanisms will not only encourage retail-driven gambling, manipulative volatility and arbitrary financialization. What is most needed is a clear presentation of the potential benefits, because right now the evidence from the core market is not good.