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FTX aims to shake up the sprawling U.S. derivatives market, marking the biggest intervention yet by a crypto group into the heart of traditional finance.
The three-year-old exchange, founded by Sam Bankman Fried, offers customers Bitcoin futures, a contract that allows users to bet on the price of the world's most actively traded digital token. The company is seeking approval from the U.S. Commodity Futures Trading Commission to provide this service. If the group succeeds, it could change the way markets work for everyone from farmers who fix corn prices to hedge funds that bet on oil prices.
The proposed process would eliminate brokers, who for the past 40 years have acted as intermediaries between customers and the exchanges where trades take place. Rather than a broker asking a customer to put up additional cash, known as margin, when a trade goes wrong, the exchange automatically monitors the market 24/7 and adjusts the customer accordingly. Withdraw the balance.
This process is already used by largely unregulated offshore crypto platforms such as Binance and FTX, but the US market requires regulatory approval. The United States accounts for the majority of the global futures market, with 29 billion contracts traded last year, meaning the impact could be far-reaching if FTX's plans are approved.
Automatic liquidation and margin call
Central to the existing system and FTX's proposition is leverage. Futures traders typically trade only a small portion of the total value of a position, magnifying potential profits and losses. The chips that market participants place on the table are known as “margin.” Margin is very important in leveraged trading because it can provide peace of mind to the participants on the other side of the trade if the stake goes against them.
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The main difference between the current system and the FTX proposal is the approach to margin. Under the current framework, if a bet goes too far below ground, brokers will ask traders to put up additional funds to back the trade, known as a “margin call,” by a certain deadline. If the trader reaches the margin call, the trade will remain open, but if not, the broker will start unwinding the position and get back the margin used for the trade.
Cryptocurrency exchanges such as FTX and Binance constantly update margin requirements for products such as Bitcoin futures. Traders trade directly with exchanges without going through a broker.
When a user's margin falls below a preset level, the crypto platform will automatically start unwinding the position. Users typically receive a warning if their account is at risk, but given the volatility of digital assets, traders can quickly disappear when this type of liquidation event occurs. .
Unlike cryptocurrencies, which are traded non-stop, most traditional futures such as those tracking commodities close at the end of the week. However, some smaller market participants are concerned that after-hours trading would disappear under the FTX proposal, as most firms trade efficiently at all times during the business day. It has said. In contrast, margin calls provide some leeway to meet funding requirements.
Case Study: May 2021 Cryptocurrency “Flash Crash”
Automated liquidation is already widely used in the crypto industry, with $1.3 trillion worth of Bitcoin futures traded last month alone. Traders can disappear very quickly during market turmoil, and higher leverage increases the speed at which users are forced to liquidate.
The case study below is based on the “Flash Crash” from about a year ago that left many leveraged Bitcoin traders in the lurch. The trader in this picture took a 100x leveraged position on Binance by putting $2,500 into a trade worth $250,000. When the market starts to fall, you need to put more and more money into it to avoid liquidation even if the price quickly recovers.
The brief market crash in May 2021 caused many individual traders to suffer huge losses. However, due to automatic liquidation, market participants can typically only lose the amount they bet on a trade rather than increasing their debt.
discussion
The FTX plan has sparked intense debate in the United States since the CFTC began discussions in March.
Supporters of the FTX proposal believe that this is the next evolution of the market, as technology will inevitably advance in the market, as in the rest of society. Proponents say this is to increase competition, democratize futures trading and, just as importantly, protect small investors from accumulating debt they can't afford, with sometimes tragic consequences. say:
On the other side of the debate, there are those who argue that the traditional system provides important “breathing space” to make important decisions and time to find additional cash. Farmers, for example, no longer have to worry about positions they opened to protect against fluctuations in commodity prices being wiped out by sudden market movements. Customers no longer need to invest more money than necessary to have peace of mind. Exchanges and brokers, the central intermediaries in the system, will be able to use human judgment to resolve potential problems during volatile times.
The CFTC is taking its time to investigate every step of the chain to understand how it works and what the consequences are. A decision may not be made this year. Both models may be allowed. But as investors explore Bitcoin futures, they could face further offers.
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