- Traditional finance at risk
- Who could be affected by the innovation
- Smart contracts instead of brokers
A financial industry gathering was held in Florida. Sam Bankman-Fried, whose cryptocurrency exchange FTX has quickly become a dominant place to invest in digital assets, and Terry Duffy, CEO of CME Group Inc, a leading U.S. financial derivatives company, attended the event. Among the topics touched on in their intense conversation was a proposal for the FTX exchange to handle every aspect of customers’ crypto derivatives transactions on its own, thus bypassing other exchanges, banks and financial intermediaries.
If FTX’s proposal is approved by regulators, many in traditional finance fear that the model could be applied not only to cryptocurrencies, but to other assets as well. Central to the cryptocurrency exchange plan is the use of algorithms, not brokers, to help guarantee transactions. It is a crucial transaction settlement process that ensures that sellers get their funds and buyers get the assets they purchased.
“This is the first real constructive disruption of the traditional market structure we have seen,” said David Weisberger, who previously built trading systems for Morgan Stanley and Two Sigma in his career and now runs cryptocurrency company CoinRoutes. “All the changes create tension.”
Opponents say the FTX plan will undermine investor protections, could cost brokers their jobs by removing them from trades and risk disrupting markets that function well. But the bigger issue is that the proposal, which is being considered by the Commodity Futures Trading Commission, could give FTX access to vast markets for everything from oil to gold to currencies.
When asked about the plan in an interview Tuesday with Bloomberg Television, Bankman-Fried said FTX is now focused on retail crypto transactions, although he added that “there are really interesting applications for a pretty wide range of asset classes.”
CME, the New York Stock Exchange, Intercontinental Exchange Inc., Cboe Global Markets Inc. and the Wall Street banks that clear trades on those platforms could be hit with innovation if FTX really grows beyond crypto. Last year, CME posted $3.8 billion in revenue from futures trading and clearing, while ICE earned $2.4 billion.
Smart contracts instead of brokers
The main difference between cryptocurrency exchanges and traditional finance is that customers open accounts directly on the platform, and its computers will track their trades made on margin, which includes providing collateral. The automated system, unlike brokers, will then assess whether the investment has lost value and whether more funds need to be deposited. If positions fall below a certain level, the algorithms will even liquidate them. At DeFi, this approach has become classic, replacing intermediaries with smart contracts.
The FTX cryptocurrency exchange already clears some trades directly, but the innovation will allow it for the first time for crypto futures bought on margin by retail investors. The firm will put $250 million of its own capital to stop losses if buyers or sellers fail to meet their obligations. That contrasts with the model used by the CME, which requires its member brokers to send money into a community fund to cover defaults.
“This is a huge change from the way the futures industry has worked up until now,” said Julian Hammar, a partner at law firm FisherBroyles who previously worked for the CFTC.
The FTX proposal has its supporters on Wall Street, including Executive Vice President of Nasdaq Inc. Tal Cohen, who called it a “big step forward” in a recent interview. Anthony Scaramucci, founder of SkyBridge Capital, said the plan to eliminate middlemen would benefit investors by reducing costs and making the market more efficient.
Lawmakers said the FTX proposal could make the derivatives regulatory system riskier and customer protections weaker. FTX executives, for their part, argue that their proposal is intended to offer an alternative way to trade, not to bypass intermediaries entirely.