This week in Crypto live From FTX SALT

I discuss the transformative potential and reasons for the CFTC to approve the FTX proposal to offer real time margining and liquidation via their open, cloud based platform.

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Good afternoon. This is Dave Weisberger, CEO of coin routes, coming from the sunny Bahamas, where FTX Salt Crypto Bahamas, has just concluded. And it’s important because FTX is actually what I really want to talk about today, given that there’s an unprecedented thing occurring in the world of market structure.

On May 25th, the CFTC has scheduled an open hearing to debate a proposal from FTX to allow their unique market structure model to work in the US futures regulated market. Many of you might not know this, but they bought a company called LedgerX, which has a regulated futures exchange and clearinghouse, and FTX has put together a proposal to allow for what is a significant advance in market structure, and one that is potentially revolutionary in the way that futures and delta one derivatives are traded in the United States. So let’s talk about that, because to be honest, when we do this week in crypto, we want to talk about the markets. But the markets are still mired in a trading range, still relatively correlated to other assets like the Nasdaq and speculative assets. And really not a lot has happened, unless you happen to be a devotee of Apecoin, in which case you’re wondering how it’s up so much when the rest of the market isn’t. But that’s a story for a different day. So let’s dive right in. So what is the FTX proposing? Well, the first thing they’re proposing is to have real time risk and realtime liquidation. Now, let’s contrast what that means. In the case of FTX’s model, every client is assigned post-collateral. They can post collateral across their positions, and the leverage that’s given today is limited to 20 times leverage. But in the proposal, it’s not at all clear to me that they wouldn’t be open to limiting it to far less or having a volatility based metric or something. So the amount of leverage given is not really the issue here. What is the issue here is that every 30 seconds on their platform, they calculate risk and they calculate what normally people in futures would call variation margin.

The difference is that the CME that’s calculated once per day, and only at that time, if you’re in violation, do they require to either post more margin or have a percentage of up to potentially the whole position liquidated. What does that mean? Well, in FTX, since it’s happening tick by tick all day long, the odds that a position would get liquidated and leave the exchange actually losing money on it is dramatically lower. Brett Harrison gave a wonderful talk, which is probably available on the web as well at this conference. And what he said is, despite trading incredibly volatile assets, and we all know how volatile Bitcoin and Ethereum and other cryptos have been, and despite offering this for a couple of years, during some periods with intense volatility, their largest drawdown from their own internal insurance fund that they self fund was $2 million in a day. That is an incredible number, and really important for people to understand just how much real time risk decreases risk. Because if you consider taking that market model and moving it to things like trading US. equity index futures, for example, that are generally much less volatile, it bodes quite well for controlling it.

He also pointed out something very interesting, which is that if you end up taking a position at the end of a trading day, it could be a full 24 hours before that position is evaluated for its risk. Well, a lot can happen in 24 hours, frankly, in equity based markets, given the fact that markets are closed, there’s what we call gap volatility, the volatility of the price from the previous close to the open. That could be extreme. And we’ve seen some incredibly extreme numbers, for example, in Netflix with 25% moves in a print. No, I don’t care how volatile you think Bitcoin is, it has never moved 25%. Well, not never, but it has not in any recent history move 25% in one ticket, it tends to be a much more gradual process, even though when you zoom out and look at it over the course of 15 or 20 minutes, yeah, it looks like it’s a big deal. So in any case, they will shorten that period from potentially as long as 24 hours to 30 seconds. That is a definite decrease in systemic risk to the overall system. If you want to understand just how big of a difference it makes, think of what happened on the London Metals exchange with nickel there.

By the time they were able to evaluate the risk on the nickel position of the big short seller, when Nickel spiked, their position was already so much underwater that not only was their collateral wiped out, but the whole firm was going to suffer and multiple banks were going to lose enormous amounts of money. So they took the unprecedented decision to break those trades, meaning that people who had bought on the expectation that they had that and they have hedged it elsewhere, are now on the hook for huge losses in a totally unprecedented manner, because the systemic risk was too great. So anybody who tells you that we don’t have systemic risk in the CME or Ice model here in the United States is lying. The only question is, is the insurance fund significant? The second big difference between the FTX proposal is it’s non-requiring an intermediary. You can still use a broker. You can still use what is now called a designated clearing member, or DCM. You won’t need to use an FCM to send your orders out there, or maybe I have those reversed. I’m not a futurist guy from the beginning, but the reality is you don’t need a dedicated clearing member to trade, but you can use one.

So if you’re a customer that wants to take advantage of broker dealer products, you’re welcome to do so. On the other hand, you could also trade directly with the exchange in this model. This eliminates an enormous amount of economic rent. It is one of the reasons why perpetuals trade a significant amount of the crypto volume. Because people who trade who would ordinarily either looking for leverage or want to trade in a frictionless, being able to short sell, can do so well. In the US futures market that’s increasing, but it is significantly more barriers to entry. The last big difference is they’re open, open source and open in the cloud in terms of your connectivity. All market data is free, all market data is cloud-based. So you don’t need to have big data center implementations that are priced at basically oligopolistic prices by the various exchanges. Typically the CME is in Aurora, but there are many of them in equities that are all throughout northern New Jersey. We understand how that works. Essentially, those high frequency firms have created big barriers to entry. It cost hundreds of thousands of dollars of upfront investment in order to be able to trade.

With FTX that will not be necessary. You can spin things up in the Amazon cloud and be parry pursue with everybody else. So those three big changes, the risk, the lack of necessary intermediation and being parry pursue without having to spend a lot of money could be potentially revolutionary in market structure. The fourth one, which isn’t necessarily something that’s going to be easy for people to get their heads around, is 24 hours trading. And frankly, while I actually think it makes sense and we’ve seen in the crypto market, it decreases risk, it’s better for investors. That might be a hard sell. It’s important to de-link that from the other three, however, when you start considering it, because frankly, that is where most of the arguments against this lie from my traditional financial friends. So got a little longer than usual, so that’s where we’re going to wrap it up today. But on May 25 there will be a very interesting hearing and there’s also a lot of comment letters pouring in. So stay tuned because this could change things dramatically. Thank you.

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