CFTC praises FTX's new proposal, digital assets and smart contracts could replace traditional futures commission merchants (FCMs)

FTX previously proposed to the CFTC to achieve automated financial risk management using blockchain digital assets. In the new world described by SBF, smart contracts will replace the traditional role of financial brokers.

Novelty of FTX's Proposal: Margin Handling

Traditional finance currently involves a "Futures Commission Merchant" (FCM) role, responsible for collecting and chasing user margins. For special clients, FCM provides "pre-funding services" to ensure that the positions of special clients are not liquidated.

On the other hand, FCM also needs to provide collateral funds to the clearinghouse, which are used to offset significant violations.

FTX believes that FCM can be replaced by smart contracts.

According to the proposal, FTX users will deposit collateral in their accounts, which can be cash or cryptocurrency. The system will calculate margin positions every 30 seconds and notify users.

If the margin ratio falls too low, FTX will start liquidating user positions within seconds. The worst-case scenario is to sell the positions to liquidity providers at an "agreed-upon amount."

FTX officials believe that this margin practice is safer.

FCM's current practice involves expecting clients to make payments at a "certain moment," while FTX's automated system is safer. Although liquidation may be more frequent, it provides better protection for the system. The best evidence is that FTX has been handling liquidations in this way for nearly three years and the system has proven to work well in volatile digital assets.

SBF told the Financial Times: "This is often overlooked in discussions, but from a risk management perspective, I think our proposal is somewhat more conservative. Blockchain technology enables more efficient and instantaneous exchange of collateral, so once there's new tech that can instantly move collateral, the way collateral margins are done needs to be rethought. We have to manage collateral in real-time in this system. Customers without collateral will be liquidated, which is a good thing, as it reduces systemic risk. If you have such an effective liquidation mechanism, do you really need an intermediary (referring to FCM)?"

Inspiration from Nickel Trading Suspension

SBF's recent remarks have garnered attention due to the recent challenge to the "intermediary margin call system" in the futures market.

The London Metal Exchange (LME) suspended trading of "nickel" in early March. Due to the Ukraine-Russia war causing supply disruptions, nickel surged by 78% on March 7 and another 74% on the 8th, pushing prices above $100,000 per ton, leading LME to halt nickel trading and cancel all trades after midnight on the 8th.

Initially, the market speculated that LME took such drastic action due to extreme price volatility. However, industry insiders familiar with trading rules stated that it was due to liquidity risk in the nickel market. With nickel prices soaring, institutions shorting nickel would be required to top up margins. However, due to the high price increases, most would opt for forced liquidation rather than topping up margins, causing a significant contraction in liquidity on the short end of the nickel market.

Following the event, SBF tweeted: "I want to formally announce that FTX will not cancel any trades."

At the time, some netizens believed that SBF's statement was indifferent to the impact of price liquidation. However, according to FTX's proposal, in cases of significant price surges, a "gradual liquidation" would be triggered, with the worst-case scenario being liquidity providers purchasing these collaterals at pre-agreed prices to complete the liquidation.

CFTC Chairman Rostin Behnam also publicly praised the arguments and ideas behind SBF's proposal during the same meeting, promising to carefully consider and ponder over the proposal.

He stated: "Once approved, this proposal will introduce a new model where registered DCOs can provide margin products to users without relying on an FCM intermediary. This proposal is quite innovative and worth considering. As the institution (FTX) is drawing from past experiences during the proposal process, just as the SEC has done in the past, we will maintain a cautious attitude and carefully consider it. However, there is a premise that the institution must prioritize customer protection, market stability, and the core principles of other important protective measures."

However, this does not mean that FTX completely denies the function of FCM. FTX.US President Brett Harrison believes that in the future, smart contracts and FCM can coexist, depending on how the exchange operates. Regardless of the outcome of this proposal, FTX's proposal and the discussions it sparked symbolize a new phase in the discussion of crypto regulation and traditional finance.