Hearing | FTX Attempts to Introduce "Smart Contract Clearing Model" to Traditional Brokerages, CME CEO Strongly Opposes

FTX proposed to the CFTC in March to replace traditional Futures Commission Merchants (FCMs) with automated liquidation. Yesterday, industry leaders in the commodity futures sector gathered in Congress to debate this proposal. What did they have to say?

The U.S. House Agriculture Committee held a hearing on March 12 titled "Market Role Evolution: Trends in Clearing Models and FTX's Proposal," inviting top executives from the derivatives industry to discuss FTX's proposal submitted to the CFTC in March. CEOs of CME and ICE were present to share their opinions.

According to FTX's policy website announcement, FTX aims to require customers to deposit collateral in their accounts, with the system calculating margin positions on a rolling basis every 30 seconds. If the margin ratio drops too low, FTX will begin liquidating user positions within seconds.

Several members of Congress responsible for overseeing the CFTC expressed distrust in the cryptocurrency industry at the hearing, even mentioning the recent turmoil caused by UST TerraUSD.

Chairman of the House Agriculture Committee, David Scott, believes that FTX's proposal "could pose a serious threat to the financial system."

CME CEO: A Disaster for the U.S. Economy and Investors

The CEO of the world's largest derivatives exchange, CME, Terry Duffy, believes that if the proposal is approved, it will be a disaster for the financial markets.

"The risk with this clearing model is quite high, the consequences of these products would be a disaster, and this risk is not limited to crypto commodities, because once the proposal is approved, this model can be applied to other commodities."

Terry Duffy's main concern is that once the proposal is approved, this clearing model could be applied to other commodities, increasing systemic risk. Also in agreement with Terry Duffy's opinion are Intercontinental Exchange (ICE) CEO Christopher Edmonds and former CFTC acting chairman Walt Lukken.

Their concerns are not unfounded.

If this model is used only on FTX and limited to crypto commodities, the risk is manageable. However, once it extends to other commodities and exchanges, factors such as the speed and volume of counterparties' clearing would need to be considered.

For example, if CME connects to three blockchains, each chain processing transactions at different speeds, there may be instances where some transactions cannot be settled. If settlement issues arise, the subsequent impact would be difficult to quantify.

SBF: The Proposal will Bring Innovation and Return Liquidity to the U.S.

Sam Bankman-Fried, founder and CEO of FTX, explains that FTX's proposal reduces systemic risk by requiring traders to provide collateral upfront. From a risk management perspective, this clearing method is more conservative and blockchain technology enables more efficient clearing.

"We believe that this proposal will bring competition and innovation, bring liquidity to the U.S. market, and provide U.S. users with more choices. Our derivative clearing model at FTX.US is more conservative than elsewhere globally, effectively reducing systemic risk and enhancing protective mechanisms."

In response to the concerns of CME and ICE CEOs, SBF reiterated that there are no immediate plans to launch contracts for "non-digital assets."

"We do not plan to issue contracts for assets other than digital assets using this clearing model in the short term. I am not lying, that is truly what I mean."

Additionally, SBF is open to additional restrictions, but disagrees with permanently limiting FTX's model to only trading digital asset contracts.

It can be anticipated that if the proposal is approved, although this clearing model will initially be used only for crypto assets, if the clearing method proves stable, it will also be applied to other commodities, which will bring competition to the U.S. futures market, where all trading volume is currently concentrated on CME and ICE.

Furthermore, 95% of crypto asset trading liquidity is currently outside of the U.S. If the proposal is approved, it would essentially create a 24/7 trading environment within the U.S., which is strategically beneficial for the country.

Christopher Perkins, co-founder of CoinFund, supports SBF, believing that if the FTX proposal is approved, it will empower entrepreneurs to establish cryptocurrency businesses within the U.S., as most innovation currently occurs outside the country.

Conclusion

Both sides have their own perspectives and reasons.

Opponents of the FTX proposal believe that technical issues need to be resolved, and any problems could impact market operations. On the other hand, proponents believe that the FTX proposal brings innovation and, in terms of clearing risk, is actually more conservative. Importantly, it encourages innovation and can bring back cryptocurrency trading volume to the U.S.

As Congressman Sean Patrick told SBF, "You've put out a cool idea, and a lot of people are excited about your idea. But the derivatives industry people hate your idea, which is understandable, as it affects their business. Let's face it, it's a mess right now."

Overall, FTX's proposal could potentially reshape the crypto industry, and even the derivatives industry. The CFTC has not yet approved the proposal, but a roundtable discussion will be held on the 25th of this month, inviting industry professionals, scholars, and non-profit organizations to participate.