FTX Presentation to the U.S. Financial Stability Oversight Council
FTX greatly appreciates the process of outreach and education originated by President Biden’s March 9 Executive Order on Ensuring Responsible Development of Digital Assets (EO). Fundamentally, the EO acknowledges the substantial and positive impact that the digital-asset ecosystem already has made on the provisioning of financial services globally, and recognizes that the additional potential of the industry can best be achieved through responsible oversight by the official sector. In this same vein, FTX acknowledges and appreciates the work of the U.S. Congress, U.S. federal agencies, governing bodies of other nations, as well as international standard setters that have driven the discussion about responsible supervision in a generally positive manner. FTX remains eager to engage in all of these efforts and share our perspectives on the industry.
Background on FTX
The FTX group of companies (FTX Group or FTX) was established by three Americans, Samuel Bankman-Fried, Gary Wang and Nishad Singh, with international operations commencing in May 2019 and the U.S. exchange starting in 2020. The business was established in order to build a digital-asset trading platform and exchange with a better user experience, customer protection, equitable access, and innovative products, and to provide a trading platform robust enough for professional trading firms and intuitive enough for first-time users. In the U.S., the company operates a federally regulated spot exchange that is registered with the Department of Treasury (via FinCEN, as a money services business) and also holds a series of state money transmission licenses. Our U.S. derivatives business is licensed by the CFTC as an exchange and clearinghouse, and the company also holds a FINRA broker-dealer license. FTX’s international exchange, which is not available to U.S. users, holds a series of marketplace licenses and registrations in many non-U.S. jurisdictions including Japan and the European Union (EU). FTX has aimed to combine the best practices of the traditional financial system with the best from the digital-asset ecosystem.
Early International Success. The international FTX.com exchange has been successful since its launch. This year around $15 billion of assets are traded daily on the platform, which now represents approximately 10% of global volume for crypto trading. At the time of this writing the FTX platforms have millions of registered users, and the FTX US platform has around one million users. For FTX.com, roughly 45 percent of users and customers come from Asia, 25 percent from the European Union (EU), with the remainder coming from other regions (but not the U.S. or sanctioned countries, which are blocked). In comparison to the international exchange, nearly all users of FTX.us are from the U.S.
The FTX team has grown to over 200 employees globally, the majority of whom are responsible for compliance and customer support. The FTX Group’s primary international headquarters and base of operations is in the Bahamas, where the company is registered as a digital-asset business under The Bahamas’ Digital Assets and Registered Exchanges Act, 2020 (DARE).
FTX US. FTX services U.S. customers through the FTX US businesses, which includes the spot exchange, FTX US Derivatives (FUSD) (https://derivs.ftx.us/), the NFT marketplace, and a soon-to-go-live FINRA broker dealer (FTX Capital Markets). FTX US is housed under a separate corporate entity from FTX international and is headquartered in Chicago, IL. It has a similar governance and capital structure to the overall corporate family, and also has its own web site, FTX.us, and mobile app. As with FTX.com, the core product is an exchange for both a spot market for digital assets as well as a market for derivatives on digital assets. Like other crypto-platforms in the U.S., the spot market is primarily regulated through state money-transmitter laws.
FUSD offers futures and options contracts on digital assets (or commodities) to both U.S. and non-U.S. persons. FUSD operates with three primary licenses from the CFTC: a Designated Contract Market (DCM) license, a Swap Execution Facility (SEF) license, and a Derivatives Clearing Organization (DCO) license. Prior to its acquisition by FTX, this business was the first crypto-native platform issued a DCO license by the CFTC in 2017, which was a milestone for the agency and the digital-asset industry. That license was later amended in 2019 to permit the clearing of futures contracts on all commodity classes.
Equitable Market Structure. FTX operates its trading platforms with the option of direct access to the market/matching engine and, where applicable, clearinghouse for users, which allows those who access the platforms in this manner to become participants (rather than requiring intermediated access). In practice, this allows any individual or institutional investor to onboard the platforms by visiting the relevant web site and completing the onboarding process, or by connecting to the platform through the API. Importantly, FTX is also able to allow intermediaries to connect and provide their own customers access to products for trading. By providing both direct or intermediated access, FTX maximizes choice for the investor. For direct-access users, FTX also provides all of the applicable suitability controls and KYC processes that are often done by intermediaries, ensuring that the standard safeguards are in place whichever way customers access the platform.1
The FTX Application Before the CFTC. When the FUSD DCO was originally approved by the CFTC, the order granting the license limited the products that the DCO could clear to fully collateralized derivatives. In December 2022, FUSD submitted an application to amend its DCO license (FTX Application) to allow FUSD to clear margined futures contracts.2 The submission was made after many months of informal discussions with the CFTC staff, and after voluminous materials were created in support of the application and made part of the submission. Those discussions led to various adjustments and edits to the materials during the process.
Resilience Under Market Stress. In addition to offering competitive products, the FTX platforms have built a reputation as being highly performant and reliable exchanges. Even during bouts of high volatility in the overall digital-asset markets, the FTX.com exchange has experienced negligible downtime and technological performance issues when compared to its main competitors. We believe the dual-track focus on customers and reliability, plus compliance and regulation, are key reasons why FTX has also experienced the fastest relative volume growth of all exchanges since January 2020.
For each FTX platform, the core product consists of the web site that provides access to a market place for digital assets and tokens, and derivatives on those assets. Platform users also can access the market through a mobile device with an FTX app. The core product also consists of a vertically integrated, singular technology stack that supports a matching engine for orders, an application programming interface or API, a custody service and wallet for users, and a settlement, clearing and risk-engine system. In a typical transaction, the only players involved are the buyers, sellers, and the exchange/clearinghouse.
The FTX risk-management system consists of a number of innovative features designed to limit losses for customers as well as contain risks on the platform to avoid market contagion. These features are under review in the context of the FTX Application, and include pre-funding initial margin in support of customer trading positions; real-time review and assessment of customer accounts to determine the adequacy of customer collateral based on market moves; an automated de-risking feature that sells portions of customer positions in order to re-balance customer accounts as needed; a backstop-liquidity-provider (BLP) program to manage customer positions from accounts in default; and a guaranty fund that is over capitalized to absorb losses from customers accounts when needed. The FTX risk-management system does not extend credit to customers or issue margin calls when margin levels supporting market positions decline below required levels – instead, the system requires that adequate margin levels are maintained by customers on the platform at all times, and when minimum levels are not maintained, the system de-risks those customer positions automatically.
Many global markets have experienced volatility in recent weeks and months, including debt- and equity-securities markets as well as crypto markets, but most relevant to policy makers is the performance of risk-management systems during this market stress. FTX’s operations, including the risk engine on FTX.com, have performed remarkably well and as designed during the recent market volatility. Indeed, the resilience of FTX platforms amid such turbulence illustrates how well these real-time risk-management systems can contain risk during extreme market events, and how their introduction into other markets could benefit those market places.
Consider the following data on FTX’s three most-traded futures contracts for Bitcoin (BTC) and Ether (ETH) listed on the platform. There were more than $40 billion in trading volume for just these contracts listed on FTX.com on the three trading days in June with the biggest market moves:
The month of June also saw several other days with substantial market moves of greater than 10 percent. From June 10 through July 4, more than $168 billion in notional activity was traded in the most-traded contracts for BTC and ETH.
For June 13, 14 and 18, the automated de-risking transactions performed by the FTX risk engine amounted to approximately $644 million, or ~1.5 percent of overall trading in those contracts. During the period June 10 through July 4, the automated de-risking feature of the risk engine transacted $855 million in notional trading, or ~0.5 percent of overall activity in those contracts.
There are two important takeaways from this data. First, trading volumes on FTX.com were higher on the days highlighted, but the share of trading volumes from de-risking transactions was still a very small fraction of the overall activity – this has been a consistent trend since the platform was launched. Second, the guaranty fund – a key layer of the default waterfall which contains loss-absorbing resources funded by FTX – was minimally impacted by losses in customer accounts, and in fact on two of three days, the guaranty fund experienced a net gain in resources, and was net positive for the period of June 10 through July 4.
The discussion below addresses the areas of focus identified under Section 6 of the Executive Order on Ensuring Responsible Development of Digital Assets: (1) pathways with the greatest potential for integrating digital assets and related technology into the traditional financial system; (2) actions that digital asset market participants could take to ensure operational and financial resilience; and (3) actions that financial regulators could take to address financial stability risks and regulatory gaps associated with digital assets. While discussing these points this testimony references relevant CFTC regulations as needed, as well as international considerations related to equivalency determinations made by other jurisdictions.
1. Pathways with Greatest Potential for Integrating Digital Assets into the Traditional Financial System
FTX believes that today digital-asset exchanges offer the most compelling pathways for integrating digital assets into the traditional financial system – exchanges facilitate fiat cash transfers, allow fiat cash to be exchanged for digital assets, facilitate lending activities in support of digital-asset trading, and leverage stable coins as collateral and payment mechanisms. Proper oversight to ensure adequate standards of operational and risk-management practices are therefore important in order to protect customers, investors, and the public more generally.
a. Digital Asset Exchanges
Centralized digital-asset exchanges, like FTX, today are the gatekeepers to the digital-asset ecosystem. To explain the potential for integration offered by exchanges, it is useful to start with a review of their key products and functions – here we describe those offered by FTX, and identify the particular opportunity for integration.
Product: Trading Markets for Digital Assets. On FTX.com and FTX.us, users can trade digital assets with other users for cash, stablecoins and other digital assets. On the spot markets, users can set a variety of different order types on a central limit order book (CLOB). Users are able to offer orders at a specific price (limit order) or trade on the book at the best price shown. A robust price and time priority matching engine sits in between these orders to connect buyers and sellers and display the best available prices.
Futures and volatility contracts related to digital assets also are listed on the platforms as well, with or without leverage. To cover initial and maintenance margins, derivatives and leveraged-product users can post collateral in the form of cash, stablecoins or other digital assets held in their account. The exchanges also have integrated risk-management and back-office systems to perform clearing and settlement of trades, which includes updating records of ownership of the digital asset or digital asset futures and options contracts traded (clearing), and transferring value between users’ accounts (settlement), using either delivery versus payment or delivery versus delivery. Importantly, FTX’s risk model avoids the systemic warehousing of such risks over a weekend or other period of market closure, and instead addresses at-risk positions and accounts immediately, in real time, 24/7/365.
FTX also offers an off-exchange portal that enables users to connect with other, large users, enabling them to request quotes for spot digital assets and trade directly. This facility forwards requests for quotes to large users, returning prices offered and enabling users to then place an order. The portal is similar to other facilities found in traditional markets where a central limit order book is not used to match trades.
→ Opportunity for Integration: Exchanges for trading digital assets provide a clear point of integration between traditional finance and the digital-asset ecosystem in two ways. First, persons and firms that trade in these markets on FTX use fiat payment systems to move cash onto the FTX platforms (cash is custodied by FTX using partner banking institutions) for use as collateral or to acquire digital assets, thus connecting the two ecosystems. Second, a substantial number of FTX customers also trade in traditional markets. More than 75 percent of FTX users transact at least $100,000 in notional activity each trading day, indicating the size and scope of trading the core FTX customer brings to the platform. The more participants who trade in both traditional and digital-asset markets, and the more trading those customers engage in, the deeper the integration of the ecosystems becomes. From a risk perspective, the larger the positions, the more important risk management becomes – a market participant that defaults in their market position in a traditional-asset contract could lead to a default in their market position in a digital-asset contract, or vice versa. Therefore robust supervision of digital-asset exchanges is key.
Product: Third-Party Lending. Once onboarded, FTX platform users can lend their digital assets to those who seek them for spot trading. Users (including eligible users on FTX.us) wishing to trade digital assets they do not have may borrow them from users willing to lend them by posting collateral in the form of cash, stablecoins or other digital assets held in their account. The FTX platform maintains a borrow/lending book and matches users wanting to borrow with those willing to lend.
→ Opportunity for Integration: Users can post cash as collateral in order to borrow digital assets from other users on the FTX platform, making both the lender and borrower a conduit for integrating the two ecosystems. Cash must be custodied at traditional banking institutions by both FTX users (in their own accounts) as well as FTX itself (as custodian for the user), but can enable the borrow-lend transaction, and ultimately can be used to cover a default. The custody and the transfer of cash on the platform for third-party lending also create discrete points of integration between the two ecosystems.
Product: NFT Marketplace. FTX operates a marketplace for users to mint, buy and sell non-fungible tokens (NFTs). NFTs are tokens that are not fungible with any other tokens. They can take a number of forms and, for example, can be redeemed for a physical object, or an experience (such as a movie or phone call), or can be linked to a digital image, etc. FTX’s NFT marketplace is conducted through an auction system. Alternatively, users can purchase directly at the prevailing selling price set by the seller. Users can choose to display their NFT collection on the FTX NFT marketplace portal, and/or to continue to buy or sell on the NFT marketplace.
→ Opportunity for Integration: Again, digital-asset exchanges offer fiat payment mechanisms for acquiring NFTs (and in future other tokenized assets) which enable platform users to purchase a NFT with cash and present clear opportunities for integrating the two ecosystems.
Product: FTX Pay. FTX Pay is a service offered to merchants to accept payments in digital assets or fiat. Users have the option to top up their FTX accounts with ACH or credit cards, which are then used to make payments to enrolled merchants. For digital-asset payments, the relevant user’s FTX account would be debited by an amount in the chosen digital asset that is equivalent to the amount that is payable to the merchant. FTX facilitates the payments to the merchant by providing the payment infrastructure. This allows merchants to accept digital-asset payments, without having to assume any volatility risk for the assets.
→ Opportunity for Integration: Other digital-asset platforms also offer products such as FTX Pay, which uses the FTX exchange to convert digital assets into cash, and vice versa, as needed during the process of facilitating payments made in one form or the other between sender and recipient. By leveraging public blockchain payment rails when relevant, FTX Pay can settle these payment transfers more efficiently than through use of traditional payment methods. This product enables seamless integration of public blockchain technology with the traditional banking system.
Stable Coin Redemption. FTX and many other digital-asset exchanges redeem stable coins on behalf of customers when customers seek to withdraw dollars. FTX does not offer this service as a standalone product per se, or issue stable coins, but performs this service through the normal course of customer-account management. (The next section discusses the role of stable coins.)
In sum, the products available now in the digital-asset economy and on the FTX platforms are very similar to ones found in the traditional finance space. A key differentiator from traditional finance is that investors can get access to all of them on FTX without going through multiple intermediaries. FTX believes the market structure for digital-asset platforms is risk reducing compared to others because it facilitates more effective risk management and eliminates unnecessary points of failure. In addition, all market data on the exchanges is made public and free – all users are given full knowledge of the orderbook and trades. Easy access to financial products and solutions on one, easy-to-use platform is a powerful feature that empowers investors, consumers and entrepreneurs, and will continue to drive integration of the two ecosystems.
b. Stable Coins
Stablecoins play a crucial role in the digital asset ecosystem. The majority of all transactions in crypto are settled via stablecoins, and they are one of the most promising payment tools for the broader financial sector and represent perhaps the most pure and obvious integration point between the traditional financial system and the digital-asset ecosystem. These transactions also include M&A activity where one digital-asset company merges or acquires the other, and the transaction is settled using stable coins. While there are a wide variety of stablecoin designs that have been utilized in the cryptocurrency ecosystem, the focus of this discussion is placed on payment stable coins where 1 token represents 1 U.S. Dollar. In this construct, the stablecoin is a blockchain-based asset that can be created on a number of the public blockchain networks, including Ethereum and Solana.
The component parts and processes of a stable coin include:
- Reserves: typically a stablecoin is backed by one or more USD accounts or other similar assets, generally held at a bank, in an account under the name of the stablecoin sponsor, issuer, or other similar body. The USD value of the assets should be at least the supply of the stablecoin.
- Token: a blockchain-based token, such as USDC, where one token represents $1 (as supported by the creation / redemption process, described below). Tokens could be issued by a private company, a central bank, or a decentralized protocol.
- Creation/Redemption: In order to create 1 token, an eligible user must send $1 to the reserve account. In return, the issuer or protocol mints 1 new token and sends it to the user. Similarly, an eligible user may send 1 STBC token back to the protocol to redeem it for $1. The protocol destroys the token and sends $1 back to the user.
Stable coins have become so widely used in the digital-asset ecosystem for two primary reasons: (1) greater and near instantaneous operational certainty of settlement; and (2) actual integration with the digital-asset ecosystem since the issuer creates a token leveraging a public blockchain. Regarding the former, some public blockchains can confirm the transfer of a stable coin on their network within seconds. The same can be said for other traditional payment services available to consumers, where the payment platform can debit/credit dollar transfers; but there are often transaction-size limits for these platforms, and the platforms only are useful if both counterparties are admitted to use the same platform. Regarding the latter reason, the U.S. dollar is represented by a token native to a public blockchain, which is a network accessible by anyone, thereby allowing that specific unit of value to be transferred on the blockchain by anyone who chooses to use it.
→ Opportunity for Integration: As confidence in stable coin issuers as well as the performance of public blockchains continue to rise, integration of the two ecosystems will continue to accelerate. Trust in stable coin issuers will depend on the reliability, resilience, and risk management of those issuers, which in large measure will turn on the transparency into their operations and reserve assets. Such transparency will improve as policy makers adopt and implement minimum standards for issuers through regulation and supervision. Policy makers also should adopt appropriate reporting, risk-management, and reserve requirements for the issuers and ensure regular examinations of compliance with these standards.
c. Tokenization of Assets
Just as blockchain technology can enable tokenized dollars, or stable coins, it can enable the tokenization of other assets, including other commodity assets, securities and other tangible assets. This process can bring the same benefits described for stable coin transfers and settlement to additional assets. For example, tokenized stock trades can be settled in seconds for pennies, reducing cost, settlement uncertainty, and risk. For tokenized securities, important regulatory questions would need to be solved, and practical considerations around the funding of settlement of securities transactions at scale would need to be addressed. As these issues are resolved, however, FTX envisions harnessing real-time risk-management tools and more efficient collateral movements using blockchain rails to lower risks in securities settlement.
2. Actions to Ensure Operational and Financial Resilience
For operational and financial resilience, and in the absence of commiserate regulatory requirements promoting the same, market participants in the digital asset ecosystem should focus on implementing the following key items: (1) system safeguards for customer-facing platforms to ensure the protection of customer assets (to the extent customer assets are being custodied) and protect against insidious malware contagion – this includes adequate cyber hygiene to ensure customers of market participants protect themselves and their assets from theft (e.g., two-factor authentication gating features before accessing digital platforms); (2) maintaining adequate financial resources to ensure the efficient operations of a digital-asset platform, including during times of market stress or wind down; (3) segregation and avoidance of re-hypothecation of customer assets for customer-facing platforms; (4) for trading platforms, adequate disclosures related to the risks on the platform as well as disclosures related to the safekeeping of customer assets and; and (5) adequate capital for borrow/lending platforms as well as clearing house platforms (e.g., derivatives trading) in order to buffer losses incurred by customers to those platforms. Various organizations have formed to drive best practices by digital-asset market participants in the absence of clear regulatory guidance.
3. Actions to Address Financial Stability Risks and Regulatory Gaps Associated with Digital Assets
FTX recommends multiple actions that the FSOC and federal regulators could take to address systemic risk and regulatory gaps associated with digital assets. First, regulators should bring digital-asset platforms into the regulatory perimeter when those platforms apply for licensure, and do so expeditiously. At the time of this writing, FTX has license applications (or similar analogous requests) before the CFTC (to amend its DCO license), FINRA (a change in control review), the New York Financial Services Division (a New York trust application to offer digital-asset custody services), and money-transmission-license applications before multiple state regulators. The known reality is that digital-asset platforms do not always fit neatly into the regimes of these regulatory agencies, but all of them nevertheless have legal requirements that apply to certain products. It is also the case that some agencies have authority to provide exemptive relief from, or innovative guidance on how to otherwise comply with, specific requirements in order to massage the licensing and implementation process, so long as the same policy goals of the agency can be met in doing so. FTX believes that the FSOC should encourage these agencies to move with haste to issue licenses in the pursuit of the broader policy goals identified in the EO if the applicant can make a showing that the public interest could be served by doing so. These goals include protecting investors and mitigating systemic risks, both of which are better accomplished when digital-asset platforms are subjected to federal oversight.
This approach carries the added benefit of promoting responsible innovation and competition within the U.S. financial services industry more broadly, another goal of the Biden Administration. For example, FTX has argued that approving the FTX DCO application could help address broader market concerns related to market-trading concentration, consequent systemic risk, rising costs, and collateral movements.3 Market concentration has manifested itself in two ways in U.S. derivatives markets: (1) approximately 97 percent of the total futures trading volume for May 2022 traded on only two platforms,4 and (2) while there were 176 FCMs registered with the CFTC in early 2008, today there are only 61.5 Approving the FTX Application would address both by offering another venue for investors to trade derivatives, and introducing innovations in market structure and risk management that would ease cost pressures on FCMs and disperse risk more broadly in the system.6
Second, FTX recommends that agencies promote regulatory clarity, protect customers and promote innovation by approving new products presented by licensed digital-asset platforms, unless the product approval would clearly encroach on another agency’s jurisdiction. This recommendation especially applies to the market regulators and in particular the CFTC, which has oversight over “commodities” that are very broadly defined by statute (whereas “securities” are a more narrowly defined category of “commodities”). FTX was encouraged by a recent statement by Chairman Behnam of the CFTC:
[M]any digital asset-related companies now operate CFTC-registered exchanges, and our Division of Market Oversight is regularly reviewing new products tied to digital assets both from these new entrants and from more traditional registrants. I have asked the staff to be proactive in considering the extent to which our authority can be leveraged to bring these novel products into the regulatory fold to ensure important protections for customers and market integrity provided by CFTC regulation.7
FTX agrees that reviewing products with an outcomes-based approach that seeks to expand the protections of an agency serves the public interest, and provides additional certainty to the digital-assets industry.
Third, FTX recommends that Congress provide the CFTC the authority to oversee spot-market activity for non-security digital assets. This authority would close existing regulatory gaps but also promote financial stability by bringing spot-market activity onto the same platforms that operate markets for derivatives on non-security digital assets, much like FTX.com operates today. Indeed, a unified regulatory framework would provide operational, capital and risk-reducing efficiencies that will better protect investors as well. Such a step also should involve a consideration of the appropriate disclosure regime for digital assets that ensures investors are adequately informed of their risks. The CFTC already has considerable experience and expertise in the regulation of digital assets, and FTX believes that policy makers would be wise to leverage that expertise for the benefit of the public as well as the digital-asset industry. Until such authority is provided by Congress, the CFTC should be encouraged to work with industry to permit retail commodity transaction contracts related to digital assets to be listed on boards of trade registered with the CFTC, pursuant to the agency’s existing authority over these transactions as established by CEA section 2(c)(2)(D) and as affirmed in the 2020 Actual Delivery Guidance issued by the CFTC. This would clearly promote the public interest and would not require further legislation, being consistent with the current authority of the CFTC.
Fourth, as recommended in FTX’s Market Regulation Key Principles, Congress, the CFTC and the SEC should pursue a scheme where a digital-asset platform operator could opt into a program of joint supervision by the CFTC and SEC when there is joint jurisdiction over digital assets listed on the platform (e.g., when listings include non-security digital assets as well as digital assets that are securities).8 Under these circumstances, FTX recommends that one of the market regulators serve as the primary regulator, and the other as the secondary regulator, for market oversight. This type of paradigm is familiar to market regulators globally and also could include the accommodation of one rule book, one matching engine and risk engine supported by one technology stack. This approach should also allow for digital assets to be taken out of this trading environment and used for their native use case - i.e., deployed to accomplish functions on their underlying blockchain - without undue regulatory friction. FTX believes this approach could largely be created under existing CFTC and SEC authorities, but Congress should encourage the agencies to leverage their authorities today with these goals in mind, and consider legislating such an approach when feasible. This approach facilitates one collateral and risk-margin program for customer accounts holding both cash and derivatives positions, allowing the platform to better manage market risk, and reducing operational risk owing to a single technology stack for the front end (the user interface) to the back end (settling and risk managing positions). Public policy should permit this one-rule-book model due to its risk-reducing and customer-protection attributes.
2 FUSD currently only offers futures, options, and swaps on digital asset commodities.
6 FTX also recommends that the FSOC request a list of all applications for license made by digital-asset platforms to the agency members of FSOC, as well as the dates when those applications were made, in order to assess the timeliness of licensing review. The FSOC also could request an explanation of the reasons those licenses have not been granted yet, including through the identification of specific regulatory requirements the applicant could not meet. This exercise could help identify regulatory gaps or requirements inapplicable to digital-asset platforms that might be needlessly preventing licensure and the broader benefits it could bring.