Clash between FTX and CME over crypto derivatives

The world’s largest derivatives exchange, the Chicago-based CME Group, has officially applied to become a Futures Commission Merchant (FCM). 

The Wall Street Journal reports this, noting that with this move the CME would eliminate brokers in the futures market. 

Something similar, in some ways, was also requested last May by the famous FTX crypto exchange, when it submitted an application to the CFTC to become a derivatives clearing organization. 

In both cases, should the applications of CME and FTX be granted, the two companies could issue and sell derivatives directly, without going through third parties. 

FTX and CME share a common goal

The strange thing is that in May, when FTX submitted its application, CME Group President and CEO Terry Duffy had strongly criticized this initiative. 

He explicitly said not only that FTX’s proposal was deficient, but more importantly that it posed “significant risk to market stability and market participants.”

In fact, according to Duffy, FTX would thus remove standard credit controls and destroy incentives for risk management by limiting capital requirements and mutualized risk. 

He added: 

“FTX’s proposal is nothing more than cost-cutting measures that would come at the expense of risk management best practices, market integrity, customer safety and, ultimately, financial stability.”

However, it now appears that CME Group wants to do the same thing, which is to eliminate intermediaries in order to reduce costs and offer cheaper, though perhaps less safe, derivatives to the market. 

According to Alexander Osipovich, author of the Wall Street Journal article, CME’s move would literally take its cue from that of rival FTX. 

The crypto derivatives market is definitely thriving now, and the CME is by far the most active traditional finance firm in the sector. 

However, the new, or relatively new, crypto exchanges are able to gather a larger audience of traders specifically interested in cryptocurrencies and their derivatives, so they are absolutely capable of competing with the Chicago giant in this specific area. 

For example, according to Coinglass data, right now in the ranking of platforms with the highest open interest in Bitcoin futures, CME would only be in fifth place, tailed by FTX itself. 

Hence they are for all intents and purposes direct competitors, as far as the crypto derivatives market is concerned, with CME coming from traditional finance, while FTX is from the crypto world. 

CME and FTX want to revolutionize the crypto derivatives market

With the above-mentioned proposals, both players want to gain an advantage over others by lowering costs, but with the risk that the derivative products they create and bring to market will be less secure. 

According to Duffy’s May statements, FTX would like to implement a light risk management clearing regime, which could increase risks significantly, potentially removing up to $170 billion of capital that can absorb any losses. 

On the other hand, according to others in the industry, the CME’s move could initiate a major turnaround for the FCM industry, generating dramatic concerns to every FCM currently in existence. 

Indeed, the risk is that specialized FCM operators will be wiped out by the behemoths that are directly operating exchange platforms. 

The speculation circulating is that CME would not actually want to initiate this turnaround, but is somehow trying to influence the CFTC’s decision on the FTX application. 

The CFTC has not yet made any decision on this, for either proposal, and in view of the situation that may arise should it accept CME’s proposal, it is assumed that it could also decide to reject both. On the other hand, should it accept that of FTX it seems difficult for it to reject that of CME. 

This is thus a direct confrontation that in theory could also cause damage to the entire crypto derivatives sector, and not only, but in fact constitutes a kind of attempt to revolutionize, or at least evolve, a sector in which few major innovations have been seen in recent years. 

The entry of crypto traders into the derivatives market, on the other hand, is changing several things, first and foremost the ease of access of small retail speculators to this market once dedicated specifically to professional traders. 

The fact that the CME ranks only fifth in open interest in Bitcoin derivatives speaks volumes about how important crypto exchanges have now become in this specific sector. 

It is also worth noting that the leading operator, Binance, has had several problems in the past precisely because of its derivatives offerings to retail customers. 

The clash between traditional and crypto-based finance

As far as crypto exchanges are concerned, this is still a very young industry, so much so that Binance is only five years old. On the other hand, as far as traditional exchanges are concerned, for example, the CME (Chicago Mercantile Exchange) started as far back as 1898 as a nonprofit agricultural commodities exchange, and became the leader of the global derivatives market about sixteen years ago. 

Thus, these are not only two completely different generations clashing, but also probably two different views of financial markets. 

On the one hand, there is the classical and professional one, while on the other there is the innovative and open to all. And while financial derivatives can also be dangerous for those who do not handle them well, crypto markets are now opening the doors of finance to virtually everyone, including those who want to use advanced instruments that exist only in the form of derivatives. 

The CFTC (Commodity Futures Trading Commission) so far has shown some openness to crypto innovations, but it is worth remembering that it is a US government agency that is probably trying to protect the country’s financial infrastructure. The CME is now very much among them, while FTX is the outsider trying to unhinge a long-established framework. 

Considering that doubts remain among institutions as to whether it might be considered excessively risky to open derivatives markets to all retail speculators, the CFTC may well side with the CME this time, despite the fact that over the past few years it has been very open to crypto markets. 

Its decision in this regard could also be a milestone for the derivatives market should it decide to approve both requests.