(Bloomberg) -- "No one saw this coming" has been a common refrain in the financial world since the swift disintegration of Sam Bankman-Fried's cryptocurrency empire. Nowhere is that sentiment more plain to see than in the letters sent to US regulators in support of FTX's application for a controversial plan that would have revolutionized trading of derivatives, a heavily regulated corner of Wall Street.
From Fidelity Investments to Fortress Investment Group, Susquehanna International Group and Virtu Financial, from faculty members at Georgetown, the University of Chicago, William & Mary and Stanford, from the Jones Day law firm and the Heritage Foundation think tank, hundreds of letters in support of FTX’s plan landed with the CFTC earlier this year.
Collectively, the comments highlight how, even in some of the most sophisticated corridors of finance, Bankman-Fried’s operation had been looked upon as an important source of innovation with the potential to helpfully disrupt not just the crypto industry but traditional markets as well. Instead, FTX’s collapse revealed a tangle of businesses rife with the potential for conflicts. Scant oversight jeopardized customers’ funds, leaving a gaping balance-sheet hole that sent the firm into bankruptcy.
While FTX US Derivatives, formerly known as LedgerX, wasn’t among the more than 130 FTX-related entities involved in the bankruptcy, the company withdrew its application with the CFTC amid the turmoil. Before the reckoning, though, it garnered much support.
"The FTX proposal innovates in risk management," Virtu's general counsel Justin Waldie wrote of the application, also adding support for the plan’s ambition to provide broader access to markets “subject to a robust disclosure, compliance and surveillance framework.” A spokesperson for Virtu declined to comment for this story.
The “innovations” that impressed the market maker Virtu and many other supporters were contained in FTX’s application with the Commodity Futures Trading Commission seeking approval to allow its derivatives exchange to trade directly with investors using margin generated via algorithms rather than traditional financial intermediaries such as brokers. The plan was for margin levels to be computed by FTX every 10 seconds at all hours of the day, rather than the traditional practice of computing them once daily and only on regular trading days. Under-collateralized positions would be liquidated automatically.
Fidelity Digital Assets President Tom Jessop wrote to the CFTC to support FTX’s plan: “We believe innovations like the proposed FTX margin model, in principle, generally help to decrease systemic risk, increase investor protection, and facilitate broader access to financial products,” while adding that the plan would substantially change market structure. He also noted there were several questions that needed to be answered about it. Spokespersons for Fidelity declined to comment.
Several others praised FTX’s plan to interact directly with investors in crypto derivatives, allowing retail traders access to a new set of opportunities previously only available to pros. The application indicated the company planned to execute every aspect of customers’ crypto derivatives trades on its own, cutting out other exchanges, banks and brokerages known technically as futures commission merchants.
The fact that customers’ assets were controlled by FTX, rather than by brokerages like in traditional finance, is why many of its users’ cryptocurrencies were frozen by FTX as it collapsed. The fate of those funds will be determined in bankruptcy court.
The promise of added liquidity from this new type of derivatives exchange also played into much of the support for FTX, whose failure ultimately stemmed from a lack of liquidity to meet a groundswell of withdrawal requests.
“FTX has a direct-to-investor model that enables investors to access the market though an application on their mobile device,” Peter St. Onge, research fellow at the Heritage Foundation, wrote in his letter supporting FTX’s application. “The mobile accessibility alone is an attractive user experience for retailer investors. When combined with other features of FTX US’s overall product offering, FTX US could offer customers a superior experience and, as a result, could meaningfully attract liquidity to its platform for these derivatives products.”
St. Onge said in an interview that FTX reached out a “number of times” to get his support, and while he was suspicious at first, he agreed to write the letter not because he supported Bankman-Fried’s company, “but the whole reason why I would back anything that FTX was trying to do is to open up these industries to new competition.”
Not too surprisingly, FTX investors Sequoia Capital and SoftBank chimed in with their support, as did Anthony Scaramucci of SkyBridge Capital, which counted FTX as an investor.
“We believe this proposal, if approved, will empower retail participants and harness responsible innovation as the digital asset market continues to grow and advance,” wrote Brian Conklin, SoftBank’s co-head of global government affairs, wrote. Conklin did not reply to an email seeking comment for this story.
Several letters noted the fact that the derivatives market had become concentrated in a dwindling number of players, and argued that it would be safer to trust middleman-free operations such as Bankman-Fried’s. “In the traditional intermediated model, a dependence on a limited number of clearing organizations creates a systematic concentration of risk,” Richard J. McDonald, chief regulatory counsel for Susquehanna International Group, wrote. “The CFTC has an opportunity to minimize market risk by enabling platforms, such as FTX, to provide direct access to trading on margin without required intermediation.”
FTX’s plan would “protect and empower” US investors, permitting retail investors access to products “previously available only to the small subset of well-resourced and powerful investors able to connect to the complex, traditional market infrastructure,” Peter L. Briger, CEO of investment manager Fortress Investment Group, wrote to the CFTC. “We note that FTX has previously succeeded in providing services directly to customers who did not have the infrastructure or relationships to support the involved clearing mechanisms required by competitors.” A spokesperson for Fortress declined to comment.
One of the longer letters of support came from William & Mary Law School professor Kevin S. Haeberle, whose 14-page comment includes disclaimer that West Realm Shires Inc., an affiliate of FTX US Derivatives, compensated him for the effort, adding that “My conclusions and reasoning are my own, and are consistent with my scholarly publications as well as with my larger thinking on the optimal market structure for financial-instrument trading markets.”
Haeberle said in an interview this week that he was asked to write the letter by Bankman-Fried’s father, the Stanford law professor Joseph Bankman, who was familiar with his academic papers on market structure. He wouldn’t disclose how much he was compensated but said that there were no efforts to shape or constrain what he wrote. “I read the proposal and I said, well, this could bring a lot of benefits from the digital-asset market structure to secondary markets for trading in more traditional financial instruments.” He stands by his opinion that the innovations proposed by FTX would be helpful to markets, though FTX’s bankruptcy means that those improvements are unlikely to implemented. “People will be dubious of that, because of the larger problems of this company,” he said.
Apart from the lawyers, financial professionals and professors writing in to support FTX’s application, there were hundreds of individuals who wrote to the CFTC, many of them apparently using a form letter with identical language.
“As an independent investor, I am urging the Commission to support direct access to trading on margin without intermediaries,” reads the beginning of a six-paragraph letter sent to the CFTC over and over and over again. “ I believe that independent investors should not face any barriers to entry on markets, other than access to the Internet or a phone app.”
Not all comment letters were supportive, especially among firms with the most at stake from FTX’s attempt at a derivatives revolution. CME Group and Intercontinental Exchange Inc. were among those voicing criticisms.
“The purported `innovations’ of FTX’s proposal are best understood as simple cost-cutting measures utilized in its offshore markets,” CME’s general counsel Kathleen Cronin wrote. “These cost cutting measures would come at the expense of risk management best practices, market integrity and ultimately, financial stability.”
Another conspicuous critic of the proposal was FTX’s rival Binance. Norman Reed, general counsel for Binance.US, wrote in to say that individual investors could get hurt by the plan: “FTX has not adequately demonstrated that its proposal is fair to its retail customers.”
To contact the author of this story:
Michael P. Regan in New York at [email protected]