In the age of bitcoin, buy side braces for 24/7 risk management

Investors forced to rethink “nine to five” mentality, as crypto exchange FTX proposes auto-liquidation model

FTX’s proposed 24-hour auto-liquidation of cleared crypto derivatives is a “very scary notion” for traditional asset managers, and would require firms to change their usual risk management approaches if they were to trade the emerging asset class, a DRW executive says.

Cryptocurrency exchange FTX has proposed a direct clearing model for crypto futures whereby retail traders would bypass futures commission merchants (FCMs) and post margin directly to the exchange. The US Commodity Futures Trading Commission held a public discussion on May 25 to discuss the plans.

FTX’s mooted clearing service features an auto-liquidation mechanism, which would close out customer accounts within 60 seconds if margin drops below minimum threshold levels. Liquidation could occur round-the-clock, aping the 24/7 activity in the wider crypto market.

Rob Strebel, head of relationship management at US proprietary electronic trading firm DRW, said this could alarm traditional asset managers who are considering whether to trade the products.

“If I think about the safety of the markets, auto-liquidation is a very scary notion for traditional finance. To think that a bot is going to come in and liquidate you at midnight on a Saturday when you’re asleep, and you have no idea what’s happening, that doesn’t bode well. For a lot of the BlackRocks and the Pimcos, that’s just not how business is done,” said Strebel, speaking on a panel at the Eurex Derivatives Forum in Frankfurt on May 25.

The new clearing model would force asset managers to adjust the way they think about risk management compared to traditional financial assets, he said.

“If you’re in a market, and you know that you could get auto-liquidated, your risk profile of that trade is going to look very different than if you know that one of your FCMs is going to call you up, and maybe you can post a little more [margin], and then you’ll have a discussion and then maybe a day or two later things will settle down. That doesn’t happen in crypto,” Strebel said.

Tension is already visible between the internal systems of traditional finance firms and the 24-hour nature of the crypto market, said Chris Tyrer, head of Fidelity Digital Assets Europe, but that could be set to change.

“24/7 is how crypto trades. If you don’t trade 24/7 that’s an anomaly,” said Tyrer. “The idea that your investments are made from Monday to Friday between nine and five, I think is slowly going to seep away.”

One of the benefits of a speedy auto-liquidation process, though, is that it quickly becomes clear what your risk position, DRW’s Strebel said. He gave the example of the recent spikes in volatility of nickel contracts at LME, where he said it wasn’t immediately clear what firms’ risk positions were.

“That’s a clear example of what can happen in traditional finance, days go on and you don’t know what your risk is. Something like that would not happen in the crypto markets,” said Strebel.

“In crypto, you get the pain and then you move on and then the markets settle down and you continue to trade,” he added.

Also speaking on the panel, Wilhelm Beller, head of trading at crypto trading platform BitMex, claimed such a process could help prevent the uncertainty around volatility periods in the market, such as when Lehman Brothers went bust in 2008.

“Some of the people here might still remember when Lehman went bust, how long it took us to figure out what our exposure was and what was going on, where everyone was trying to look at contracts. What is the situation, what can I do, what is our position, what do I net out, what can I not net out,” said Beller.

“You don’t have that in the crypto native world, if you stopped out, you stopped out, you move on,” he added.

Editing by Lukas Becker and Alex Krohn