How FTX is making investing in crypto derivatives institutional-grade
When the price of Bitcoin dropped on April 19th, an astounding amount of $10 billion of leveraged crypto positions had been liquidated across various exchanges. For starters, who’ve never used a long leveraged position, it simply means betting on the fact that the price of bitcoin will increase. Opening the position is done using your funds (collateral) plus funds you borrow from the exchange platform you’re trading on. This concept is also known as Margin Trading.
Let’s say you want to use 10 x leverage in your trade. In that case, you could deposit 0.1BTC and borrow 0.9BTC. You use those funds to buy 1 Bitcoin at $50,000. One week later, as Bitcoin reaches $55,000, you decide to close your position and take profits. From the $5000 you made, you still have to pay trading fees; nevertheless, the return you made is substantially higher than had you just invested your own 0.1 BTC.
The above described is a best-case scenario. Unfortunately, the Bitcoin price doesn’t always go up. While leverage can increase returns, it’ll also increase the losses traders might face. So when the price of Bitcoin goes down, the long positions make a loss, and once the loss exceeds the net asset value, we have a problem. Bitcoin price falls by $6000, and suddenly the $5000 in BTC initially deposited won’t be able to cover the position anymore; the net asset value drops to negative.
And unlike in traditional financial markets where exchanges or brokers could repossess assets from outside the system, this is impossible in crypto. So to ensure that the exchange doesn’t face losses when long positions go negative, they monitor and liquidate them if traders don’t close their positions fast enough. During a liquidation, the exchange will attempt to sell the assets for the best price possible to cut losses. Guess what happens when an exchange suddenly tries to sell off a substantial amount of a particular cryptocurrency? It often impacts the market negatively, which then increases the loss the exchange makes—a lose-lose situation.
Luckily, we see innovation and new exciting business models addressing such challenges in the crypto space. One of them is FTX.
FTX is a cryptocurrency derivatives exchange. In case you’re unsure what derivatives are, derivatives are financial assets that track the performance of an underlying asset. This way, traders can benefit from the price increase of a specific asset without holding the actual asset.
FTX also offer futures that give traders the option to speculate on the future price of a cryptocurrency and leveraged tokens, which enable traders to go long or short on an asset by simply buying one token. Similarly to using regular leveraged positions, it’s best to use them with care as things can quickly move against a trader.
FTX offers an OTC desk that quickly scaled to $30 million in volume per day and impresses with intuitive UI and easy-to-use settlement systems for institutional clients or traders with big orders. Alameda Research, a leading quantitative crypto trading firm, is backing FTX and enabling the exchange to have one of the most liquid orderbooks in the industry. Launched in April 2019 by well-respected figures with extensive experience from wall street quant funds and tech, FTX has soon developed a vast and loyal following among traders.
One of the biggest challenges FTX set on to solve is the above-described scenario of liquidations that, in the end, benefit no one. They blame other exchanges flawed risk management system for the frequent occurrence of clawbacks. On FTX, these are reduced by using a three-tiered liquidation model.
The liquidation engine constantly screens all open positions and will detect those where users fall below their maintenance margin (deposit ratio) using intelligent and efficient values. When users fall below the maintenance margin, they can deposit additional capital, or the position is liquidated. Unlike on other platforms, FTX uses reasonable, volume-limited liquidation orders starting at 4.5% to avoid the risk of crashing the market.
Even when the price goes down, FTX will continue doing its best to recover as many funds as possible instead of hoping things will get better after getting worse. Usually, these efforts are sufficient to liquidate positions.
For large orders at risk of being liquidated, the backstop liquidity provider kicks in and takes on the entire position and the collateral before the position goes bankrupt. This allows the backstop liquidity providers to hedge their books and manage the position without incurring losses.
The third component ensuring that the other traders won’t suffer losses by carrying positions that go negative on the platform; FTX employs a leverage insurance fund to prevent customer losses.
The FTX Token (FTT)
The whole FTX ecosystem is fuelled by the FTX token: FTT. When describing the process of taking on a long position, we used Bitcoin as an example. Imagine you wanted to take out several positions on different cryptocurrencies and always deposit in that specific currency. So you deposit some BTC for your Bitcoin position, some XRP to open a position on Ripple and ETH to go long on Ether. That does seem inconvenient but is still common practice on many crypto exchanges.
On FTX, however, traders can deposit FTT as collateral without the need to use any other crypto. FTT can be used to pay for trading fees for a discount and to access rebates on OTC fees. Furthermore, FTX uses a third of all fees generated on the exchange to buy back and burn FTT until at least half of the total FTT supply is burned.
Another revenue stream that the team will employ to buy back and burn tokens are OTC fees. Lastly, FTT holders might benefit from big increases in the insurance fund. In that case, FTX has pledged that holders will receive a pro-rata bonus on their FTT holdings from the insurance fund, which is another great way to incentivise traders to purchase FTT — the outlook of passive income.
From a tech perspective, FTT isn’t as exciting. It’s an ERC-20 token that can be stored in any ERC-20 compatible wallet. So if you were to HODL FTT, you could just add it to your existing hardware wallet.
With increasing institutional interest in the cryptocurrency sphere, FTX is in a great position to capture increasing demand and grow its platform. To learn more, check out their website. And if you want to see what positions are getting liquidated, follow this Twitter account.
The FTT token is trading on Bitcoin.com Exchange with BTC and USDT pairs.