For a long time, high leverage ratios have prevailed in the crypto market, not only causing huge losses for many investors, but also exacerbating the volatility of the crypto market, becoming one of the biggest systemic risks affecting the crypto market. It is precisely because of this that in recent months, many countries around the world have issued warnings on derivatives services provided by exchanges such as Binance.
In the past week, the FTX exchange and Binance have successively announced the reduction of the maximum leverage, from a maximum of 100 times to a maximum of 20 times, which means that the two major global cryptocurrency derivatives trading platforms have compromised under regulatory pressure .
In this context, the New York Times reporter recently interviewed two nomads in the crypto industry-FTX founder SBF and Binance founder Zhao Changpeng, discussing their growth and entrepreneurial history, as well as their views on the derivatives market and Strategies to deal with regulatory pressures, while analyzing the development history and problems of the crypto derivatives industry, I believe it will be helpful for readers to understand the development status of the derivatives industry.
In Hong Kong just after midnight, Sam Bankman-Fried (hereinafter referred to as SBF) stared at the transaction data on his six monitors, watching the collapse of the global crypto market in real time.
SBF is a 29-year-old Californian who often works around the clock, just like he did that night in May. He took a nap on the beanbag next to the computer. A folded blanket was placed on the floor. His book value is at least 8 billion U.S. dollars.
Even after the downturn that began in the spring, the total global loss of all cryptocurrencies in this crash eventually exceeded $1.3 trillion. When SBF saw it happen, he knew his business played a role in the collapse.
Cryptocurrencies-cryptocurrencies that are not supported by any country-are known for their crazy and frequent fluctuations. But FTX, a cryptocurrency trading platform operated by SBF, specializes in a transaction that accelerates the collapse of the global market.
Most of his clients are betting on future cryptocurrency price fluctuations, instead of buying and selling bitcoin, they borrow money to increase their bets.
This is a risky method. But it can produce huge victories.
Now, the value of Bitcoin is falling rapidly, which smashes bullish traders’ high leverage bets on FTX and other exchanges and forces them to liquidate accounts wave after wave. These forced sales are destroying the price of cryptocurrencies.
“As far as price movements are concerned, the biggest part is liquidation.” SBF wrote an email to The New York Times in Hong Kong on May 24.
This is exactly the situation that U.S. regulators are trying to avoid by prohibiting FTX and other cryptocurrency exchanges from selling high-risk futures to U.S. non-professional investors. This is also the reason SBF moved to Hong Kong-because he wanted to provide these products, namely derivatives.
SBF is a cryptocurrency nomad. He is one of a group of industry leaders who once lived in the United States or Canada. Since then, he has established a number of companies whose operating bases are beyond the jurisdiction of U.S. regulators to some extent.
Other nomads include Changpeng Zhao, 44-year-old Chinese Canadian, founder of Binance, currently living in Singapore; and 35-year-old Arthur Hayes, a Detroit-born trader who founded BitMEX in the Seychelles.
This is a tribe that never closes: transactions are conducted 24 hours a day, 365 days a year. (SBF said he sleeps when there are no meetings, “working when this counterparty is awake and when that counterparty is awake.”)
These crypto nomads are inspired by multiplayer online games to build a global playground and provide a “leaderboard” for customers who use aliases such as Dark Crypto Lord, and can win prizes from Tesla or iPhone.
Industry data analyzed by Carnegie Mellon University researchers shows that the highly leveraged trading forms provided by these platforms have become so popular that the total daily value of these derivatives transactions in July reached 10 times that of cryptocurrency spot transactions. Much.
All this should be a forbidden zone for American investors, but this is not the case. The transaction data provided to the New York Times also showed that despite the ban, billions of dollars worth of investments from customers connected to the United States have been transferred to at least one of these global websites.
“I’m not saying this will lead to the next financial crisis,” said Timothy Massad, the former chairman of the US Commodity Futures Trading Commission, which oversees derivatives trading. “But could it be a butterfly flapping its wings in Brazil and causing a tornado in Texas?”
Changpeng Zhao, the founder of Binance, admitted in an interview, “Leverage magnifies volatility. So this is for sure.”
But he and other industry advocates believe that highly leveraged futures trading is common on Wall Street and foreign exchange exchanges. Some people also stated that they had to relocate because American regulators did not fully accept these creative investment opportunities.
“This will not go away,” said Mark Cuban, a billionaire entrepreneur, TV personality and cryptocurrency enthusiast, who is also a supporter of FTX financing. “But by pushing the derivatives exchange overseas, we are losing a lot of job opportunities and a lot of financial depth.”
In fact, just last week, FTX raised US$900 million in funds to help it expand its global business, valued at US$18 billion. Forbes estimates that this transaction may push SBF’s wealth to $16 billion, making him “the richest known cryptocurrency billionaire” because he owns nearly 60% of the company’s shares.
Bet on the future
When SBF entered the cryptocurrency industry, it had graduated from MIT for four years.
SBF was still living in California at the time — his parents were both law professors at Stanford University — and he noticed that Bitcoin and other tokens were sometimes sold at different prices in different countries.
This is an open invitation to make money for creative players. There is a classic arbitrage strategy: buy at a lower price in the United States and sell at a higher price in Japan.
This eventually becomes very complicated. When he tried to quickly transfer large sums of money, financial institutions began to close his account. He also needs Japanese national status to complete the transaction at the local bank. But he eventually made tens of millions of dollars through these early actions.
SBF
He attended a two-week cryptocurrency conference in China in 2018, and he actually settled in Hong Kong. “I think I should cancel my lease in the bay at some point,” he recalled. He decided to create a new company, FTX, which specializes in derivatives business.
In traditional markets, derivatives are used to help farmers or other companies hedge against changes in the prices of commodities such as oil or grains.
In the United States, some cryptocurrency derivatives are traded on platforms such as the Chicago Mercantile Exchange, which has long provided commodity options and futures in various fields such as agriculture, energy, and metals. But CME is a traditional exchange, it has more restrictions and federal government supervision, only professional traders can use a lower leverage limit.
Cryptocurrency innovators like Arthur Hayes, one of the founders of BitMEX, took this classic approach and turned it into a more profitable idea, at least for the platform.
BitMEX started what Arthur called a perpetual contract-betting on future price changes that will not expire-and finally provided 100 times leverage. This means that a $1,000 investment can immediately be converted into a $100,000 bet on the future price of Bitcoin.
As Arthur explained in an industry speech in 2016, from the beginning, BitMEX clearly aimed to attract not only professional traders, but also retail investors who like gambling and gamers who like adventure. “Some people offer similar types of products, but focus on depraved gamblers, that is, retail traders of bitcoin,” he said. “Then why don’t we do this?”
The exchange targeted social media advertisements to potential customers in the United States, and claimed that “registration takes less than 30 seconds.”
At least at the beginning, some exchanges like BitMEX made little effort to screen investors to determine their true identity or confirm their actual location, just as banks and other trading companies in the United States are required to do. Although participants in the United States are prohibited from entering. Many platforms, including BitMEX and Binance, have recently stepped up enforcement efforts to try to curb transactions by American investors.
This happened after the U.S. Department of Justice filed charges against Arthur at the end of last year. The government claimed that he and other BitMEX executives illegally operated a cryptocurrency exchange that processed approximately $11 billion in transactions involving at least 85,000 US A linked user account. After that, he left the company.
But the market size of the business model he helped create has expanded.
Arthur Hayes
FTX and Binance are currently one of more than ten global cryptocurrency platforms that provide perpetual contract products, most of which are located in Asia. FTX alone has 1 million users worldwide, and the daily transaction volume processed is as high as 20 billion U.S. dollars, most of which are derivatives transactions.
Like their customers, these platforms are also competing. In order to compete with BitMEX, FTX began to provide up to 101 times leverage for derivatives trading. Binance then defeated them with a leverage multiple of 125.
Traders’ losses can be transformed into huge gains for the exchange.
When the price of the underlying cryptocurrency is not good for traders, the platform will earn transaction fees based on forced sales. The May crash began with China’s regulatory crackdown and Musk’s cryptocurrency operations. But the liquidation subsequently greatly promoted it.
Some executives such as SBF also own related companies that conduct algorithmic transactions to immediately profit from the market distortions that occurred during these sell-offs. SBF said that he believes that his business has no conflict in playing these two roles, as these measures help maintain market liquidity during periods of sharp decline.
The founders of FTX, Binance, and BitMEX all argue that only a small percentage of customers actually use high leverage. But even for those who bet smaller, if cryptocurrency prices start to fall, problems will soon arise. According to crypto derivatives data company Bybt, on May 18 alone, the total liquidation of BitMEX, Binance, and FTX reached $1.6 billion. In mid-May, there was a total of US$20 billion in mandatory liquidation in the crypto market.
“If you go all out with maximum leverage every time, the market will be against you at some point and you will be eliminated.” Changpeng Zhao said, “Professional futures traders will manage risks.”
But cryptocurrency critic Michael Green said that derivatives markets are inherently opposed to novice traders. ” The mathematical principle of highly volatile instruments is that casinos almost always have to win. ” He added that from his perspective, “these are unregistered casinos.”
From Shanghai to Malta
Changpeng Zhao focused on Binance’s branding so much that he tattooed the company logo on what he now calls the “crypto arm”-two diagonal squares representing bids and inquiries in transactions.
He and other cryptocurrency nomads have become global celebrities, with millions of followers on Twitter, podcasts and even YouTube. They are diplomats in a rebellious industry and are not affiliated with any particular country.
Binance opened an office in Shanghai in July 2017. But two months later, when the Chinese government announced its crackdown on cryptocurrency exchanges, the company moved to Tokyo.
Japan subsequently announced new cryptocurrency trading rules. “So we said, um, that’s not appropriate.” Changpeng Zhao explained, “We have to move again.”
The next stop is Malta, a small island country in the central Mediterranean. Now Zhao Changpeng has not specified any location as the company’s headquarters.
To some extent, Binance’s ever-changing base camp reflects his own life story. He was born in China and moved to Canada when he was 12 years old. He interned in Japan while studying computer science at McGill University, and continued to develop trading products in Tokyo, New York, Singapore, Hong Kong and Shanghai.
“I often walk around in my life.” Zhao Changpeng said. This international experience has provided him with a “broader world view” and provided information for his company and its borderless mentality.
Other companies are also migrating. The Dutch cryptocurrency exchange Deribit announced last year that it will be operated by a subsidiary called DRB Panama, and several of its executives have moved to Central America. Palm trees and tropical landscapes are now appearing in executives’ social media posts. BTSE, another exchange specializing in derivatives trading, moved its headquarters from Dubai to the British Virgin Islands.
But in some cases, the claimed maritime operating base is nothing more than a trick. BitMEX lists its headquarters as Seychelles, an island republic in the Western Indian Ocean, but federal investigators found that most of its employees work in New York, Hong Kong and San Francisco.
US federal prosecutors charged him at the end of 2020 and said that founder Arthur claimed that bribing the Seychelles authorities cost only “a coconut”-less than buying from regulatory agencies in the United States and elsewhere. Arthur pleaded not guilty in April, and his case is pending. He now lives in Singapore.
“Arthur Hayes and his co-defendants in this case are innocent and they look forward to defending themselves in court,” said Nate Johnson, a spokesperson for Arthur.
Until recently, Hong Kong was a gathering place for cryptocurrency masters, at least before the outbreak, they often met in industry conferences or local bars and cafes there.
Changpeng Zhao said that this community made him popular in the cryptocurrency industry. He said that he found at conferences around the world, “This is a very geek and honest community.”
These personal relationships sometimes lead to economic relationships. Zhao Changpeng’s company is an early investor in the SBF exchange, and SBF’s trading company is a customer of the Zhao Changpeng platform. They often talk to each other.
“I think I have seen him in Taiwan, Hong Kong, Singapore, and even Europe,” Changpeng Zhao said of his fellow crypto vagrant compatriots, “but mainly in Asia.”
SBF and Zhao Changpeng said in separate interviews that they are committed to complying with US regulations, even if their global exchanges are located abroad.
But globally, the cryptocurrency derivatives market continues to soar- there are clear signs that major US players are still injecting money into the game.
Traders involved in the transaction told the New York Times that more than a dozen large private trading companies with American ancestry have set up offices in the Cayman Islands and other offshore locations to create new corporate entities to pass Binance and FTX overseas Derivatives platforms promote funding on a large scale.
“I am not an American,” said a trader who moved to the Cayman Islands on behalf of a large fund. He initially left his family in the Midwest to conduct business, “but I am still a US citizen.”
The trader requested anonymity because he did not have the right to discuss the arrangement publicly.
This stateless method of running these cryptocurrency exchanges — coupled with the constant introduction of new unregulated and often high-risk products — is now facing perhaps the most important test.
Since June, Binance has become the target of financial regulators in the United Kingdom, the Cayman Islands, Hong Kong, Lithuania, Italy, Poland, and Thailand, many of whom have set their sights on its highly leveraged derivative products or new product lines. This spring, Binance allowed customers to buy token versions of some stocks, such as Tesla and Apple.
Faced with strong opposition, Binance announced in mid-July that it would abandon its stock token products.
The company said in a statement to The Times: “The crypto industry is a very new industry, and the landscape, including the regulation of crypto exchanges, is constantly evolving.” It attributed part of the recent review to The mainstream acceptance of cryptocurrency last year, and said that the regulator’s review of the industry was “correct.”
SBF said at the end of a three-hour series of interviews with The Times that it may be time for the industry to withdraw its most extreme products, such as the leverage of derivatives trading as high as 125 times.
“It’s easier to get rid of it than to continue talking about it,” SBF proposed a possible 10 times leverage limit, adding that it was mainly to counter the industry’s belief that risky bets are encouraged. He thinks this is unfair.
Binance and FTX are also looking forward to ensuring the space for recognition in the US market. In the past two years, they have opened a US platform that does not provide derivatives but focuses on actual cryptocurrency trading.
FTX also recently purchased the naming rights for the Miami Heat arena and posted its company logo on the patch worn by Major League Baseball referees because it is committed to building awareness here. With a donation of US$5.6 million, SBF was also one of the largest donors to help Biden’s presidential campaign last year-although he said in an interview that this has nothing to do with his business.
At present, compared with overseas counterparts, the profits generated by these operations in the United States are minimal. However, they do abide by US regulations. This does make a difference.
“This is a less exciting product.” SBF said.