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Leader in cryptocurrency industry moves to curb highest-risk trades

Global platforms such as FTX allow traders to borrow big when betting on price fluctuations — traders do not buy and sell cryptocurrencies but instead predict where prices in the underlying assets will head.

By: New York Times |
Updated: July 26, 2021 11:55:24 am
Leader in cryptocurrency industry moves to curb highest-risk tradesSam Bankman-Fried, 29, the billionaire founder of the cryptocurrency exchange FTX, at his office in Hong Kong, May 26, 2021. (Lam Yik Fei/The New York Times)

Written by Ephrat Livni and Eric Lipton

A popular cryptocurrency exchange announced Sunday that it was curbing a type of high-risk trading that has been blamed in part for sharp fluctuations in the value of Bitcoin and the casinolike atmosphere on such platforms globally.

The move by the exchange, FTX, would reduce the size of the bets that investors can make by lowering the amount of leverage it offers to 20 times from 101 times. Leverage multiplies the traders’ chance for not only profit, but also loss.

“We’re going to be the ones to take the first step here,” Sam Bankman-Fried, 29, the billionaire founder of the platform, which operates from Hong Kong, said on Twitter on Sunday. “Today, we’re removing high leverage from FTX. The greatest allowable will be 20x.”

The announcement came after The New York Times, in an article published online Friday, detailed the risky trades offered on FTX and other global exchanges such as Binance and BitMEX that accelerated a global crash in May. That month, more than $20 billion worth of those bets were liquidated on cryptocurrency exchanges worldwide.

Bankman-Fried said lowering the leverage amounted to “a step in the direction the industry is headed, and has been headed for a while,” adding that “while we think that many of the arguments are high leverage miss the mark, we also don’t think it’s an important part of the crypto ecosystem, and in some cases it’s not a healthy part of it.”

Global platforms such as FTX allow traders to borrow big when betting on price fluctuations — traders do not buy and sell cryptocurrencies but instead predict where prices in the underlying assets will head. Those bets, known as derivatives, mean that if investors put up $1,000, the exchange extends them credit to allow them to make a bet on the future price of cryptocurrency worth as much as $101,000 on FTX. Now, with the new cap, the maximum in that transaction would be $20,000.

This type of transaction is not supposed to be available to nonprofessional investors in the United States, but — at least historically — some of those investors used workarounds to trade on the sites.

Leverage leaves investors much more vulnerable to having their accounts liquidated as a result of an automated margin call if the price of cryptocurrency moves against their prediction, and they do not have enough collateral in their accounts to back up their bets.

That is what happened in May. Once prices of cryptocurrency began dropping based on market-moving events, such as China’s announcement of a regulatory crackdown or the decision by Tesla to halt Bitcoin payments, it automatically prompted the exchanges to liquidate the accounts of the most highly leveraged investors before their collateral became insufficient to cover their positions.

“These liquidations are obviously a huge factor in the price crash,” said Clara Medalie, research lead at Kaiko, a cryptocurrency market data provider in Paris, recalling the sudden decline in cryptocurrency value in mid-May. “It is a vicious cycle.”

Bankman-Fried said Sunday that only a small percentage of traders take advantage of the maximum available leverage. He also argued that FTX had fewer liquidations than other exchanges and he had long tried to “encourage responsible trading.”

Still, he had predicted in an interview last week that some investors might not welcome any move to cut leverage. “We would get consumer outcry if we got rid of it, and we’d get very bad press,” he said. “But it might be the right thing to do.”

Bankman-Fried also acknowledged that high leverage created a perception that exchanges like his encouraged risky trading, even though he asserted this was not a fair conclusion.

Binance, the world’s largest cryptocurrency exchange, offers leverage up to 125 times. Changpeng Zhao, the Chinese Canadian founder of Binance and a developer tracing his professional roots to Wall Street, has said that the extreme leverage figures were just a “marketing gimmick” and that most traders do not use them.

Timothy Massad, former chairman of the Commodity Futures Trading Commission, which regulates derivatives in the United States, said that he embraced FTX’s decision and that he hoped other platforms like Binance would follow.

The change, he said, might be motivated in part by FTX’s success this past week in raising $900 million in venture capital, the most for a cryptocurrency exchange. The high-leverage offerings on FTX are more of a reputational liability as Bankman-Fried looks to expand his platform’s global reach, Massad said.

“Sam has bigger visions, and this move eliminates a flashpoint that might get in the way,” Massad said. “Take it off the table.”

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