BoE's Cunliffe Cautions Against 2008 Repeat With FTX's Derivatives Rule Change Proposal

Using crypto technology to cut out the middleman in financial trading should not lead to the kind of risk shortfalls that caused the 2008 meltdown, the Bank of England’s (BOE) Jon Cunliffe said on Wednesday.

The BOE deputy governor for financial stability appeared potentially open to making markets more efficient. However, Cunliffe urged caution over the kind of changes to U.S. trading rules proposed by crypto exchange FTX.US that would allow direct-to-consumer derivatives trades, rather than collateralizing positions through an intermediary.

Cunliffe told the Point Zero conference in Zurich that crypto innovations should not be used to cut corners on financial collateral – a feature he regards as a vital safeguard, even for near-instant trades, as it cushions the rest of the financial system from the impact of defaults.

“Margin is there to protect against counterparty credit risk,” said Cunliffe, who has led international work on stablecoin standards. “If the transaction happens in a nanosecond, then you have a nanosecond’s worth of counterparty credit risk.”

FTX.US' proposed solution would allow derivatives risk to be settled in real time.

“Margin is just ‘pay as you go’ for risk … rather than waiting until the risk crystallizes and see if you have enough,” he said. “What happens if you don’t pay as you go? … 2008 showed us what happens when prices move.

“I won’t go into FTX, but there's all sorts of interesting ideas there about collapsing margin, clearing and settlement all into one smart contract which could have tremendous efficiency,” he said.

Cunliffe expressed faith in crypto, saying the technology will outlive current volatility, just as the internet economy ultimately overcame the dot-com crash of 2001.

But he is more skeptical about trends in decentralized finance (DeFi), which cuts out financial intermediaries and poses a headache for policymakers used to dealing with centralized and regulated lenders.

“I don’t know if full disintermediation will ever be possible; my sense is it’s a bit illusory,” Cunliffe said. “What you would be saying to us is: Do you have the confidence to regulate the code, and that these basic risks that could disturb the financial system could be managed with the algorithm.

“At the moment I have the same confidence in that as in a fully automated pilotless plane,” he said. “I want to know where liability lies if the algorithm goes wrong and I crash.”

The U.S. Commodity Futures Trading Commission (CFTC) began consulting on the FTX plan on May 10, with CEO Sam Bankman-Fried forced to justify the plans to an audience of largely skeptical traditional financiers.