Trading Derivatives with Sam Bankman-Fried

NTE 55 | Trading Derivatives

 

It was 2016 to 2017 when things were starting to go crazy in crypto land. Market cap was skyrocketing and volumes were running up. You went from no one talking about Bitcoin to every single conversation in the country being about Bitcoin in a three-month period. It was also around that time Sam Bankman-Fried decided to leave Wall Street and founded Alameda Research, a quantitative trading firm in the crypto world. Sam dives into crypto and lays out the process that an investor has to go through to create an account with FTX.com and start trading derivatives.

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Trading Derivatives with Sam Bankman-Fried

I’m here with Sam Bankman-Fried. He’s the Cofounder and CEO of FTX as well as the precursor and predecessor of Alameda Research. Thank you so much, Sam. I appreciate you taking the time to join us.

Thanks for having me.

I usually ask where they’re located, but we had quite a bit of back and forth here because we were trying to coordinate schedules literally exactly twelve hours apart. It’s not totally impossible. It’s right in the middle or right not in the middle of somebody’s day.

I have to keep three different time zones in my mind when I’m first scheduling. What I do is I have my computer clock set to a different time zone than my Google calendar. Whenever I’m comparing things to US hours, I look at my computer clock and whenever I’m comparing to Asian hours, I look at Google calendar.

I feel like I needed to adopt something like that because that would’ve helped me. Where are you based?

I’m in Hong Kong.

How long have you been there?

I’m here about three-quarters of the time and I have been for a year or so. We’ve got offices in a bunch of different countries and so I fly back and forth between them as well as to conferences but spending the bulk of my time in Hong Kong.

NTE 55 | Trading Derivatives
Trading Derivatives: There doesn’t yet exist a full regulatory framework for margin trading in the United States.

 

Where were you based before that?

Before going into crypto, I was working on Wall Street for Jane Street Capital Trading International ETFs. I was in the Bay Area for a while.

What year was it that you decided, “This whole Wall Street thing, I think I’m going to abandon the fax machine and try email?”

It’s 2017, right when things were starting to go crazy in crypto land when market cap was skyrocketing, volumes were running up. You went from no one talking about Bitcoin to every single conversation in the country being about Bitcoin in a three-month period.

I remember sitting in a random restaurant beachside in Santa Monica. I had been in a conference, but the conference was in San Jose. It’s far away. It wasn’t like I was outside the conference. I was at a random place and I’m sitting there having a glass of wine decompressing and what do I hear in the next table? People talking about Bitcoin. The next night, I went to the restaurant, the same thing. I was like, “I thought this was obscure.” I thought it was not something that was not very known but you’re right. It was 2016, 2017, things just shut up.

It’s pretty crazy.

That’s when you decided to found Alameda Research.

I left Jane Street and started up Alameda Research, which is a quantitative trading firm and crypto. It does a combination of arbitrage-based trading, quantitative strategies, OTC providing and a bunch of other things liquidity finding and other things tied in with all of those.

It’s important to hire people who are a good fit for the culture. Click To Tweet

Being based in Hong Kong, I know a lot of our audience are US-based because we are US-based and seems to be so far where a lot of our audiences are. We have many people throughout the world as well. A lot of times our conversations are a bit US markets focused and I think that’s not just because we’re so self-centered.

It’s a big market. It’s important to the world.

Also, it seems like the SEC is the global watchdog and people perk up their ears. They’re like, “What are they doing? Maybe we should consider that.” When the decree comes down from the SEC, people at least pay attention. They may not all want to imitate that in their jurisdiction, but they do pay attention. We often want to talk about how does this apply to investors in the retail and accredited market in the US? Can you speak a little bit to how FTX is available or not available to different forms of investors in the US?

First of all, this is an evolving thing and something that we’re looking at and trying to get guidance. You can find the exact definitions of who it is and it’s available on the website. The basic answer is that it’s not available to individual accounts of Americans and it’s not available to US entities although foreign entities are able to access it.

When you say access it as this exchange, you’re listing essentially derivatives market assets and things of that nature that are a little bit more complicated than the average, let’s securitize something and give some shares out. Because of these more complicated packages essentially that you’re making available via crypto, is that part of why it’s not available in the US or is it that it can’t be a US-based offering?

The big thing here is margin. By and large, you can have spot BTC USD markets in the United States. That’s more or less kosher. As long as you’re complying with regulations and looking into getting a money transmitter license. When you look at the longer tail of points, it gets more complicated because of worries about what is the security. The big thing for derivatives is leverage. You’re not talking about SEC regulations. You’re talking about CFTC regulations. You’re talking about what are these things? Are they swaps, are they futures, are they interest rate products? What is the regulatory landscape for these? The basic answer is that the CFTC is taking it slow. This is why you see all of the derivatives platforms and crypto outside of the CME are not US approved. The reason is that there doesn’t yet exist a full regulatory framework for margin trading in the United States. Similarly, you’ll see that all spot exchange is ban margin trading, even on spot contracts in the states. The reason is that the CFTC is not so much that it’s decided that margin trading is evil.

They don’t know what to say about it. They’re like, “You caught a spoiler in the bathroom. We’ll be right back.”

This is our one big difference between US regulators and a lot of other jurisdictions is that in the US, it’s very much the regulator is developing a framework for something and then you can do it. Whereas in a lot of other jurisdictions, it’s more of a blacklist type thing. Regulators will develop things that they want to outlaw that they think are bad, but there’s a little bit of a whitelist versus blacklist distinction here. It’s not so much that the United States is lagging on crypto regulation progress that they take way less favorable view towards operating in a space where they haven’t yet fully flushed out the regulatory framework.

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Trading Derivatives: Shitcoins are an important part of crypto but it’s hard to trade them efficiently.

 

That is what essentially led you to being based in Hong Kong.

One of the big things is that it’s very difficult to run any margin trading crypto platform from the States including a futures exchange. I think there are a few things to link to that, and that’s one of the big things. The other big thing is just the customer base, partially because of this boost of crypto flow comes from Asia. It’s primarily coming from either multinational whether it’s China, Korea, Japan, Hong Kong, Taiwan and Southeast Asia. It’s a way more prevalent thing in Asia. In terms of being near where our customer base is, especially honestly as a firm that has a Western background, it’s important for us to get interaction and FaceTime with our user base because we need to know what product they want.

Can you go through in the most layman’s terms what exactly would be the process that an investor would go through if this is available to them? What is the process they go through on the FTX.com website?

It’s pretty clean. You go to FTX.com and you click register and you can create an account. You can submit KYC information. For individuals, it’s quick. It should only take you a few minutes. You’ve got to take some selfies with your ID, write some nice notes to us on a piece of paper, the usual stuff. That’s all it takes to create an account at FTX. Once you do that, it should get approved within the day or not approved, instead you uploaded just like a picture of banana. You’d be surprised at some of the things that we see coming through.

People are like, “I don’t use a banana.” Isn’t that good enough?

Some parts, it’s clearly jokes. Sometimes you literally see someone copy-pastes a GIF of someone bouncing on trampoline, ID photo or something. Other times, we’ve seen a lot of people trying to create fake accounts, whether the same picture gets uploaded for ten consecutive accounts or badly Photoshop things.

People go through that process. They do KYC and then what is available to them. What’s a common process that a normal audience at home if they were able to engage in your platform, what would they do?

You fund your account. Most of the trading care is derivatives trading, which means that rather than depositing the token you want to sell and withdrawing the token you want to buy, you just deposit collateral and then you can trade any of the products with it. The standard collateral is US dollar stable points. USDC to USD and packs are all accepted, but you can also deposit Bitcoin or Tether. You can use any of those as collateral on the platform for any of the futures. Once you have that, you can go trade any of the futures on the platform. We have futures on Bitcoin, EOS, LTC, the standard large-cap tokens.

Consumers don’t care what you're complaining about. All they care about is your product. Click To Tweet

We also have futures on a bunch of things that most platforms don’t have. We have futures on a bunch of exchange tokens including BNB token of OKB. We have futures on a few indexes. If for instance, you wanted to get short altcoins, you could deposit collateral and then go short sell our altcoin index future. You can click around at the top and see all these. It’s a cool product. I’m surprised that no one else has done it. It’s a pretty useful product for a lot of things. First of all, if you just think altcoins are going to outperform Bitcoin, the obvious thing is to get long in index about altcoins, short Bitcoin rather than picking one altcoin and being exposed to its movement. Conversely, if you think that you’re a big fan of EOS, you think it’s going to outperform, you could get long EOS and then hedge it by getting short the altcoin futures so you don’t lose money if crypto is a whole goose on. Even if BTC dominance goes up, you’re betting on something against its reference class. We have index futures on altcoins, mid-cap, tokens and shitcoins.

Somebody used that term too. I was like, “Is he going to say it?” I’m so glad you said it.

We rushed that product to the market just for the name.

This is our shitcoin index futures.

An important thing is shitcoins are an important part of crypto and it’s hard to trade them efficiently. First of all, you can’t get leverage on any of them, so you can’t short-sell them. Second of all, the spreads are a percent wide, so you’re going to lose a lot by trading them. You have to be on the right platforms. You can’t get much size off it. It’s a big pain and you have to go through that if you want to trade a particular one. If you want to generally get exposed to do that sector, the shitcoin perpetual futures are super liquid. You can get millions of dollars off them if you want to. You could get a 100x long or short at them.

I love the idea of a 100x long or short on this. That’s what the crypto market is for. How did you get into this? I know you were working at Wall Street before. Is that what you studied in school? Were you not generous and be like, “Always numbers?”

I did physics technically. It’s a Physics degree. I took not very many classes. I realized about halfway through college I probably didn’t want to be a physicist, so I pivoted away from that. I took a smattering of classes in my last few years. I didn’t know what I want to do with my life.

Whoever knows what they want to do with their life? It’s anytime, especially in your twenties. How is at a time when you’re supposed to make important decisions? The only decision in one’s twenties is tequila or vodka.

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Trading Derivatives: Unhappy employees are never good.

 

I certainly knew. I thought I knew what I wanted, but I was wrong. I had no idea. I tried a bunch of things, most of which just didn’t excite me. I interned at Jane Street and I liked it. I did that after my junior year and then went back to work full-time after I graduated. I worked on Wall Street then trading internationally ETFs for about three years. Those are US-listed ETFs that are baskets on foreign stocks. It might be a US ETF that has Honda, Toyota and other large half Japanese companies, and was there until 2017, whoever knows exactly what they want to do with their life. I think in the end, that’s why I decided I was happy at Jane Street. They’re good to me. I liked it, but there are a lot of things I want to try through my life. I don’t know what they all are. I had a lot of ideas. I didn’t know which was going to pan out and it was another thing. It felt to me that was the time to decide whether I was going to make my lifetime career there at Jane Street. It’s a tough call. I’m not quite flipping a coin, but I came close. At the end, I left. Afterwards, I started off Alameda Research.

What’s the biggest thing you feel like you’ve learned from a philosophical standpoint as well as a professional standpoint? What’s the biggest thing you’ve learned by taking this leap?

I formed a lot of things. One is management. I managed two people prior to this, but not a whole company. They’re also as a position where it’s my job to help them do as well as possible, but I wasn’t responsible for them. It’s not like if they did poorly, I was going to ruin my life. If they did well, that was going to be the best thing ever. As their mentor for some of the younger people on my desk, some of the interns. I had never been put in a position before like I have to make hiring and firing decisions, and it’s important to get that right.

You have to make sure that you offer the right thing to the right person instead of advice them to stay. Also, you have to be willing to cut the wrong person off for the better of the whole.

You’ll be shocked to know that’s not something that I did right the first time. It’s just classic mistakes, not firing soon enough because it sucks to fire someone. Maybe another thing which I think is less obvious. It’s not shocking, but it’s true and I underestimate this. The importance of hiring people who are a good fit for the culture. One of the mistakes I made was hiring people who were brilliant, hardworking, had the right skills on paper and would be great at a lot of jobs. They didn’t like the way that our company worked. A classic thing is if you look at developers, their surface spectrum from getting the product out focus. I care about the product, the coding is a means to get there. The goal of the code is used to be functional versus the code is the goal. My goal is to write the most beautiful code I can. If it’s something less than that, my highest goal is to keep reforming that until it’s right.

Don’t ship yet, it’s not good enough. If you’re proud of what you shipped the first time you shipped too late.

It depends on the industry you’re in. If your core product is software, then it makes a lot more sense. Your products are only going to do well if the software is better than all of their software. That’s what people are interfacing. The software is the thing that you do to create that, but it’s not the product itself. That an example of a spectrum where I didn’t appreciate this at the beginning, but it’s important to hire people who are on the same side of it as your company is. They’re not going to be happy. They’re not going to be able to work hard. There’s going to be a lot of tension, a lot of arguments over things that you think are stupid and they think are stupid, but you disagree on what the stupid thing is.

You can’t always be fighting that fight. It’s like, “I’m sorry, I don’t have time to come in and fight you on the philosophy of how we’re going to move forward. We’re moving forward this way and this isn’t a good fit.” It can be tough. I found that you can train pretty much anything into a person. A person can learn a lot of things. They can astound you with how fast a quick study can pick something up. The things that they cannot pick up that you have to make sure just inherently there is a culture fit. For me, it’s integrity. If someone doesn’t have honesty, integrity, the ability to own their own crap, you can’t train that in. That’s either in them or not. Either they fit because they can take responsibility and they can do those things or they just don’t fit. We have often reminded people that have worked for me and colleagues of mine. I don’t have kids for a reason. If you didn’t know that already on your own, you have bigger problems than this one mistake. I’m not here to check your work.

When one person saying one thing and another person's asking for the exact opposite, someone's going to be pissed no matter what. Click To Tweet

It totally makes sense. Being able to say to someone, “You’re a great person. You’re smart, you’re a hard worker. This isn’t the right place for you. I’m not going to give you an offer or I’m going to fire you, but this isn’t a reflection on me thinking you’re bad or anything like that. I’ve seen this before. I know how this is going to go. In two months, you’re going to be unhappy.”

“We’re not going to get a good fit out of you and you’re not going to get a good fit out of us.”

Unhappy employees are never good. That’s one lesson I learn. Another thing that I had to deal with the first time is what if something bad happens and it’s ultimately your responsibility? What I mean by that is when I served at Jane Street, I tried to take responsibility for as much as I could and do the right thing. Ultimately, there are a lot of people at the company and also a lot more senior than me who made the ultimate calls on a lot of things. There are times where I say, “Here’s the deal. You can make this call if you want.” Whereas, I love the employees to solve everything. They do solve a lot of things, but sometimes it’s my responsibility to make sure that everything goes well whatever that means. Even if I thought it was someone else’s responsibility, even if it seems stupid or unfair, there are meaningless concepts. You’re sitting there complaining about, “It’s so unfair that I have to deal with this shit. It’s so annoying.” The world’s being unfair. The employees aren’t doing the right thing. Meanwhile, the consumers of your product are like, “This website doesn’t load.” They don’t care what you’re complaining. It doesn’t matter to them.

It’s you, you have to be like, “I’m the voice of the consumer right now, sorry.”

They’re like, “Don’t worry. I get it. Comcast is difficult to deal with.” They’re going to be like, “I want to access the website.” It doesn’t matter how difficult Comcast is. We have to find a way to route around that. I think that was another thing that I’ve spent time working on is a lot of strategies to troubleshoot problems when the straight forward approach doesn’t work because my job isn’t just to put in a good faith attempt to get things to work. My job is to make sure that they do work.

You’ve started in your own wheelhouse going, “We’re going to take the derivative markets and cram it together in crypto and go do this.” You realize, “There are multiple different skillsets that I have to know.” It’s almost like the core of what you started is like in the back of your head, you’re like, “I know that like the back of my hand, no problem.” Everything else that I have to learn to execute on this, to lead and to get everybody involved and everything else and run on the same page, hire, fire. I love that about the entrepreneurial process. If you think that you’ve got this all handled, you’re probably about to die in the water because it changes so fast. If you’re not agile then you’re just not going to make it, especially in the crypto space. Did you take any classes in college that prepared you at all for these challenges? Leadership, people skills, group dynamics, anything like that that ever came across. Are you pulling from anything in your past that is helping you or you’re like, “I’m going to read another management book and I’m going to keep trying?”

The answer is surprisingly close to no. It’s not quite exactly no. I did some competitions in college and they’re fun. They also helped me explore building a thing from scratch. It’s not like nothing was helpful but surprisingly little ones. There aren’t classes that prepare you for this both in terms of the management, but also in terms of the subject matter. It turns out finance classes don’t teach you about quant trading, neither do economics classes.

It’s all going to throw you into the fire and see if you can handle it. I had another question about your consumers. Do you feel like you have a good feedback loop with your actual customers? How does that get fostered for you? It sounds like you’ve got a close eye on what they need and the in-between is the management part, but you’ve got a direct line with your customers.

NTE 55 | Trading Derivatives
Trading Derivatives: Getting feedback helps you make your product better.

 

We get a lot of feedback. We have thousands of people in WeChat groups. For Chinese language support, we have thousands of people in the telegram group. People will tweet at me when they don’t like a feature. People DM me on Twitter. I get LinkedIn messages alternately asking for jobs and asking me to change something about FTX. People are quite creative about contacting us. One challenge that we go through is how do we synthesize it, especially when it’s contradictory. When one person is saying one thing, another person is asking for the exact opposite and someone’s going to be pissed no matter what. We have to decide what to do. What we try and do rather than literally say, “We have to decide between what person A and B ask first,” we have to say, “What does this person A want? What’s the core feature they want? What are their complaints about the current version of it? What does person B want? Is there some structure that has both those properties, even if it’s not what either of them proposed?” We try to do that but sometimes we fail. If you can’t do that, then that sucks.

You’re left having to make a judgment call about which is the least bad. Sometimes we make that call wrong and we hear very quickly. This was something that I did not realize it was going to be true. When you train on FTX, you’ll have some profit or loss from your trading and your account balances will change. In addition to that, people want the website to tell them how much money they’ve made. They want your P&L, but there are a lot of ways to define P&L. To give you a few different examples of that. Should this be P&L on your recent trading, on every trade you’ve ever done, on your current open position? What should it mark you? How should these things spot futures markets? Should they include fees? How about funding rates? There are a lot of fiddly questions about what P&L means. If you do percentage P&L, it’s even trickier because what’s your denominator? If you make $2,000, it’s out of what? Out of the amount of collateral you had in your account, out of the size of your position, the amount of collateral necessary for your position.

What metric does a consumer even want to be monitoring and what are you supposed to make? How do you even design that to bring that first and foremost to their mind?

We’ve played around with a few different versions and we got negative feedback when we choose the wrong ones. I was not expecting this, but I think the angriest we’ve ever seen our user base was when we had one particular set of P&L calculations that didn’t include the ones people wanted. We had to do an emergency patch to roll out some new calculations. To be clear, none of this was changing the amount of money that people made.

Is this changing what they believed or what they saw?

That was an example of like, “Did we get a lot of consumer feedback on that quickly?”

It sounds like you’ve got your hands full with this and this has taken off very quickly. Do you have any more plans for expansion? What’s on the horizon? Do we have any talk of the futures market?

Yes, a bunch of things. Some of these we’ll see which come to fruition, but I think on the docket are launching some more futures, some more indexes, some altcoin against Bitcoin futures, more spot markets. Bigger things, we’re probably going to launch options sometime soon. After that, we’re going to look into potentially prediction markets, hash rate and Bitcoin dominance futures. These are all things that we’re still churning about how we would do, trying to understand the regulatory frameworks for them, the demand for them, what product exactly people want.

On a product side, what we have and then serve on usage side, mobile apps and are probably the biggest thing that we’re working through. Outside of that, we released a troll box. You can chat. It’s a chat room on the website. One last interesting thing that we’re working through is FTX is sometimes slow when access from Mainland China because of firewalls. This is a sensitive thing to work with. We’re doing a lot of research and also starting on what we think but are not sure are going to be solutions for this to have data hosted locally in China for Chinese users to make the product more responsive.

You mentioned hash rate futures. Talk about being way ahead of the regulatory framework. I don’t think there’s ever been an option for people to engage in a market where you can place your bets on technology advancement directly.

It’s a cool product. Miners have a lot of interest in among other things. There are some definitional issues here about exactly what this product should be. One interesting thing is that because of difficulty adjustments block time reverts every two weeks. There’s a question of whether or not you want to be adjusting by that and a few other things. By and large, I think that it’s a product that we’ve seen a bunch of excitement for and hopefully we’ll launch.

Sam, I am so grateful that you took the time to talk to us about this. Not just that running a company is its own huge monster, but the type of company that you’re running and where you’re running it from. In a way, you’re not waiting but it will be nice when the CFTC figures out what they want to say about this and whether they’re going to allow US investors to even engage in. In the meantime, you’ve got a lot going on in Asia. This is incredible. It’s very exciting. Thank you so much for telling me about it. Do you have any announcements? Do you have anything else that you’d like to add before we sign off?

We’d love users to try out the platform and we’d love to hear your feedback. It’s super helpful. I make fun of it sometimes, but it does make the product better. It’s how we know what people like and what they don’t like. I love for FTX to be the product that works for you and has what you want.

Thank you so much, Sam. It’s been a total pleasure. It’s great to be finally connected. I wish you all the best with FTX. This is very exciting and I can’t wait.

Thank you.

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About Sam Bankman-Fried

Before founding Alameda, Sam was a trader on Jane Street Capital’s international ETF desk. He traded a variety of ETFs, futures, currencies, and equities, and designed their automated OTC trading system.

 

 

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