How will the collapse of Alameda Research affect liquidity in the cryptocurrency market?

Original link: 《Crypto Liquidity in a Post-Alameda World》

Authors: Clara Medalie \& Dessislava Aubert \& Riyad Carey, Kaiko

Compiled by: Qianwen, ChainCatcher

Various strange tales about FTX have emerged. Last Friday, FTX, FTX US, and 134 related entities filed for bankruptcy, indicating that the exchange and its associated companies are deeply mired in trouble. Just hours later, the exchange suffered a massive hack, with over $600 million siphoned from FTX and FTX US wallets, immediately sparking rumors of insider involvement.

Perhaps most shocking was a report from Reuters stating that SBF established a secret backdoor to transfer funds between Alameda Research and FTX without the auditors noticing.

Today, we will focus on the impact of Alameda's market-making business on cryptocurrency and what their collapse means for liquidity.

The Alameda Gap

Alameda Research is one of the largest market makers in the cryptocurrency space, providing billions of dollars in liquidity for tokens of all market capitalizations. What is gradually coming to light is that their entire trading operation was conducted by improperly mixing customer funds with FTX. Last Thursday, Alameda Research announced that they would officially cease trading. What does this mean for liquidity in the entire market?

Cryptocurrency liquidity is dominated by only a few trading firms, including Wintermute, Amber Group, B2C2, Genesis, Cumberland, and the now-defunct Alameda. With the disappearance of one of the largest market makers, we can expect liquidity to decline significantly, which we refer to as the "Alameda Gap." Other market makers will also face more losses due to FTX's collapse, further widening this gap. So far, Amber Group, Wintermute, and Genesis have announced that they have funds on FTX, which may affect their overall market-making activities.

Liquidity typically declines during volatility because market makers withdraw sell/buy tasks from the order book to manage risk and avoid adverse liquidity. However, we have observed that liquidity has decreased more severely than in any previous market downturn, indicating that the "Alameda liquidity gap" may persist, at least in the short term.

Since November 5, CoinDesk has published an investigation into Alameda's asset situation, revealing that BTC liquidity within 2% of the mid-price has dropped from 11.8k BTC to 7k, the lowest level since early June.

The chart above summarizes the market depth of 18 exchanges, including FTX, which no longer has any real market-making activity. Even excluding FTX from the chart, the depth still shows a significant decline, indicating that the entire market's liquidity has been severely impacted by Alameda's collapse and the losses of other market makers. Since November 5, Kraken's BTC depth has decreased by 57%, Bitstamp by 32%, Binance by 25%, and Coinbase by 18%.

The ETH market has also been affected by the collapse, with 2% market depth dropping to levels seen in late May.

Fortunately, since the cryptocurrency credit crisis in May and June, the overall market liquidity for BTC and ETH has been steadily increasing, so the depth decline should not be too destructive. More concerning is the liquidity of altcoins. Alameda invested in dozens of projects, holding low liquidity tokens worth millions of dollars. However, since Alameda is also a market maker, we can assume they are also the primary liquidity provider for these tokens.

It is still unclear what the full details of Alameda's token holdings with FTX are, but here are the details of FTX's balance sheet provided by the Financial Times, ranked by liquidity of the held assets.

In the "less liquid" category, the top four are FTT (the source of it all now), a Solana DEX token called Serum (SRM), Solana's native token SOL, and a token called MAPS.

Let's take a look at the liquidity situation of SRM, SOL, and MAPS before and after Alameda. The following chart summarizes the market depth across nine exchanges providing SOL trading pairs. Overall market depth has decreased by 50%, with market depth on all order books dropping from 1 million SOL to below 500,000, and this decline has occurred across every exchange.

SRM and MAPS have also seen significant depth declines. To avoid price impact, we represent depth in the native units of each token, and the data indicates that market-making activity has been severely affected by Alameda's collapse.

Alameda holds a large amount of illiquid tokens and is (almost certainly) the market maker for these tokens, making it nearly impossible for the company to survive in the face of bankruptcy. Overall, it can be expected that the liquidity of altcoins will be very low in the near future, especially for those altcoins heavily invested in by FTX/Alameda entities.

Will Stablecoins Be at Risk?

While illiquid altcoins make up a significant portion of Alameda/FTX's balance sheet, Alameda also holds millions in stablecoins. Below is a Dune Analytics dashboard created by 21 Shares, tracking the holdings of known Ethereum wallet addresses associated with Alameda.

As of Monday morning, Alameda held over $46 million in stablecoins, with the largest stablecoin holding being TrueUSD (the sixth largest stablecoin by market cap), followed by $11.7 million in USDC and $11 million in USDT. Since last weekend, their USDC holdings have dropped fivefold.

Although TUSD is one of the least liquid stablecoins, with active trading on only 10 centralized exchanges, its price on centralized exchanges has remained relatively stable over the past week.

USDT has shown the most extreme price volatility, dropping to $0.989 on November 10 and then soaring to $1.058 on November 11. Since then, it has been trading at a slight discount, indicating ongoing selling pressure in the centralized spot market.

There are even speculations that Alameda is actively shorting USDT, borrowing USDT using USDC on Aave, and then selling it on other exchanges like Curve. The following chart shows the activity on Curve's 3pool, where a large amount of USDT was sold in exchange for USDC and DAI, causing the price of USDT (blue) to briefly drop below its peg by 2 cents. The price has since recovered, and it is now only 10 basis points below its peg.

Most market activity for stablecoins still primarily occurs on centralized exchanges, so despite slight discounts in the DeFi market, their prices seem to remain stable.

Extreme Volatility in the Derivatives Market

Last week was undoubtedly the most tumultuous week in cryptocurrency history, with BTC and ETH experiencing their largest single-day drops in over five months after Binance withdrew its acquisition of FTX on November 9. Spot prices fluctuated violently, leading to $875 million in cascading long liquidations within just 24 hours, and perpetual futures open interest plummeted by double digits.

Open contracts for BTC across five exchanges (excluding FTX) fell from around $8 billion to $5.5 billion during the week, while ETH dropped from $4 billion to $3 billion. The collapse of FTX could have significant implications for the derivatives market, as of early November, it accounted for 14% of total BTC open contracts and 28% of ETH open contracts.

Last week's events had a major impact on market sentiment. The funding rates for both BTC and ETH plummeted into negative territory, remaining in a loss state as of Monday morning, as the market has clearly turned bearish.

The options market also saw a sudden shift in sentiment, with implied volatility for BTC and ETH options surging from November 8 to 9. Implied volatility can measure options traders' expectations for future price fluctuations.

The implied volatility for BTC ATM options expiring on November 25 more than doubled from around 50% to over 117% within just 24 hours. The implied volatility for ETH ATM options also soared to 165%, before slightly retreating. Implied volatility remains high, indicating a significant change in the market's perception of risk.

The Relationship Between Cryptocurrency and TradFi

Following the token inflation triggered last week, the cryptocurrency market is sure to experience a significant rebound in the coming weeks, which may provide hope that inflation could peak and the Federal Reserve will slow its monetary tightening policies. While cryptocurrency assets plummeted, the Nasdaq 100 and S&P 500 indices jumped 8.8% and 5.9%, respectively. Consequently, the 30-day rolling correlation between BTC and the US stock market dropped to just 0.17, the lowest level since November 2021, before recovering to 0.4.

After several months of rising, the correlation between BTC and gold turned negative, nearing zero by the end of the week. In contrast, its correlation with ETH surged to the highest level in over a year.

The turmoil in the cryptocurrency market has led to a significant decline in stocks related to cryptocurrencies, with these stocks performing far worse than the broader market amid declining confidence in the industry and spreading concerns.

The value of Microstrategy's 130,000 BTC plummeted by about $500 million in just five days, with its stock price experiencing the largest drop, down 37% by the end of the week. The largest BTC investment vehicle, Grayscale Bitcoin Trust (GBTC), lost 28% of its value. This volatility further led to an increase in the Grayscale discount, reaching a historical low of over 41%. The discount is the difference between GBTC's stock price and the market price of the Bitcoin it holds. Since February 2021, this figure has been widening due to structural reasons and increased competition. Rumors about Alameda Research holding a large GBTC position likely added to the selling pressure.

Despite a slight loss this week, Coinbase, the only publicly traded cryptocurrency exchange, recovered most of its losses on Friday due to strong buying demand.

The Spread

The impact of the FTX incident is just beginning. Over the weekend, Blockfi announced that it had accepted FTX's rescue during the cryptocurrency credit crisis and would be forced to halt withdrawals. Hedge fund Galois Capital acknowledged that half of its funds were left on FTX. FTX's investors, including SoftBank and Sequoia, subsequently wrote down their investments to zero. It will take months to fully understand the extent of the collapse.

However, cryptocurrency has its peculiarities, and in the aftermath of the FTT collapse, a brand new exchange token has emerged. Last Friday, Bitmex launched their native BMEX token, which they dubbed "the token for true believers." The use case for this token is strikingly similar to that of FTT.

Since its launch, BMEX has surged over 100%.