Making Sense of the FTX Situation

Louis Sykes
November 8, 2022

From the Desk of Louis Sykes @haumicharts

It's nearly impossible to switch off when you're invested in crypto.

I'm a little jealous of those solely involved with legacy markets; it must be nice to have an off-switch. In this part of the financial world, there's always something happening.

And my passion for the space often makes it difficult for me to let go.

But, last weekend, my hand -- indeed, my whole body -- was forced. A night in the ER and a few days bedridden with a gnarly viral infection overwhelmed my ardor for fake internet coins.

Happy to report I'm recovering. And here's me after I stumbled to my computer to catch up on the action:

It certainly helped get me in touch with all the confused people out there who aren't involved in this ecosystem. Much of crypto's comings and goings can often seem unworldly and completely foreign.

"This must be how normies feel..." I said to myself.

And now we can turn to the substance of this exchange war between Binance and FTX. It's so entertaining that it'd be an absolute crime not to discuss what's happening.

Let's start at the very beginning...

Some will say this dramatic turn of events kicked off when CoinDesk's released Alameda Research's balance sheet just recently. Others note the roots of the clash were planted all the way back in 2019.

In short, CoinDesk published a segment of Alameda's balance sheet on Thursday.

This report revealed that much of the assets of Alameda Research -- a prop trading firm founded by FTX founder Sam Bankman-Fried -- were tied up in illiquid altcoins, with a considerable portion in FTT, the native token of the FTX exchange.

In fact, Alameda Research had been holding $5.8B worth of FTT, which at the time was greater than the market cap of $3.4B. Moreover, it had been holding millions in completely illiquid Solana-based altcoins, like SRM, MAPS, OXY, and FIDA.

After that information was made public, speculation began to brew that if these coins continued to fall, Alameda could face a similar situation to Three Arrows Capital, or 3AC -- another crypto trading firm that blew up months prior.

At the height of this speculation, Binance founder Changpeng Zhao dropped the bomb that he's moving to sell his entire remaining stake in FTT:

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Throughout the day, he continued to spread FUD (fear, uncertainty, and doubt), quoting an alert that over $580M of FTT had been deposited to Binance, ready to be sold on the open market.

At this point, Caroline Ellison, the CEO of Alameda Research, stepped in to defend the released balance sheet. She even offered CZ to take the order OTC at $22.

That created even more speculation whether she was stating this as the price she needed to guard for a margin call or merely trying to limit the market impact.

Seeing this tweet, CZ immediately starts TWAP-selling the hell out of Binance's FTT reserves to break this $22 support level, while Alameda took the other side and bought the coins CZ was dumping on the market.

I'm not much of an order flow guy, but it was literally impossible to miss this.

On the left, we're looking at FTX:FTTUSD, while on the right we're looking at BINANCE:FTTUSDT.

The bottom pane is the cumulative volume delta (CVD) of each product, which is simply the cumulative sum of market buy orders less market sell orders. The volume bars also reflect the dominant sell/buy volume delta.

CZ was dumping hard. And Alameda was his exit liquidity.

Alameda needed the cash from somewhere, and the logical source was to sell its Solana ecosystem coins.

Well-known Alameda projects like SOL, MAPS, SRM, and OXY all began bleeding lower in an attempt to keep FTT above this $22 support level.

The chart below is a visual representation of the order book on the spot FTX:FTTUSD product -- this is where Alameda was giving CZ exit liquidity.

You can literally see the moment when Alameda pulled liquidity. The moment it did, FTT crashed right through that $22 support it'd been defending all day.

And it dumped down to an intraday low of $15 over the space of three hours.

I think it's important to note that, as counterintuitive as it may seem, FTT is not a great barometer for the health of the FTX exchange.

Many like to draw comparisons between FTT and BNB. But the two have incredibly different utilities.

One is the native token for an entire ecosystem and blockchain (the BNB Smart Chain), while the other only grants holders slight discounts on fees on the exchange.

This is a mistake I've made in the past. The FTX token is good for sweet f*ck all, other than awarding holders with small discounts.

Its main purpose is for speculation on the part of degens and for collateral by Alameda -- who, given this recent turn of events, could also be considered degens, am I right?

The question we're left wondering is why did Alameda try so hard to defend this $22 support level?

We know by studying technical analysis that this $22 level is no coincidence. Given the minuscule trading volumes below this level, if FTT were to break down, downside momentum could really accelerate.

But why the need for Alameda to defend it? If it wasn't overleveraged like insiders were arguing, then surely averaging down would be more advantageous than taking it over the counter?

While this was all taking place, FTX withdrawals began getting delayed, and the fees begin skyrocketing -- 50x, 100x, and even up to 250x -- as people removed their holdings from FTX.

Nexo, for instance, withdrew over $110M from FTX over a 24-hour window.

So, from all this, it's rather apparent that this was a tense situation for FTX and Alameda.

The reality is that we don't have a lot of data to go on right now, and we're left with many questions.

We all know Alameda and FTX have an extremely close relationship, but the degree to which FTX is exposed to counterparty risk from Alameda is unknown. The run being experienced by FTX is likely a testament to this uncertainty.

If FTX is ever to recover from this damage, I think its reputation can only be repaired if they provide greater disclosure on its relationship with Alameda.

Under no other circumstances in traditional markets would a similar relationship like this be considered remotely appropriate. Alternatively, if FTX completely crumbles, which I think is unlikely, this entire space is going to be dead for a long time

At the end of the day, this stuff isn't really our wheelhouse as technical analysts, and if I'm being real, I feel like a "hearoooooor" while writing this letter...

But it's such an interesting development that it'd be a shame to ignore it.

And, from a more practical standpoint, it's valuable to incorporate this into your risk analysis, particularly if you hold funds with FTX.

Crypto exchanges have had a noxiously shaky past. We're doomed to repeat the mistakes of the past if we don't exercise caution in holding funds in hot wallets managed by exchanges.

Not to sound like too much of a Bitcoin maxi to round this conversation off, but it fills me with great comfort knowing I have Bitcoin funds locked away in self-custody, which is the purest way of hedging exchange counterparty risk.

In a wider sense, I think it'd be prudent to re-evaluate the risk/reward profile in holding funds in FTX hot wallets for the time being. By their very nature, exchanges should be significantly over-collateralized.

But if that's not the case and/or they have too much risk exposure to Alameda, then it's fair to say that FTX is in deep trouble.

Never a dull moment...

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Thanks for reading, and please let us know if you have any questions!

Allstarcharts Team

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