Ahead of the curve - Nov 15 2022Crooks, contagion, distortion, and March 12 flashbacks After publishing our last report, the gravity of FTX’s dire situation quickly became apparent. The collapse took us by surprise, and it’s been shocking to learn the extent of the damage caused by FTX’s unforgivable mishandling of customer funds. To read our view on the implications of FTX’s collapse, check out our post from last Wednesday. In short, the insolvency has short-term led to a distorted derivatives market and harmed liquidity. We believe this will cause prolonged headwinds related to contagion, regulation, and institutional presence. BTC, BNB, and ETH are all down 18% in the last seven days, mainly trading in a strongly correlated environment. Meanwhile, correlations with equities have fallen amid this devastating and unique crypto-related structural collapse. Macro will likely have a less central impact on BTC’s direction until the current storm settles. State of derivatives: Multiple similarities to the March 12 aftermath Crypto markets are very distressed, derivatives in particular. The uncertainty introduced by FTX’s insolvency has had direct implications on liquidity, generating an enormous demand to hedge. The aftermath of March 12, 2020, is the only period comparable to the current state of the BTC derivatives. Even institutional activity in CME has blossomed, but activity has been heavily concentrated towards the short side. CME’s November contract has traded at an extreme discount to spot in the last week. CME has traded at a more considerable discount to spot than what we saw in the days following the March 12, 2020, collapse in crypto markets. On November 3, ETFs accounted for 61% of the open interest on CME. Today, they account for 47%. This indicates that the surging open interest in CME is predominantly caused by organic, direct futures activity. Based on the extreme CME discounts and massive backwardation, it seems evident that the new vibrant activity on CME’s BTC futures is heavily oriented towards bearish positioning. The current unique risks associated with contagion following FTX’s massive balance sheet hole are the root of loads of uncertainty, likely to have long-term implications on the market, and it may take time for market conditions to normalize. FTX insolvency to impact liquidity The FTX collapse has hurt many and will likely impact liquidity massively onward. Per our knowledge, the market maker Genesis Trading has suffered the largest losses, amounting to $175m stuck on FTX, while market-making firm Wintermute saw losses of $55m. The blowout of one of the key market makers in the space, Alameda, and significant losses at other market makers impacts BTC’s liquidity, as demonstrated by Kaiko Research this week. Amidst the uncertainty, we see a trend of massive exchange withdrawals, as crypto owners are moving coins of exchanges following the FTX insolvency. If any other exchanges run similar schemes to that of FTX, this may expose their skeletons in the cupboard, as liabilities cannot be met.