The term quantitative trading strikes fear into the heart of many a trader. These quantitative trading firms are the boogeymen of financial markets. Engaging in the so called “dark arts” of trading. They are sarcastically known as the people who run your stops and liquidate your positions. Being solely responsible for any financial loss you incur. This poor reputation is partially due to the air of mystique surrounding quantitative trading. Nobody knows who they are, what they do, or how they make money. So, Alameda Research, who are they? And what do they do?
Alameda was one firm of said esoteric nature. Occupying 2 spots on BitMEX’s infamous profit leaderboard. Netting 7000BTC in profit. Yet, no one knew who these mysterious figures were. That was up until recently when Alameda started going public. Giving insight not only into how a quantitative trading firm operates, but also the new found institutional presence in the cryptocurrency industry.
The Birth of Alameda Research
Alameda was first founded during the famous bull run of 2017 by Sam Bankman-Fried and Gary Wang. They currently manage over 100 million dollars in assets. Trading between 600 million and 1.2 billion dollars everyday across a variety of crypto assets such as spot Bitcoin, altcoins and crypto derivatives. Alameda makes the majority of its money from quantitative trading. However they have diversified into other areas such as creating their own over the counter trading desk and recently launching their own exchange FTX.
The CEO Sam Bankman-Fried goes into detail on how he got started in the cryptocurrency industry in an insightful interview with Venture Coinist.
The first thing that struck me was just how inefficient it (referring to the cryptocurrency industry) wasInterview with Venture Coinist
To understand what he means by this this we must first understand a key component of quantitative trading. Market inefficiencies. Market inefficiencies can be very loosely defined as a situation where the current prices do not reflect all the publicly available demand and supply information, due to negligence or breakdown of buyer-seller communications. This is best shown in terms of crypto by means of an example. In the run up to the Bitcoin bullrun top of 20000$ there were incredibly large price discrepencies between exchanges. One exchange may have quoted 19000$ per BTC while on another exchange 16000$ per BTC was quoted. If one were to short Bitcoin on the exchange quoting the price of 19000$ and buy Bitcoin on the exchange quoting 16000$ one could make a profit of 3000$ (19000$ – 16000$ = 3000$) risk free. This is one among many examples of a market inefficiency commonly known as arbitraging.
Alameda exploits inefficiencies similar to this on a daily basis (Though not as extreme). Alameda recently uploaded a video to their YouTube channel from a live trading session in which they talked through how they traded a large seller on Binance who created a 2% price discrepancy across exchanges. Creating a perfect arbitrage opportunity.
Alameda also engages in the nitty gritty and what quantitative trading is most known for. Its large programming and mathematical basis for trading. Alameda like most other firms is quite secretive in regards to their quantitative models. Divulging very little details on how they are formulated. On their website they simply state they employ “medium term quantitative strategies” such as “mean reversion” and “machine learning”. However, who can blame them? quantitative models can make millions of dollars. But once they leave the four walls of the firms trading floor the models become null and void, and practically worthless. Secrecy is an essential element of these models.
The Challenges Presented by Cryptocurrency Infrastructure
In Sam’s interview with Venture Coinist he also goes in depth on how cryptocurrency infrastructure as a whole presents challenges to quantitative firms due to its decentralized nature.
One of the key pieces there that makes these sort of opportunities exist but hard to take advantage of is in Finance its not that you can move Apple stock from one exchange to another instantly. It’s that you don’t have to because you just have centralized clearing firms.Interview with Venture Coinist
Later in the interview he also discusses how the variance in exchanges and lack of co-ordination and standardization between them opens up quite a few problems for Alameda. For example one exchange may have a completely different way of interacting with trading programs (Through API’s) than another while some may be limited in what they can do at all. Not only does he criticize exchanges and their API set-up but also their infrastructure as a whole. Making reference to the infamous order submission errors which are common on BitMEX, preventing trades going through, poor quality exchange matching engines, as well as the way bankruptcy’s are handled while on margin.
The Creation of the FTX Exchange
These issues are what motivated the team at Alameda to create their own exchange called FTX. Which they feel is done the right way.
FTX is a cryptocurrency derivatives exchange built by traders, for traders. We strive to build a platform powerful enough for professional trading firms and intuitive enough for first-time users.FTX.com
FTX brings a whole host of new products to the cryptocurrency such as leveraged tokens, perpetuals swap contracts on a range of coins which aren’t found anywhere else such as $LEO and $BNB, and newly added tradeable index’s such as their altcoin index which allow traders to short or long the altcoin market as a whole. Not only does it improve in providing traders with more products and opportunities but also improves the trading process as a whole. No order submission errors and margin clawbacks are revamped and because Alameda are market making there has been liquidity since day one.
In conclusion I feel that as a whole Alameda Research is a net benefit for the cryptocurrency industry. Their liquidity providing and OTC trading are crucial for successful and efficient markets even if they are acting purely out of self interest. Although many retail traders may feel justifiably put off and even fearful by the ever increasing institutional presence in crypto, and in a memetic and humourous way may even feel that alameda is “hunting their stops”. However, Alameda are representing a key and necessary step forward for the industry.