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Comment by chisquared | Hacker News Reader

Almost everything here is an unmitigated disaster. However,

> the secret exemption of Alameda from certain aspects of FTX.com’s auto-liquidation protocol

— barring the part where this is secret — this seems like it would make some sense?

Alameda was, by my understanding, meant to be a market maker for the markets that FTX allowed its customers to trade in. You probably don’t want to apply the same auto-liquidation protocol to the market maker as you would regular traders.

Of course, I’m not a finance person, so I’d be happy to be enlightened here.

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If market makers are getting liquidated with any consistency frequent enough to require exceptions, they are in deep trouble.

Market makers almost universally remain delta-neutral (that is, their goal is to be hedged against almost any market movement). Sure they sometimes get off balance and lose some money, but the margins for makers are typically so thin that liquidation is basically equivalent to total failure.

Hypothetically, if a market maker had the ability to create lots of little accounts, trade as those accounts, let some go negative, and continue to do this, some very positive expected value strategies should be available based on allowing some accounts to go negative, keeping the average profit only slightly negative over time, and walking away from the negative balances.

Making money on average requires actual competence. Creating a large profit variance with a small expected loss is much more straightforward and is normally a losing proposition.

This plan ends up being a more complicated version of just stealing customer funds though. And they just stole customer funds.

Exactly, this only works if the clearing venue is a third party. In this case, Alameda === FTX

My fund was also a market maker at FTX. We signed two contracts that modified the typical agreement with the venue. One of them stipulated that we had less access to leverage than normal (i.e. we could be liquidated earlier than we otherwise would be, but these terms were vague and apparently never had any effect) and enabled parallel risk checks on our account. The other was a line of credit from the venue which would allow us not to be liquidated when we otherwise would be in exchange for interest when the LOC was preventing liquidation. Our actual use of the LOC was entirely as collateral for open orders, so we never paid any interest on it.

It is not normal to allow market makers to take on arbitrarily large risk or arbitrarily large negative balances.

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