FTX Collapsed: Harsh Lessons For Investors To Learn
The Explosive Collapse Of Cryptocurrency Exchange FTX
The explosive collapse of crypto exchange FTX has sent shock waves throughout the industry and cost up to a million investors an awful lot of money.
The cryptocurrency exchange FTX was one of the largest in the world until it collapsed in spectacular fashion over the course of a week.
On November 11, cryptocurrency exchange FTX filed for bankruptcy in Delaware along with a number of other companies founded and run by crypto entrepreneur Sam Bankman-Fried. The collapse of FTX, at one point valued at $32 billion, is the most high-profile and significant casualty of crypto’s wavering fortunes both on the market and in Washington.
Now, let’s discuss what is FTX
What Is FTX?
The success of Alameda Research allowed Bankman-Fried to build a crypto empire. One of the key components of this portfolio was the creation in 2017 of FTX, a cryptocurrency exchange. Crypto exchanges allow customers to buy and sell digital assets using both digital assets and traditional money. FTX, along with its competitor Binance, dominated this space, processing the majority of all crypto trades made anywhere. FTX is incorporated in Antigua and Barbuda and headquartered in the Bahamas. Binance has no formal headquarters, and not being based in the United States allowed the two firms to engage in and permit trading that is not legal in the United States (but both have U.S.-based arms that comply with U.S. regulations). Binance itself was instrumental in the establishment of FTX as an initial investor.
In addition to its trading platform, FTX launched a “native” cryptocurrency, FTT, used among other things to pay for operating on the FTX platform. In 2021, Binance Chief Executive Changpeng Zhao sold the stake in FTX he received as an early investor and was paid partially in FTT tokens.
What Happened
On November 2, influential crypto news publication Coindesk reported on a leaked document that appeared to show that Alameda Research had an unusually large number of FTT tokens on its balance sheet, despite the financial separation that is supposed to be in place between the two companies as distinct legal entities. Not only did this have segregation of asset implications, but FTT is not viewed as liquid enough to make it suitable to support Alameda’s balance sheet.
On November 6, Zhao announced on Twitter that he had decided to liquidate its FTT holdings, in response to the Coindesk “revelations.” Zhao noted that the sale would take place over time in a way that sought to minimize market impact. Despite these assurances, the move spooked the market and the price of FTT plummeted. Traders quickly tried to liquidate their own FTT exposures, and the resulting “run” on FTX led to an estimated $6 billion capital shortfall over only three days.
On November 8, Binance agreed to bail out FTX, buying its only significant competitor. Zhao noted that the sale would allow FTX to honour its commitments and pay out its withdrawals.
On November 9, Binance announced that it would no longer purchase FTX, coming to this decision “as a result of corporate due diligence” (this tweet is no longer available). Binance pointed to FTX’s regulatory investigations and reports of mishandled funds.
On November 10, FTX announced that it had reached a deal with blockchain platform Tron that would allow it to use digital wallets other than FTX to swap some tokens.
On November 11, FTX, Alameda Research, and a number of other Bankman-Fried vehicles pled for bankruptcy in Delaware and Bankman-Fried stood down as CEO, with prices and market value having fallen between 80–90 percent.
On November 11, shortly after the bankruptcy filings, more than $600 million in digital assets were reportedly stolen from FTX in a hack.
What Happens Next
The collapse of FTX was swift and brutal. Both Bankman-Fried and FTX were viewed as relatively safe hands, the reputable face of an industry that has struggled to dodge criticism as being an unregulated hotbed of crime and speculation. In addition to the reputational loss, the fall of FTX has had significant economic knock-on effects on crypto markets. The total market capitalization of digital assets has decreased by roughly 20 percent with all major digital currencies seeing significant losses. It is, however, worth noting that the spectacular fall of its only real competition will likely have positive outcomes for Binance, provided it can avoid a similar end.
State, federal, and international financial regulators have announced their scrutiny of FTX, FTT, and Alameda Research, and specifically whether FTX funds — and by extension client funds — were used to illegally prop up Alameda Research. In the absence of congressional legislation, federal agencies will use the fallout to propose more authorities and closer supervision, most obviously Securities and Exchange Commission (SEC) Chairman Gary Gensler. The collapse of FTX puts the SEC in the very interesting position of potentially being simultaneously correct in calling for tighter crypto regulation and also as having failed in its regulatory and supervisory oversight in allowing (or at least not preventing) the collapse to happen.
D.C. lawmakers and lobbyists will be reeling from the fall of one of the loudest and most powerful voices for crypto. Those in Congress who have sought to introduce legislation that is broadly enabling the crypto industry will now have those designs frustrated by those who see FTX’s investors as victims. In a rare show of bipartisan agreement, the House Financial Services Committee has announced a December hearing to investigate FTX which Bankman-Fried is expected to attend. The House Financial Services Committee Chair Maxine Waters noted “The fall of FTX has posed tremendous harm to over one million users, many of whom were everyday people who invested their hard-earned savings into the FTX cryptocurrency exchange…” and her Republican committee counterpart, Ranking Member Patrick McHenry, likewise issued a statement saying, “It’s essential that we hold bad actors accountable so responsible players can harness technology to build a more inclusive financial system.” Senate Banking Committee Chair Sherrod Brown also announced the intent to hold a similar hearing.
What remains to be seen, however, is the impact that the collapse of FTX will have on cryptocurrency legislation being drafted in Congress, including both the Waters-McHenry bill and another bill in the works from Senate Agriculture Committee Chair Debbie Stabenow and Ranking Member John Boozman. The Waters-McHenry bill is viewed as overdue due to difficulties reaching agreements in the drafting process. The collapse of FTX will provide lawmakers with the impetus to get these legislative texts finalized but will do nothing to make this an easier task.
In the long term, the collapse of FTX will likely empower the traditional banking sector and other highly regulated entities in their own offerings (this is somewhat ironic given that at one point Bankman-Fried had boasted that FTX would have a balance sheet large enough to buy Goldman Sachs).
Bankman-Fried has lost an estimated 96 percent of his $26 billion personal wealth, in what can be described as one of the fastest and most significant losses of fortune of all time. In addition, Bankman-Fried will certainly be under investigation bot by both the federal financial regulators and courts in New York and the Bahamas. Bankman-Fried is viewed to have not helped matters with a series of confusing and misleading tweets over this period, despite stepping down as CEO of FTX.
Some critics have likened the collapse of FTX to other chaotic bankruptcies. While the significance of the bankruptcy is suggestive of Lehman Brothers, former Treasury Secretary Larry Summers told Bloomberg that the situation reminded him of the Enron scandal, saying: “The smartest guys in the room. Not just financial error but, certainly from the reports, whiffs of fraud. Stadium namings very early in a company’s history. Vast explosion of wealth that nobody quite understands where it comes from.”
Lessons From The FTX Collapse For Investors To Learn
After a difficult year for digital assets, many investors were blindsided by the recent collapse of cryptocurrency exchange FTX, as customers wait for answers about an estimated $1 billion to $2 billion of missing funds.
While the future of the company — and investigations into the vanishing assets — are in limbo as FTX enters bankruptcy protection, experts say there are key lessons for crypto investors.
“The FTX collapse provides harsh reminders that ‘there is no such thing as a free lunch when trying to make a quick buck in a still fairly new, unregulated financial industry,” said certified financial planner Jon Ulin, CEO of Ulin & Co. Wealth Management in Boca Raton, Florida.
1. Know The Risks Of Where You’re Holding Cryptocurrency
Kevin Lum, a CFP and founder of Foundry Financial in Los Angeles, works with younger investors and said about 50% of his clients hold crypto in some form.
While he doesn’t necessarily think clients need to reduce their exposure, he said they need to understand where digital currency is held and the possible risks of keeping assets there.
“I think the collapse of FTX will end up being good for traditional finance companies like Fidelity who are entering the crypto space because they come with a certain level of trust,” Lum said.
Earlier this month, Fidelity Investments announced plans to launch a commission-free crypto product, allowing investors to buy and sell bitcoin and ether.
The FTX collapse has also renewed interest in cold storage or taking digital currency offline, making it less susceptible to hacks. However, the move makes assets less liquid and harder to trade quickly.
2. Diversification Is Always Important
Whether you’re investing in stocks, cryptocurrency or other assets, experts say a large percentage of a single holding can be risky.
“Diversification is always important,” said George Gagliardi, a CFP and founder of Coromandel Wealth Management in Lexington, Massachusetts.
“For individuals who had a very high allocation to cryptocurrencies, whether in FTX or not, the crypto price crashes this year were a painful lesson in diversifying one’s investment classes,” he said.
Since topping an all-time high of $68,000 in November 2021, the price of bitcoin has plummeted by more than three-quarters, dropping below $17,000 as of Nov. 17.
“The [FTX] collapse should be a lesson that any individual company — be it a crypto exchange or more traditional business — can go bankrupt in times of distress,” said Kevin Brady, a CFP and vice president of Wealthspire Advisors in New York.
When weighing portfolio allocations, he said, 5% of a single asset “starts to be material” and 10% is “very concentrated.” Of course, there may be mitigating circumstances for some investors.
“Even if a financial asset is speculative in nature, it can still play a role in a well-diversified portfolio, albeit in small amounts,” said Ulin of Ulin & Co.
3. Expect More Crypto Regulation
There’s been an ongoing debate about how cryptocurrency should be classified and regulated and it has intensified amid the FTX fallout.
Sens. Cynthia Lummis, R-Wyo., and Kirsten Gillibrand, D-N.Y., in June introduced a bill to create a regulatory structure for digital currency, defining the majority of assets as commodities, such as gold or oil, which are overseen by the Commodity Futures Trading Commission.
Experts say the FTX meltdown may accelerate these discussions — and speed up the timeline for future guidelines. “I think we’re going to see regulations,” said Ivory Johnson, a CFP and founder of Delancey Wealth Management in Washington. “And I think these bad business models will go away.”
House Financial Services Committee Chairwoman Maxine Waters, D-Calif., and the ranking Republican, Rep. Patrick McHenry, of North Carolina, on Wednesday, announced plans for a bipartisan hearing in December to investigate FTX’s collapse.
While Congress will ultimately decide how government agencies may regulate cryptocurrency, Securities and Exchange Commission Chair Gary Gensler has been pushing for tighter rules. “Investors need better protection in this space,” he told CNBC’s “Squawk Box” on Nov. 10.
4. Back Up Your Crypto Transaction Records
Regardless of where you’re holding digital currency, experts suggest downloading your transaction history periodically.
Gathering reporting documents is one of the most difficult parts of crypto taxes, said Andrew Gordon, tax attorney, CPA and president of Gordon Law Group. And if an exchange closes down, you’ll still need records to file your return, he said.
“Two weeks ago, very few people suspected FTX would be facing this,” Gordon said.
Plus, you’ll have a better feel for your profits and losses by tracking throughout the year, he said, making it easier to trim your bill with strategies such as tax-loss harvesting. “It will put you in a much better position when tax time comes,” he said.
A Harsh Lesson In Hype Advertising
There is a laundry list of issues surrounding the dramatic rise and fall of FTX. Still, one is how most of the advertising for the brand — and the bulk of crypto-related brands — has, for at least the past year, used celebrity and hype to frame crypto investment as a historically good move. As Matt Damon (now infamously) said while comparing crypto to the invention of human flight and space travel, “Fortune favours the brave.”
The advertising industry is one that has worked relatively hard at — and talked a lot about — leaning into brand purpose work and brand transparency, while also taking on pro bono PSA and advocacy work for any number of social causes. While obviously blatant awards bait, this type of creative output has also reframed advertising’s traditional reputation (as both a media and a profession) as more style than substance. The hyperbolic hubris of the industry’s crypto work, as epitomized by its FTX work, undermines all that noble effort.
The debate around using major celebrities to market cryptocurrency companies has been happening for more than a year, at least since June 13, 2021, when Kim Kardashian posted an Instagram Story touting EthereumMax. According to a Morning Consult study, that ad was seen by 21% of Americans, and the U.K.’s Financial Conduct Authority called it, “the financial promotion with the single biggest audience reach in history.” In October, Kardashian was fined $1.26 million by the SEC for not disclosing to that audience that she was paid for the endorsement.
FTX had collected a very impressive stable of big sports names, including Tom Brady, Steph Curry, the Miami Heat, Mercedes Formula One, Washington Wizards (NBA) and Capitals (NHL), Golden State Warriors, and the University of Kentucky men’s basketball team.
Last year, R.A. Farrokhnia, Columbia Business School professor and executive director of Columbia Fintech Initiative said about the complexities of using advertising methods typically familiar in consumer packaged goods or entertainment for something as new and confusing as crypto. “This poses reputational risks for both ad agencies and celebrities that are a part of these campaigns”.
Sources familiar with the making of FTX’s Super Bowl ad, though, say that the brand’s biggest goal was to be entertaining and that there were few conversations around acknowledging the risk in crypto investment. They wanted to say, “Don’t miss out,” without saying “don’t miss out on getting rich.” Mission not accomplished, seeing as the brand also ran a big Bitcoin giveaway during the game.
Elizabeth Paul is the chief strategy officer at The Martin Agency, which worked with Coinbase for almost a year but ultimately resigned from the business by end of 2021. (Though, the agency did have some influence on the brand’s own viral Super Bowl ad.) She says that the bulk of their strategy work with Coinbase was aiming to position the brand as the adult in the room, with support of regulation and responsible use. “For the long-term maturation of the crypto market, it would have been better for the world to look at those investments more like a 401k than sports betting,” says Paul.
Paul says that agencies always have a responsibility to use their influence on clients for good, and that choice isn’t limited to crypto, but a decision to make every day for every category they’re in. Paul points to a 2021 study that reported consumers to have more faith in brands to impact positive social change than government or religious institutions. “As the builders of those brands, (agencies) always have the opportunity to flex our skills of storytelling and persuasion for good — to bend platforms and resources in ways that are (good) for businesses as well as the communities they serve,” says Paul. “Or you can abdicate that responsibility, choose not to question the brief and participate, in which case you have contributed for good or ill.”
Advertisers and marketers need to be aiming for the former over the latter or else risk the dilution of effectiveness and trust in all their work. The crypto winter has fundamentally altered how it will be marketed, at least in the short term. No one is waiting for a call from Tom Brady.
Paul suggests that ultimately, crypto brands will have to advertise more like the institutions they’re looking to replace. “To give people a better sense of security, they’ll probably have to act like unsexy banks,” she says.
Wrap Up
In this article, we have known about the collapse of the cryptocurrency exchange FTX, and we have also discussed the harsh lessons learnt from this collapse.
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