Thoughts On FTX Collapse
I promised an article on EMP Money to follow up on my previous article. However, things have taken a sharp turn after the shock of the FTX-Alameda collapse, and I thought I would give my thoughts on the situation. This article could get old very quickly, so I have tried to minimise “up-to-date” facts. We have also seen BlockFi pause withdrawals, and there are concerns about contagion, we are really seeing a crypto industry wide bank run. If you haven’t already done it, get your crypto off the exchanges.
Run On The Bank
Due to the bear market, people have discovered the risks being run by centralised exchanges. The simple fact is that exchanges are not profitable if they simply put your money in allocated cold storage unless they charge higher transaction fees. Like the banks, they generally need to use deposited funds to make money. This is fine when things are going well, but when you have a toxic combination of a crypto bear market, high inflation, and a global economic slowdown you have all the ingredients for a run on these crypto exchanges.
The whole market is feeling it as we experience the Lehman Brothers moment. For those of you old enough to remember the 2008 global financial crisis, Celsius appears to be the Bear Stearns and FTX the Lehman Brothers moment. I remember the dread and despair, the whole world was going to fall apart. People really believed that the global banking system would collapse. Thankfully it didn’t. I can’t predict the future, but at some point the pain will end. I just don’t know if I will still be walking at the end of it.
Identifying The Problem
While I could write a lengthy report, I will boil it down to 2 things. Centralisation and Risk Management. These systemic issues are not due to a DeFi protocol blowing up. There may be rug pulls and scams in DeFi, but a common factor in the recent carnage we have experienced is centralisation. A large, centralised party built up an out-sized position by funneling money from a large number of people. This gave them heavy influence on the market. Eventually, they collapsed, and we have contagion. When you need money, even your Bitcoin has to go.
The second issue is Risk Management. I took a quick look at Alameda’s website and noticed on their careers page that there wasn’t any mention of Risk Management in their staff. They may have had them, but the fact there was no mention of them should give pause for thought. Any serious organisation will pride itself on their risk management staff.
Risk Managers provide independent scrutiny of the risks, something an optimistic CEO may not always do very well. I personally did not follow Sam Bankman Fried or Caroline Ellison (from Alameda) but coming across some old footage should have (with perfect hindsight) created red flags.
Of key importance is managing liquidity and collateral. I am personally experienced in this area on the Risk Management side and have an acute understanding of how important liquidity management is. As market conditions change, you will suddenly find yourself needing more and more collateral while finding yourself with less of it. People will want to withdraw funds, and you will not want to pay them. Liquidity management for the good times no longer works, so you need to be able to track it closely and be ready to adapt to the market conditions. This is something FTX and Alameda weren’t ready for.
Not Your Keys Not Your Crypto
An important takeaway is that when you hold crypto on the exchange, it is not technically in your possession. In prior years, leaving your funds on exchanges exposed yourself to hacks, but now it is bank runs. It is vital to keep most of (if not all) your crypto in your wallet. I also suggest a hardware wallet like Ledger or Trezor to mitigate against scammers and hackers.
Final Thoughts
The collapse of FTX is a blow for all of crypto. I am not celebrating this at all. My portfolio has been savaged when things looked to be turning around. I also lost my job just last week, so could really have used a higher level of passive income, which has been obliterated by this sell off.
I never like to celebrate any form of loss because I know it can easily happen to me. I got very fortunate with Celsius as I did a routine withdrawal the day before they paused withdrawals. I also imagine this incident will keep many out of the crypto markets and wrongly blame Bitcoin or the underlying technology.
For me, this reinforces my convictions about DeFi being the future. Crypto is meant to empower people to take responsibility for their own money. DeFi has its own risks, for sure, but you are accountable for the decisions you make. DeFi definitely needs to improve, but centralisation is not the answer. Make no mistake, it will be a tough period for DeFi, and there is a lot of blood on the streets. Even I am wounded right now.
